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Harley-Davidson Inc. (NYSE:HOG)

Q4 2009 Earnings Call

January 22, 2010 9:00 am ET

Executives

Amy Giuffre – Director of Investor Relations

Keith E. Wandell – President, Chief Executive Officer & Director

John Olin – Chief Financial Officer & Senior Vice President

Lawrence G. Hund – President & Chief Operating Officer Harley-Davidson Financial Services

Analysts

Tim Conder – Wells Fargo Securities

Sharon Zackfia – William Blair & Co.

Rod Lache – Deutsche Bank

Craig Kennison – Robert W. Baird & Company

Robin Farley – UBS

James Hardiman – FTN Midwest

Ed Aaron – RBC Capital Markets

Operator

Welcome everyone to the Harley-Davidson 2009 fourth quarter conference call. (Operator Instructions) I would now like to turn the call over to Ms. Amy Giuffre, Director of Investor Relations. You may begin your conference.

Amy Giuffre

Good morning and welcome to Harley-Davidson’s fourth quarter 2009 conference call. Today’s call will be webcast live on www.HarleyDavidson.com and supported by slides that can be accessed by clicking on Investor Relations and then Events and Announcements.

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.

This morning you will hear from Harley-Davidson’s CEO, Keith Wandell; CFO, John Olin and President of Harley-Davidson Financial Services, Larry Hund. At the close of prepared comments we will open the call for your questions.

Keith?

Keith Wandell

Thank you Amy. Good morning everyone and thanks for joining us on the call. We have a lot of ground to cover this morning so we will get right to it.

As you saw on the press release today Harley-Davidson reported its first quarterly loss in many years with full-year revenues and profits decreased from last year. These results were not surprising. In fact they were as we expected because they were the direct result of the economic climate and the decisive actions we took throughout the year. Actions to deal not just with the recession but to position our company for the future through the go-forward strategy that we unveiled in October.

We firmly believe the short-term pain Harley-Davidson is going through as a result of our actions is worth the longer term gain we expect to see as a result. We have confidence we are doing the right things to manage our business prudently and effectively in this economy and to restore Harley-Davidson to greater profitability going forward.

So let’s take a look at 2009 and our actions and then I want to turn my attention to what lay ahead. When I joined Harley-Davidson in May we set out two key priorities for our team. First was to continue to take the actions necessary and execute effectively on our strategy to manage the business in the current economic environment. At the same time it was even more essential we develop a clear, comprehensive and powerful strategy to maximize our opportunities for growth and profitability going forward.

So looking at our actions to execute effectively in the current environment we reduced shipment volumes significantly to align our inventories, we embarked on a major restructuring of our production operations, we obtained funding through the lending activities of HDFS and positioned HDFS for solid [inaudible] in 2010 and launched our go-forward business strategy to deliver results by focusing on the four key pillars of our strategy which are growth, continuous improvement, leadership development and sustainability.

Under our strategy we are focusing our investment behind the uniquely strong Harley-Davidson brand as the most attractive path to sustained, long-term growth, through products and experiences, global expansion, outreach to new customers and our commitment to core customers. As we look at the year in front of us we expect 2010 to continue to be challenging. Our strategy and the performance goals we have laid out through 2014 are based on an appropriately prudent approach. Our growth targets will take hard work and intense focus to reach but we believe they are imminently achievable and appropriately conservative.

Even in an environment where consumers are more practical and cautious we believe that people still dream about the Harley-Davidson experience and everything we see indicates that the brand is as strong or stronger than ever both in the US and globally. We will continue to solidify our position and execute on our go-forward strategy including bringing exciting products to market like the 48 that we are introducing today and which like the other dark customer bikes is intended to reach new young, adult customers.

In addition to our focus on growing core and outreach markets in North America we will also continue to focus on expanding the brand in the international markets. Harley-Davidson’s brand appeal around the world is as strong or stronger than ever.

