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Harley-Davidson, Inc. (NYSE:HOG)

Q2 2009 Earnings Call

July 16, 2009 9:00 am ET

Executives

Amy Jefferies - Director, Investor Relations

Keith E. Wandell - President, Chief Executive Officer, Director

John Olin - Interim Chief Financial Officer; Vice President and Controller of Harley-Davidson Motor Company

Lawrence G. Hund - President and Chief Operating Officer of HDFS

Analysts

Tim Conder - Wells Fargo

Craig Kennison - Robert W. Baird

Robin Farley - UBS

Felicia Hendrix - Barclays Capital

James Hardiman - FTN Midwest

Ed Aaron - RBC Capital Markets

Patrick Archambault - Goldman Sachs

Rod Lache - Deutsche Bank

Operator

Good morning. My name is Patrick and I will be your conference operator today. At this time, I would like to welcome everyone to the Harley-Davidson second quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the call over to the Director of Investor Relations, Amy [Jefferies].

Amy Jefferies

Thanks, Patrick and good morning, everyone. Welcome to Harley-Davidson's second quarter 2009 earnings conference call. Today Harley-Davidson's President and CEO, Keith Wandell, will provide comments on our business. Harley-Davidson's Interim CFO and Controller, John Olin, will share the financial results for the second quarter and Larry Hund, President of Harley-Davidson Financial Services, will share details from that segment.

At the close of our prepared comments, we will open the call for your questions.

Before we begin, please note that this call is being webcast live on harleydavidson.com and will be available for replay throughout the next several weeks. It can also be accessed until July 23rd by calling 706-645-9291, or 800-642-1687 in the U.S. The PIN number is 15669305#.

Our comments today will include forward-looking statements that are subject to risks that could cause actual results to be materially different. Those risks include, among others, matters we have noted in our latest earnings release and filings with the SEC. Harley-Davidson disclaims any obligation to update the information in this call.

Now I’ll turn the call over to Keith.

Keith E. Wandell

Well, thank you, Amy and good morning, everyone and thank you for joining today’s call. It’s good to have this time with you today to talk about our second quarter results.

Before I get started, I wanted to use this opportunity to thank our employees and our dealers for the great professionalism that they continue to demonstrate and for staying highly focused during these tough times. Since May 1st, we have focused on two clear priorities. The first priority is to ensure a long-term strategy that will align all of our resources on relentlessly driving sustainable, profitable growth for all of our stakeholders and to align our suppliers, our dealers, our employees, and our leadership as one team with clarity of purpose and to continue to build the iconic Harley-Davidson brand with an intense customer focus.

The second priority is to make sure that we are doing the right things to guide us through the current economic downturn and that our team is properly aligned to execute on these actions.

While our current challenges are substantial, so are our unique strengths and if those strengths are properly put to work through the right long-term strategy, we have a strong conviction that we can indeed operate as a competitive, growing business as the economy strengthens. With that said, given the urgency of our current situation, we really wanted to focus today on our immediate challenges and the key actions we are taking to work through them.

By now you’ve all seen our second quarter results in this morning’s press release but let me quickly call out just a couple of key points. Overall, sales of Harley-Davidson motorcycles are retail in the U.S. declined significantly in the second quarter, with the back drop of unemployment at 25-year highs and consumer confidence at near-record lows and while our company did take actions earlier in the year to modify our cost structure, we are committed to making the additional tough decisions required to balance supply in line with our current demand and to emerge from this recession positioned to move ahead with strength.

The further declines at retail have led to an intensified imbalance in our supply and demand in the last few months and as most of you know, when it comes to protecting and enhancing the brand, managing supply in line with that demand is one of the most important things that we can do. So we are taking more aggressive action by reducing our 2009 shipment plan by 25% to 30%. As a result, we are taking the corresponding actions to bring our cost structure in line with the volume reductions and overall, we’re reducing the size of our hourly production work force by approximately 700 positions beyond the reductions that were announced earlier this year. And in addition to that, we believe there’s a tremendous opportunity for improved efficiencies and cost effectiveness at our touring and soft tail facility in York, Pennsylvania. We’ve undertaken a study along two parallel paths -- one path is to look at how we restructure those operations and the other path is to potentially relocate those operations to another U.S. location. We expect to make a decision on the best path forward later this year.

We also announced today that we are making further reductions in the size of the non-production, primarily salaried work force, about 200 positions on the motorcycle side and about 100 more at Harley-Davidson Financial Services.

Let me assure you we are not taking these actions lightly. We are taking these actions because we feel a strong sense of accountability to make the tough calls that are required to ensure the long-term viability and success of Harley-Davidson.

And with respect to Harley-Davidson Financial Services, even though these are challenging times, the ability of HDFS to provide retail financing is a key strategic advantage for us and our dealers.

So the progress that we have made in recent months with HDFS have been critical. As you know, we believe we’ve obtained the needed funding for HDFS into 2010 and we continue to work diligently on the future liquidity needs of that business.

There’s one final action I wanted to share with you. We recently realigned our senior management team into a simple unified structure with clear lines of accountability. It’s extremely important that we work through this challenging period by managing Harley-Davidson as one company working as one team that is pulling in one direction. Our new structure puts us in a much better position to operate with speed, clarity, decisiveness, and the accountability that we need.

Now with that, let me turn it over to John Olin, who will go through more details with you on the financials for the quarter. John.

John Olin

Thanks, Keith and good morning. We provided a great deal of information in the press release and accompanying financials this morning so on today’s call, we will use this time to provide additional information on the most critical areas and get right to your questions.

I’ll start by reviewing the three important areas that we have focused on as we manage through the recession.

One, investing in our brand; two, improving our cost structure; and three, obtaining funding for HDFS.

While spending has been reduced on a year-over-year basis, we continue to invest what we believe is our appropriate levels of resources in our brand, products, and businesses. As Keith noted, managing the supply of our motorcycles in line with demand is one of the most important things we can do to protect and enhance the brand and as evidenced by today’s shipment announcement, we are committed to maintaining our brand strength.

Also, on July 25th, the essence of our brand investments and strength will be brought to light as we introduce our new 2010 [latter year] motorcycles to the global market. We believe that our investments will fortify the power of the brand as well as position us for a strong recovery.

Our second area of focus is to improve our cost structure. We continue to make good progress toward our overall goal of lowering our fixed costs. The additional restructuring activity we announced today will further our efforts.

As a result of our shipment expectations and our continued focus on reducing costs, we will reduce approximately 1,000 positions. This is in addition to the workforce reductions totaling 1100 to 1200 hourly production positions and about 309 productions, primarily salaried positions, during 2009 and 10 that we announced earlier this year.

We expect the costs associated with today’s announced activities to be approximately $40 million, which increases our expected total restructuring costs to be between $160 million and $190 million over the next two years. Of that total, between $130 million and $150 million are expected to be incurred during 2009. Approximately 80% will be cash charges.

The expected savings associated with today’s announced activities will be approximately $70 million on an annual basis, which increases our expected ongoing restructuring savings to be between $140 million and $150 million. In 2009, we expect restructuring savings to be between $70 million and $85 million.

Of the $70 million of annual savings expected from today’s announcements, $60 million is expected to come from reduced SG&A spending at the motor company. HDMC will accelerate various productivity efforts, reprioritize spending, and reduce its work force by approximately 200 non-production positions. The remaining $10 million is expected to be realized by Harley-Davidson Financial Services, primarily as a result of the work force reduction of approximately 100 positions.

These costs and savings do not include any actions that may result from the York assessment currently underway.

Our third area of focus is to obtain funding to support the lending activities of HDFS. I am very pleased to report that we have made great progress on this very critical initiative. In April, we replaced a $500 million asset-backed conduit facility with a $1.2 billion asset-backed conduit facility which matures in April 2010, and renewed a $625 million of this $950 million, [inaudible] [Crest] facility which now expires in April 2010.

In May, HDFS entered into a $500 million self-eligible term securitization transaction. Additionally, earlier this week, we closed another self-eligible term securitization transaction for $700 million. In both cases, demand was strong and we saw spreads tighten between the May and July transactions. The weighted average interest rates in the May transaction was 2.8% while the July rate fell to 2.1%.

To date, we have exceeded our 2009 expected $1 billion funding requirement by approximately $1.2 billion. We will use the excess to support our anticipated 2010 funding needs, including mitigating the three financing risks of the bank credit facility and conduit facility which come due in 2010.

Now I’ll comment on the financial results for the motorcycles and related product segment for the second quarter of 2009, which compared to the second quarter of 2008 clearly reflects the ongoing difficulties in the global economic environment.

As you saw in the announcement this morning, worldwide dealer retail sales were down significantly from last year. A couple of points worth mentioning -- in the U.S., Harley-Davidson Motorcycle retail sales fell 35.1%, while the 651 plus [inaudible] motorcycle market segment decreased 48.1% during the second quarter. Harley-Davidson's share increased to 51.5%, an increase of 10.3 percentage points over last year’s second quarter. This compares favorably to the first quarter 2009 when Harley-Davidson market share was up 8.2 percentage points.

Consequently, Harley-Davidson's June year-to-date market share was 54.1%, up 10.2 percentage points versus the prior year. International retail sales continue to be affected by the global economic downturn.

Retail sales for the second quarter were down 18.2%, virtually unchanged from the first quarter of this year.

Wholesale shipments of Harley-Davidson motorcycles for the second quarter were 58,179. Of that total, touring represented 36.1% compared to 31.4% last year; custom, including our soft tail, Dinah, VRFC motorcycles were 38.2%, compared to 52.2%. And sportster motorcycles were 25.7% compared to 16.4%.

Shipment mix typically varies from quarter to quarter and reflects changes in production line rates, consumer demand, and other market conditions. In the second quarter of 2008, wholesale shipment mix was impacted by increased custom shipments to meet initial retail demand for the new Rocker and Crossbone models, as well as timing of model year changeover.

Driving the change in Sportster mix in the second quarter of 2009 versus the same period in 2008 was our expectation of a more robust demand for Sportsters to meet the needs of what we expected to be a more value-minded customer in this tough economy, which has not materialized in recent retail sales. To address this, we expect to adjust mix in the back half of 2009 to a more favorable mix of custom and touring products, which will help offset margin pressure for the remainder of 2009.

Revenue from Harley-Davidson motorcycles was $808.7 million, down 31.7% from the second quarter of 2008. This decrease was primarily a result of lower shipments during the quarter, the negative impact of foreign currency exchange rates, and an unfavorable shipment mix resulting in a decrease in average revenue per unit of $844.

Both gross and operating margins were adversely impacted by the shipment volume reduction and the resulting allocation of fixed costs over fewer units. Gross margin in the quarter was 33.5% of revenue, down from 35.7% in the second quarter of 2008. During the quarter, gross margin was negatively impacted by the allocation of fixed costs, over 23,147 fewer units, unfavorable product mix, and a negative impact from foreign currency exchange rates, partially offset by favorable raw material prices and productivity gains compared to last year’s second quarter.

Gross margin was down slightly from the first quarter of 2009, primarily due to volume reductions in the second quarter.

Operating margin for the second quarter of 2009 decreased to 14.5% from 20.1% during the second quarter of 2008, primarily impacted by lower gross margins and the impact of SG&A spending in relation to lower revenues. SG&A spending as a percent of revenue was up, despite the fact that SG&A expenses were down $30.7 million during the quarter versus the prior year.

We continue to expect full-year gross margins will be between 30.5% and 31.5%. We are pleased that we are able to maintain this guidance despite further shipment reductions. For the second half of 2009, the negative pressure on margins resulting from additional shipment reduction will be offset by a product mix that is more favorable than previously anticipated and increased productivity coming from operations.

Now, moving on to the financial services segment, by now you are all well aware that HDFS recorded an operating loss of $62.1 million during the second quarter, a decrease of $99.3 million compared to operating income of $37.1 million during the year-ago quarter. This decrease was primarily the result of HDFS recording the following adjustments during the second quarter.

First, the establishment of an initial credit loss allowance of $10.9 million for the receivable secured ties in the $500 million term asset backed transaction HDFS completed in May. This transaction was structured in a way that did not qualify for sales or off-balance sheet accounting treatment. As a result, it was recorded on balance sheet and the receivables were reclassified as held for investment and thus an allowance for credit loss is required for those receivables.

As a result of on-balance sheet accounting, securitization, the financial statements will reflect three primary differences from past transactions. First, no gain or loss is recorded on the transactions. HDFS will recognize that interest income on those secured receivables over the life of the loan, offset by the interest on the secured debt, contrary to previous transactions where HDFS recognized a gain or loss at the time of sale and recorded income associated with its retaining interest in service fee income.

Second, as I had mentioned, the financed receivables representing the underlying collateral remain on the company’s balance sheet and are classified as financed receivables held for investment, which requires the establishment of allowance for credit losses.

And third, resulting secured borrowings are recorded as debt on the company’s balance sheet, which is reduced monthly as available collections on related motorcycle loans are applied to the outstanding principle.

The next adjustment made during the quarter is the establishment of an initial credit loss allowance of $61.8 million for receivables that were reclassified from held for sale to held for investment. We decided to reclassify the receivables because it is now our expectation and intent that future transactions will be structured in a manner that requires on balance sheet accounting.

This treatment is consistent with recently issued FASB rules which require on-balance sheet accounting for most types of securitization transactions beginning in 2010.

It is important to point out that these two adjustments totaling $72.7 million were both one-time, non-cash items. The resulting accounting treatment changes the timing of the P&L recognition of the receivables but does not alter the economics of the portfolio.

At the end of the second quarter, approximately $5.12 billion of receivables were classified as held for investment. Of those receivables, $1.07 billion were wholesale and $4.05 billion were retail.

And finally, second quarter results were impacted by an increase in credit loss assumptions which resulted in a $15 million impairment to retain securitization interest compared to a $6.3 million write-down during the last year’s second quarter. This quarter’s write-down is due to higher actual and projected credit loss assumptions on several of these transactions, partially offset by slowing actual and projected pre-payment speeds.

Now, I would like to welcome Larry Hund back to the team. Larry joined as President of HDFS a few weeks ago and will now review HDFS’ operations and portfolio performance for the second quarter.

Lawrence G. Hund

Thanks, John and good morning, everyone. First, let me say that I am excited to be back with HDFS and look forward to working again with so many friends at Harley-Davidson and within our dealer network. I am already working closely with our leadership team and our staff, as we remain focused on our previously identified 2009 priorities, which are obtaining the required funding for our business, continuing to make appropriate under-writing enhancements, and improving our collections operations in this challenging economic environment, while continuing to support the Harley-Davidson dealer network.

During the second quarter, HDFS originated $700 million in retail motorcycle loans, compared to $1 billion in the second quarter of 2008. This 33% decrease is primarily attributable to lower retail sales of Harley-Davidson motorcycles in the U.S.

HDFS U.S. retail market share of new Harley-Davidson motorcycles sold is 48.7% in the second quarter of 2009, compared to 53.1% in the second quarter of 2008. This decrease in market share is consistent with what we experienced in the first quarter and demonstrates that there continues to be a competitive marketplace in retail financing for Harley-Davidson motorcycles.

During the first half of this year, we made significant adjustments to our underwriting criteria, including requiring increased down payments in certain credit tiers, implementing more conservative loan-to-value requirements, implementing revised customized credit scoring models, and modifying certain credit authorities and controls.

On the portfolio management side, we have made significant efforts to keep delinquencies and losses in check during this very challenging period, including increasing collection staffing, modifying collection strategies, and improving motorcycle repossession processes.

Despite significant efforts from our team, the impact of a recession and high unemployment resulted in a 30-day delinquency rate of 4.97% of managed retail motorcycle receivables as of June 28, 2009, compared to 4.65% at the end of the second quarter of 2008.

Annualized retail motorcycle credit losses for the first half of 2009 were 2.69% compared to 2.14% for the first half of 2008. The year-over-year increase in credit losses was driven by a higher frequency of loss and a higher average loss per motorcycle as we saw a decline in recovery values on repossessed motorcycles during the second quarter.

Due to ongoing economic challenges and rising unemployment in the U.S., we continue to expect higher levels of delinquent loans and retail credit losses as we go through the second half of the year. Therefore, we will continue to evaluate our underwriting criteria to balance the availability of credit with the appropriate risk and return dynamics on the portfolio.

Regarding our cost structure, as John mentioned, we will be making staff reductions and reducing other general and administrative costs to generate approximately $10 million in annualized cost savings. These reductions primarily reflect the significant reduction in new business origination levels compared to the prior year.

I want to reassure you that given the current environment, there will not be any significant change in our commitment to portfolio management efforts.

So to wrap up on HDFS, we have met our expected funding needs for 2009 and continue to work to obtain ongoing funding as evidenced by our very successful securitization earlier this month. We continue to take appropriate actions in modifying our underwriting criteria, managing our portfolio, and dealing with our cost base, given lower levels of business volume.

We expect 2009 to continue to be a tough year, as it is for many participants in the consumer finance space, but believe we are taking the appropriate steps to manage through it.

Finally, I would like to take a moment to complement the HDFS team, which is doing a great job focusing on our objectives in this difficult environment, and I am glad to be back working with them.

Now, I’ll turn it over to John for the remaining Harley-Davidson Inc. consolidated financial results.

John Olin

Thanks, Larry. Cash and cash equivalents as of June 28, 2009, totaled $1.03 billion compared to $803.4 million last year. Cash used by operations was $164.4 million for the first six months of 2009 compared to $39.0 million of cash used by operations during the first six months of 2008. Operating cash flow was adversely impacted by a decrease in net income during the period and no off balance sheet securitization proceeds.

During the first six months of 2009, depreciation was $126.9 million, capital expenditures were $57.3 million for the first six months, down 42.4% compared to the same period in 2008 as we continue to work on reducing overall costs.

For the full year of 2009, we now expect capital expenditures to be between $145 million and $175 million. Included in this total are between $20 million and $30 million of capital expenditures related to the implementation of our restructuring plan in 2009.

Without the restructuring capital, expected full-year capital expenditures will be down between $77 million and $107 million from 2008.

During the quarter, we recorded a one-time, non-cash impairment charge of $28.4 million to write off the remaining balance of good will associated with HDFS. This write-down was a result of a valuation analysis that took into account 2009 results and lower shipment guidance. As Keith stated, despite the current economic conditions and this associated write-off of good will, HDFS' ability to provide retail financing is a strategic benefit to the overall company.

So all in all, it was a tough quarter. We continue to take the necessary actions to manage through the economic downturn and stay focused on strengthening the Harley-Davidson brand, improving our cost structure, and obtaining the necessary funding for HDFS. We are confident we will emerge from this economic downturn even stronger.

Please note that we will be filing an updated press release correcting hourly workforce reduction numbers, as well as a six-month cash flow and capital expenditures. We have used the correct numbers on today’s call.

Now we would be pleased to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Tim Conder from Wells Fargo.

Tim Conder - Wells Fargo

Thank you and Keith, welcome aboard. We look forward to meeting you here in a couple of weeks and John and Larry, welcome back. I look forward to working with you again.

A couple of items, gentlemen -- I guess a little confused as to why the production was up near the higher end of your previously announced range for the second quarter, given the full retail sell-through that you saw as you progressed through the quarter. And then, especially given it’s the end of the model year, so I guess that’s one thing and then related to the company level inventories, up 27%. How much of that is carry-over model year ’09 versus pre-build for your launch here of model year ’10?

Keith E. Wandell

I’ll take that question. With regard to the production being up more or toward the high end of guidance for the quarter, you know, as we got out of the first quarter, we were right on track with our expectations and volumes started to fall. Given the supply chain and all the materials coming in, it was prudent to continue to build out the model year as we had to avoid obsolescence charges, so that’s why we continued on at pace.

With regard to the company inventories, they are up, given the timing of the cut-over of the model year ’10 vehicles, what we are doing is cutting over earlier this year to model year 2010 than we did a year ago, about 10 days on average. So we’re holding those vehicles until the show next week.

Tim Conder - Wells Fargo

Okay, so would the majority of the inventory that we are seeing on balance sheet, is the majority of that model year ’10 or is there a certain percentage of it that’s maybe model year ’09 still needs to be flowed through?

Keith E. Wandell

No, it’s all model year 10 and work in process inventories are actually own. What we’re seeing is all the build for model year 10 and the launch that we’ll start shipping those out at the dealer show next week.

Tim Conder - Wells Fargo

Okay, and then finally, I’m still a little bit confused with the credit loss allowance on the reclassification. I was under the understanding, impression that each quarter there was basically adjustments made to adjust for your prepays assumptions, adjust for the discount rates, adjust for used residual values and so forth -- can you kind of -- and again, I apologize for asking this, but kind of go through again the -- walk through the reason why the majority of that in your preamble but still a little confused as to why that occurred to that magnitude.

Keith E. Wandell

Jim, you’re referring to the $15 million impairment of retained securitization interest?

Tim Conder - Wells Fargo

Well, no, I understand that part is sort of the normal quarterly ongoing where you make those adjustments but the larger portion, is that fully related to the decision to keep things on balance sheet? I mean, was that the primary trigger?

Keith E. Wandell

Yeah, let’s talk about that. You’re talking about the $73 million one-time reclassification charge resulted to that.

Tim Conder - Wells Fargo

Yes.

Keith E. Wandell

I’m sorry, yes -- as you know, we typically and historically reported incoming receivables as held for sale and it’s been the company’s intention to sell those in securitizations, and on off-balance sheet transaction, and we’ve done that for years. As we started running into the economic and credit issues, as of last year, we were unable to access those markets. We still had an intention to sell those units or to sell those receivables into the marketplace and they started to build up and at the end of the first quarter, they were over $2 billion on our balance sheet.

And then we got into the May timeframe and the [inaudible] money came in and the securitization markets opened up and we did a transaction. At that time, Tim, the transaction that we did and the way it was structured required us to account for it on balance sheet, okay? So that was recorded on balance sheet, and then we started to work on our next health deal, which just closed two days. That structure was done in a similar way that was going to require on-balance sheet accounting treatment.

So at that time, the remainder that we had in helds for sale of a couple -- of about $2.7 billion, our intent changed. We do not believe that we are going to be able to sell those in off-balance sheet transactions, so we’ve changed our intent and we are now going to hold those for investment, and that’s consistent with the newly issued FASB rule that came out earlier in June, and we would have to do this anyhow, beginning in 2010. And with that change in intent, we will be moving held-for-sale to held-for-investment, and we have to establish an initial credit loss provision and that’s the $72.7 million.

Tim Conder - Wells Fargo

Okay, so again, the key one-time [inaudible] related, given the change in intent related to the accounting treatment?

Keith E. Wandell

Correct -- one-time, non-cash, the economics of the portfolio have not changed at all.

Tim Conder - Wells Fargo

Okay, great. Well, thank you, gentlemen. I look forward [to seeing you in a couple of weeks].

Operator

Your next question comes from the line of Craig Kennison from Robert W. Baird.

Craig Kennison - Robert W. Baird

Good morning, everyone. I look forward to working with you. Keith, are there goals you have that you can point to on the cost side, maybe it would be profit per bike or a certain level of SG&A expense that you can point to for investors that are focused on the long-term and I can get excited about?

Keith E. Wandell

Well you know, we obviously do have metrics that we hold ourselves accountable to and we are actually going through the process of understanding again where we’ve been and what we think we can accomplish, so without getting into any of the specifics, let me just say that my mindset is, and I think the mindset of all of us here at Harley is no matter how good we are doing or how well we’ve done, we can always do better, so it’s really all about continuous improvement and where we are really focused on trying to understand how can we drive the continuous improvement in our product development cycles, how we bring products to market, our marketing initiatives, as well as everything we do in our plan, so I’ve had the opportunity to go through all of our operations, meet with all of our employees and clearly we have great operations but there’s also room for improvement. And I think as we go forward, you’ll begin to see some of those initiatives and actions.

Craig Kennison - Robert W. Baird

Thank you. And then on HDFS, you obviously see the strategic value of that business, but would you consider any structural changes that might minimize your capital investment? For example, partnering with a third-party to underwrite and then you would collect the origination fees?

Keith E. Wandell

You know, I think that -- and that’s one of the learnings for me in the first couple of months here is, and I’m convinced having met with several of our dealers, both on the dealer town hall circuit, as well as our dealer advisory council and then through just a lot of different visits to dealerships that HDFS is clearly a strategic asset and advantage for our company and dealer, and I think that shows up in our market share gains, in spite of the fact that the market is down in total, as John had mentioned. You know, we’ve still gained market share and we believe it’s largely due to our ability to provide both wholesale [inaudible] as well as retail loans, and then the insurance and extended service plan opportunities in a one-stop fashion at our dealer.

So having said that, it’s also very clear that we have to find lower sources of funding, if you will, for that business, so I think in terms of how we are looking at HDFS, clearly a strategic asset but we are clearly looking at what other strategic options there may be to help us to get access to lower capital cost of capital.

Craig Kennison - Robert W. Baird

And then finally, you’ve obviously decided to cut production to protect the scarcity value of the brand. We like that decision but what are you looking at to know that you have the right level of inventory? What metrics would you point to internally?

Keith E. Wandell

Well, let it suffice to say that we spent a tremendous amount of time, effort, and energy trying to make sure based on all the information that we have, market share data, trends, you know, certainly looking at unemployment trends, consumer confidence trends, those kinds of things, that the actions that we were taking are prudent, given everything we know today, to realign our inventories with demand.

Craig Kennison - Robert W. Baird

Okay, thank you.

Operator

Your next question comes from the line of Robin Farley from UBS.

Robin Farley - UBS

I wanted to ask you about kind of looking out to next year, and I appreciate the fact that there’s a lot of uncertainty and you are making a lot of decisions over the next few months but your margins, I guess when you think about your margin guidance for this year and whether that’s sustainable in 2010, you had very high margins in Q1 this year that obviously with the production cuts, you might not see next year. And then also you’ll have the benefit of not completing sportsters, your lowest margin bikes for a full quarter this year, that’s assuming it will go back to a more normalized production next year, that maybe margins in 2010 will be down even with some of the cost savings you are implementing? And so if we think about production, your guidance for this year maybe having earnings in the $0.70 to $0.80 range, and then it’s -- you know, [if what the consumer is going to do if we] just think of productions being flat, is it possible that we could see kind of an additional earnings decline next year if there’s something in your margins? Maybe you could help us think about that [inaudible], that is not as apparent.

John Olin

Robin, we’re not going to give forward-looking margin information but what I can say is that all the actions that we are taking today, and eliminating excess capacity, reducing administrative costs and exiting non-core business operations, which are the core strategies of our, fixing our cost structure, will improve our margin structure going forward and we are very focused on that. And in addition, not only to those restructuring activities, as we are seeing in the second quarter, our employees are all getting [after] the continuous improvement, going forward productivity projects, and we are dropping a lot of productivity as we go along, so we expect that to continue as well.

Robin Farley - UBS

Okay, and then the other question I had is just regarding liquidity with HDFS, and with the change in accounting treatment, I guess I’m curious partly why you decided to -- not to use the gain-on-sale accounting when [inaudible] didn’t require it yet and the ruling I think wasn’t even until after the May transaction and I don’t know if you can quantify what the -- maybe the loss on sale would have been, or gain or loss on sale would have been if you didn’t change the accounting.

But I guess the bigger question is when we look at your balance sheet now, it used to be easier to look at your receivables held for sale and get a sense of what kind of liquidities you could get from securitizing that, so I wonder if you could just help us think of what is available, what receivables are available that -- retail receivables, not wholesale, retail receivables that have not been securitized and that would not be able to back up the [inaudible] draw-down, so that [inaudible]. In other words, what’s available to securitize additional liquidity above that [$1 billion to $2 billion] conduit?

John Olin

Right now, we’ve got $5.12 billion of receivables as held for investment, Robin. Of that, $4 billion are retail and at this time, we’re not going to break out the pieces that are available for securitization or conduits or medium term note or anything else. We are looking to follow a diversified funding path and at this point, they are all on our balance sheet and we are looking more at how do we lower the cost of funds against that portfolio.

Robin Farley - UBS

But once you’ve securitized them, how do they get available for additional liquidity?

John Olin

Well, we continue to use the term -- we expect to continue to use the terms asset-backed securitization markets. We will continue to do securitizations as long as that market remains effective from a cost of funding and available to us, so that will just be one of the sources of funding that we use to fund the overall portfolio.

The securitizations will act very similarly to the way they’ve always done in the past. The only thing is is that we will have the receivables on our balance sheet as well as the debt from the securitization.

Robin Farley - UBS

So just in terms of helping us think about what you have available to securitize, is there a ballpark you could give us of whether that $4 billion retail hasn’t -- isn’t already being used to over collateralize the May and July [inaudible] and being used for the wrong criteria?

John Olin

What we can say is that we’ve got enough retail loans to continue to securitize more at this point.

Robin Farley - UBS

Okay. Thank you.

Operator

Your next question comes from the line of Felicia Hendrix from Barclays Capital.

Felicia Hendrix - Barclays Capital

Good morning. I have a few questions. One, back to your operations, a lot of talk and probably prior to your time but a lot of talk and focus on the retail environment or the retailer environment, rather, domestically and having demands better aligned with supply hasn’t in the past had a lot of talk about your focus internationally, other than continuing to try to gain market share there. But clearly inventories are building internationally, the market is weak there as well, and I’m wondering what some of your thoughts are in terms of addressing the international channels going forward.

Keith E. Wandell

Well, I think first of all, that as we look at the international markets, it’s clear that the Harley brand has significant meaning in those markets, just like it does in North America. And clearly some of the markets, some of the international markets are different in so far as the products that are being asked for or demanded by the customers. And so it certainly varies by market.

If you think about Europe as an example and you think about the custom touring market, that makes up a relatively small piece of the overall market and we have a very large share of that market, which is another indication of the strength of our brand and the demand of our brand from our customer.

So really as we think about these markets, what we are really looking at is how do we design and develop and bring to market relevant products that are meaningful, you know, to the customers in those markets so that we can continue to gain share, whether it’s in Europe or whether it’s in Japan or India or wherever it might be.

Felicia Hendrix - Barclays Capital

Okay. And then just in terms of the magnitude of production cuts, particularly in the sportster and [V-rad] lines, I’m wondering, is there any message there regarding the future viability of those two lines?

Keith E. Wandell

There’s certainly no intended message. It’s just that as John mentioned in his comments, you know, we anticipated a higher level of retail sales of Sportsters given the tough economic environment and as it turns out, we actually had a higher mix in our touring line, which is in one way good but obviously we now have this imbalance, and our actions have just only solely intended to bring that back into balance.

Felicia Hendrix - Barclays Capital

Okay, and then moving back to HDFS, I was wondering, in terms of your allowance for doubtful accounts, do you expect further positioning there? And I was wondering what it was in the second quarter.

Lawrence G. Hund

We don’t -- you know, John talked about the -- the majority of the provisioning obviously related to the one-time reclassification that John reviewed. As far as additional provisioning, obviously we have a very disciplined process that we go through every quarter and we’ll evaluate both the wholesale, which we do on a more specific dealer by dealer basis, and the retail, which will be more of a homogeneous pool, we look at it in the aggregate and we’ll evaluate those every quarter and make appropriate adjustments at that time.

Felicia Hendrix - Barclays Capital

Okay, so you won’t break out what it was in the second quarter separate from the -- what you have already discussed, which was more accounting related?

Lawrence G. Hund

That certainly is a vast majority of the provision during the second quarter, just by far, the reclassification of those receivables is really what drove it. As far as the total provision, you [will see] that broken out I think when we file our 10-Q.

Felicia Hendrix - Barclays Capital

Okay, great. And then just a final question, I was wondering if you could just let us know what the over collateralization was under the J.P. Morgan facility at the end of the second quarter and what the balance in that facility is at the end of the second quarter?

John Olin

We can’t provide that.

Felicia Hendrix - Barclays Capital

Okay. Okay, thank you.

Operator

Your next question comes from the line of James Hardiman from FTN Midwest.

James Hardiman - FTN Midwest

Good morning, guys. A quick question on the economic backdrop here, I guess just the demand back-drop -- I think most people expected that the second quarter would be down, or at least noticed that the second quarter was down versus the first quarter. Have you figured out any reason as to why that would be the case? Is it merely what’s going on in the economy, which doesn’t seem like it got that much worse from the second quarter, or is it more what you guys are doing specifically as a company, specifically some of the promotions that seemed to be successful in the first quarter that you didn’t repeat in the second?

Keith E. Wandell

You know, first of all, I think for us is a little bit unusual, if you go back to the first quarter and our retail sales weren’t down quite as much as some of the other industries. And then April, May, June, they were down more significantly and so we just believe that given the economic back drop, given the high levels of unemployment, I think which is a -- we have a close correlation probably to, as well as consumer confidence and the fact that we are selling the bigger ticket discretionary items, have impacted us.

But on the other hand, if you look at -- and I know the information we’ve given was in the releases but if you look at the sale of motor clothes, as an example, parts and accessories, even though they were down, they weren’t down nearly as significantly as retail motorcycle sales. And also if you look at our riders edge participation, that was up 7% year over year. And so all of those things again point to the stickiness, if you will, of our brand. They point to the fact that our customers are still very loyal to the brand and that there’s even more people out there looking to come into the sport through riders edge, as an example, and maybe they just can’t afford to buy a bike right now as they get through the program. But we think all those things are positives at this point in time.

James Hardiman - FTN Midwest

I certainly agree there. I’m just trying to figure out what the major difference between the first quarter and the second quarter was. Obviously you had the trade-up promotion for the sportsters in the first quarter, which potentially helped and it seemed like you are bringing that back for the third quarter. I’m just trying to figure out if you in fact do think that was a major driver towards the outperformance in the first quarter and if that could potentially help in the third quarter.

John Olin

You know, the whole industry went down from first quarter to second quarter, and I don’t think it was anything that we did specifically. You know, the ride free guarantee program might have pulled a motorcycle or two forward but nothing substantial.

And in actuality, we’ve gained share from the first quarter to the second quarter. We were up 8.2 share points in the first quarter and that increased to 10.2, so it is much more of an industry issue than it is anything that specifically we did or didn’t do.

James Hardiman - FTN Midwest

Great, thanks. And then on the cost side, how much of the cost reduction benefit that you guys have slated for this year, how much of that is gross margin, how much of that is SG&A, if you can tell us?

John Olin

We haven’t broken that out.

James Hardiman - FTN Midwest

Okay. And is it fair to say -- well, let me ask it this way. I think previously, despite the pretty significant cost savings that you guys are going to realize in 2009, the expectation was that SG&A spending wasn’t going to be down significantly because there were certain other items that you were going to have to spend money on. Is that still a safe assumption or given the incremental benefit, should we see a reduction in SG&A?

John Olin

Well, we’re not going to give forward projections on SG&A but the actions that we took today will provide $70 million of less SG&A spending going forward.

James Hardiman - FTN Midwest

Fair enough. And then finally on HDFS, it seems as if the two charges you took in terms of the reclassification, one of them was for the current securitization and one of them was for future securitization. Does that then mean that we should not expect another reclassification charge in the third quarter as a result of the securitization that you just completed?

John Olin

Absolutely. That was one-time reclassification. From now on, we will be bringing everything on balance sheet and there will be no more reclassification charges.

James Hardiman - FTN Midwest

Okay. And so of the three buckets of charges that you reported today, you know, obviously impairment charges -- impairment charge is always a possibility but the reclassification and the good will right now, we shouldn’t be seeing anymore of those?

John Olin

Correct.

James Hardiman - FTN Midwest

Okay, perfect. Thanks, guys.

Operator

Your next question comes from the line of Ed Aaron from RBC Capital Markets.

Ed Aaron - RBC Capital Markets

Thanks. Good morning. So the first question, I just wanted to gauge your level of comfort with your ability to -- your new production plan to get the inventory to where it needs to be by the end of the year. One of the things that concerns me a little bit is, especially looking at how much your competitors are down year over year in terms of their retail sales and what they might have to do to clear through some of their own inventory could make it difficult for the product to turn through the channel, so do you expect on your current view of the world that you will be potentially where you need to be in terms of dealer inventory by the end of this fiscal year?

Keith E. Wandell

Well, again I think that it goes back to the earlier comment that we put a lot of time and effort into trying to really understand the right number of units to take out of production to balance our inventories, certainly by the end of the year and going into next year, and we think we’ve done that, given everything that we understand about the economy today.

Ed Aaron - RBC Capital Markets

Okay, thanks. And I think a lot of us are scratching are obviously scratching our heads over the gross margin guidance, which was unchanged on a pretty massive production cut. Certainly it’s encouraging. Obviously there’s some mix stuff going on there but I was wondering if you could maybe give us a little bit more of a breakdown on the different puts and takes in your gross margin this year, just so we can have a better understanding of how to model it forward. I mean, I don’t know how specific you can be but the four main factors that I think are involved there obviously are fixed cost deleverage, currency, mix, and commodities. Any further clarity you can give on how those are all working together would be just helpful for our modeling purposes?

Keith E. Wandell

As we came out in January, we had the 30.5 to 31.5 and as you had mentioned, that was driven by three things -- lost absorption on lower volumes, unfavorable currency expected, and unfavorable mix. And now we’ve come out, we’ve lowered the volumes another 45,000 to 51,000 units and we are not lowering the gross margin, so the answer is why. And that is the fact that the lost absorption on the additional units that we are taking out will be offset by a more strong and favorable mix, given a shift form sportsters into our big twins.

And then secondly is we expect to generate more productivity than we did initially. Again, as I had mentioned earlier, the organization is very focused on it and we are seeing those results in the second quarter as well, as we will for the remainder of the year.

Ed Aaron - RBC Capital Markets

And lastly, you mentioned that that $70 million was coming out of SG&A. Should I interpret that all of the -- you know, the cost-cutting is more SG&A focused versus cost of goods?

Keith E. Wandell

The $70 million, 60 of it is motor company and that would show up on the SG&A line of our consolidated financial statements; $10 million of administrative costs are coming out of HDFS.

Ed Aaron - RBC Capital Markets

So all of those restructuring savings are basically below the gross profit line?

Keith E. Wandell

The vast majority is, yes.

Ed Aaron - RBC Capital Markets

Thank you for taking my questions.

Operator

Your next question comes from the line of Patrick Archambault from Goldman Sachs.

Patrick Archambault - Goldman Sachs

Good morning. I guess just on the debt side of things, is there -- it seems like you’ve been running in the 50s in terms of short-term debt as a proportion of your funding and obviously you were sort of falling down below that at a specific time and then with some of these recent transactions, you know, you are kind of back up there.

I just wanted to get a sense of where you -- what you think the appropriate mix of short-term debt is for you guys, just on a longer term sustainable basis in the interest of diversification and if it’s fairly similar to what we are seeing now, how much room is there to take your average interest costs below the 6%, 7% which it seems to be tracking right now.

Keith E. Wandell

We’re not going to give any future targets but we are very focused on further diversifying our debt and some of our benchmarks are going to be to find lower cost funds as well. We do realize that the cost of funds are up versus year-ago and we are focused on it, we’re adjusting the portfolio side of it with several price increases and we’re looking to further diversify.

Patrick Archambault - Goldman Sachs

And I guess would diversification entail doing a bit more longer term unsecured stuff as well, or are you still kind of very much focused on some of the shorter term cheaper or less expensive paper as part of that plan?

Keith E. Wandell

You know, we are evaluating all the markets continually and while we are very pleased that the markets are coming back and we’ve got access to all markets and we’ve accessed all markets this year, we are looking for the opportunities to again diversify and move to lower cost funds, and where we are at at any given time, we’ll take action if it seems appropriate at that time.

Patrick Archambault - Goldman Sachs

Okay. And I wanted to -- I know you might have said it, did you give us the sub-prime proportion of your book versus last year? And if not, would we be able to get that from you?

Keith E. Wandell

Well, we can give you sort of a broader generality of where our new originations are. You know, if you look back a year ago, it was probably 70% to 75% prime and then the remainder in the sub-prime tier. With the changes we’ve made in underwriting criteria, today it’s more in the 80% to 85% prime and then 15% to 20% sub-prime.

Patrick Archambault - Goldman Sachs

Okay, great. And then another one, you commented on delinquencies and a softening in used vehicle prices, used bike prices as being responsible for the increase in credit losses. Can you give us any kind of sense -- can you maybe dimension how used bike prices are tracking year-on-year for us?

Keith E. Wandell

As far as recovery values year-on-year, they are down probably about 15% or so. You know, if you took it relative to the initial MSRP of the motor cycle, but -- and not surprising I think given what’s going on in the economy and certainly given a lot of pressure on the consumer and just the fact that we are repossessing more motorcycles in this part of the economic downturn than we were a year ago.

Patrick Archambault - Goldman Sachs

Okay. That’s helpful. And then actually just last -- one last housekeeping one -- I guess the ride for free program that I think is being reinitiated, is that -- how do we think about the impact of that? Did you guys reserve for that this quarter? Might that have had sort of an impact? Or is that something that we’ll see accrue in subsequent periods?

Keith E. Wandell

We did not reserve for that in Q2. That will be reserved for in Q3. It was -- the program was launched there and that is -- earlier this year we did ride free guarantee. There was two pieces to that ride program earlier this year. It was if you traded in an earlier model sportster, you’d get MSRP if you bought a big twin, and then the second piece of that was if you bought a sportster that during the year, if you traded up to a big twin, you would receive MSRP.

It’s the second piece of that that is going forward in the third quarter. It’s not the entire program that we did in the first quarter. It’s just the second piece that [inaudible] sportsters.

Patrick Archambault - Goldman Sachs

And can you just remind me, how much -- because I think you guys gave out that number in terms of how much you had reserved for the program and the past program and sort of give us a sense of what we might have to factor in for it?

Keith E. Wandell

I can’t remember off the top of my head. You can call Amy. She can get that for you.

Patrick Archambault - Goldman Sachs

Okay, great. That’s all I had. Thank you very much.

Operator

And our final question comes from the line of Rod Lache from Deutsche Bank.

Rod Lache - Deutsche Bank

Keith, can you elaborate specifically on your comment on the manufacturing base not being competitive or sustainable? Do you have a preliminary assessment of the gap that you are looking at or a BBT target or something that you are kind of honing in on as the savings opportunity or gap to become competitive?

Keith E. Wandell

Well, you know, I would suggest that we have a directional number. I’m not really willing to talk about that at this point in time. We’re embedding that with obviously the entire organization and I think, Rod, you are well aware that we really focus on continuous improvement and again, I’ll reiterate that no matter how well we are doing, we can do better and we are understanding where all those opportunities are. I think the only comment you may be referring to was maybe our York facility and clearly we are working with our labor unions there and all of our employees and we are really trying to figure out -- you know, there’s clearly a bigger opportunity probably in that facility for a lot of different reasons than in many of the other ones, and so that’s sort of top of mind for all of us. But I can guarantee you that we are focused on driving continuous improvement and just understanding exactly how we are going to take the cost out of the operations.

Rod Lache - Deutsche Bank

In terms of controls, you were very transparent on what your three-year target was and what the target would be per year. Do you anticipate bringing that kind of transparency and targets across to Harley-Davidson?

Keith E. Wandell

Well, yeah, and I think again, as we move forward here, we’ll be able to bring certainly more clarity to some of those things. Right now, we are -- you know, there’s just a whole lot of work being done and trying to get everybody aligned around exactly what these opportunities are.

Rod Lache - Deutsche Bank

And just as far as the savings -- you gave us objectives for the full year. Could you tell us how much you’ve achieved already and what are your long-term expectations for where SG&A should be as a -- or your operating expenses as a percentage of sales?

Keith E. Wandell

We are just at this point be able to say that we will hit the full-year guidance that we’ve got in the range that I provided. As far as longer term, we’ll looking to size the business appropriately with our volumes but never lose sight of the fact that we are going to continue to invest in the brand and we do know that this recession and economic downturn will end and we are positioning ourselves to come out of it stronger than our competition.

Rod Lache - Deutsche Bank

Okay. I mean, you were given some specifics on SG&A savings from restructuring. I would imagine that there’s other things like advertising and other elements that you would be ratcheting down. Is there any additional color that you can give us? You commented on the gross profit margins but just as far as SG&A levels?

Keith E. Wandell

Rod, typically we don’t break out the line items of it but I can tell you that the SG&A reductions are across the organization. Some areas are getting hit harder than others and all of our employees are focused on working smarter and getting after the productivity opportunities that are available to them.

Rod Lache - Deutsche Bank

Okay, and just lastly, to clarify your comment earlier, you were anticipating that on a full-year basis, because of the downtime in sportsters, that your mix would be positive year over year for just the full-year ’09 versus full-year ’08?

Keith E. Wandell

The mix is going to be very favorable in the back half of the year.

Rod Lache - Deutsche Bank

Right, and it’s more favorable than what you anticipated earlier in the year but on a full-year basis, ’09 versus ’08, is mix a plus or a minus?

Keith E. Wandell

Not going to provide that, Rod, I’m sorry.

Rod Lache - Deutsche Bank

All right. Thank you.

Keith E. Wandell

Thank you for your time this morning. I appreciate your interest and investment in Harley-Davidson. Now I’ll turn it back to Amy for some final logistics.

Amy Jefferies

Thanks, John. If you’d like to hear a replay of this conference, call 706-645-9291 and enter pin number 15669305# until July 23rd, or access the conference on harleydavidson.com. If you have any questions, please contact Harley-Davidson's office of investor relations at 414-343-8002. Have a great day.

Operator

This concludes today’s conference call. You may now disconnect.

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Source: Harley-Davidson Q2 2009 Earnings Call Transcript
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