So in summary our fourth quarter and full year 2009 results are a direct reflection of the economy and the actions we took to manage the business prudently and effectively in the current environment and more importantly for the future. While we expect 2010 to be another challenging year for the industry and for Harley-Davidson the Harley-Davidson brand has exceptional strength and we are highly focused on continuing to grow the reach of our brand around the world. We have a great conviction that our go-forward strategy is focusing our company in the right direction and that we are executing our strategy with appropriate urgency.

So with that I would like to say thanks and let me turn it over to John Olin for the numbers and more of the details.

John Olin

Thanks Keith. This morning I will discuss some of the details around the financial results, provide an update on our restructuring activities and discuss the expectations for 2010.

During the fourth quarter Harley-Davidson Inc. revenue from continuing operations was down 40.2% and we recognized a loss for the first time in recent history. This loss was expected as a result of ongoing restructuring activities, costs associated with exiting the Buell product line and the impact of shipping 53% fewer bikes than the fourth quarter of last year. While the shipment reduction negatively impacted the quarter’s results, the positive news is that our US dealer network had a year-end inventory level that is significantly lower than last year and we believe appropriate for the current environment which I will talk more about shortly.

Moving onto slide 11, retail sales of Harley-Davidson motorcycles were down worldwide during the fourth quarter and the full year 2009 compared to last year. Two points to note about retail sales; in the fourth quarter our worldwide retail sales rate was flat compared to last quarter. In international markets we saw another sequential improvement in retail sales rates and after being down for three consecutive quarters Europe was up slightly in the fourth quarter.

Regarding market share our US market share decreased by 4.8 percentage points in the quarter as we lapped a strong fourth quarter 2008 share increase of 4.4 percentage points. Also driving the decrease in fourth quarter 2009 market share were strong sales in the performance segment due to significant price discounting during the quarter. For the full year our market share was up 7.9 percentage points versus 2008.

On slide 12 our US dealer network year-end retail inventory was down 18,000 units compared to last year. It was the third consecutive year we significantly reduced dealer inventory and we remain committed to the task of balancing supply in line with demand. As retail conditions remain challenging we continue to execute our plan to help protect the integrity of our dealer network. In October we estimated that 15-30 additional dealer points could close over the next six months. During the fourth quarter 14 dealer points closed, so during 2009 a total of 28 dealer points closed. We continue to expect approximately 15 additional dealer points will close in the next three months.

On slide 13 you will see wholesale shipments to our dealers for the full year were down 26.5% to 223,000 units. Of that total sportsters represented 21.2% of shipments, just slightly more than 2008 full-year totals. Mix shifted between the custom and touring families compared to 2008 primarily driven by the new Tri Glide models and shipments to international markets increased to 35% of the total.

On the next slide you will see revenue in all categories of the motorcycle product segment was down in the fourth quarter and the full year. The 45.6% decrease of Harley-Davidson motorcycle revenue during the fourth quarter was primarily the result of lower shipments partially offset by favorable shipments mix and favorable foreign currency exchange.

G&A and general merchandise revenue were down less than motorcycle revenue. Both were an important part of our growth strategy and we are excited about the prospects of these high margin businesses in the future. For example, the Pit Shop is a new P&A concept that enables sales people to show customers how the handle bars, seats, controls and suspension affect riders’ riding position, comfort and confidence. General merchandise just launched a new pink label collection. A portion of the proceeds will support the breast cancer network for strength. Both support our strategy to reach a more diverse rider base.

As retail sales, shipments and revenue have been down due to the recession we have been intensely focused on improving our cost structure and structuring the business to be stronger and more profitable in the future. Throughout 2009 we announced significant restructuring efforts that will result in reduced administrative costs, reduce excess capacity and increase focus on our core operations. During the fourth quarter we made the decision to consolidate our three vehicle test facilities into one location further streamlining operations.

The estimated total costs and savings associated with our 2009 restructuring activities are summarized on slide 15. During the fourth quarter we shut down Buell production. The financial results related to Buell will continue to be reported as a component of income from operations. Related exit costs will be recorded as restructuring expenses and gross profit will continue to include earnings on the sale of our remaining Buell inventory. In 2009 we recorded approximately $116 million of the estimated $125 million in costs related to exiting Buell.

On slide 17 you will see our total 2009 restructuring costs were $221 million which exceeded our estimated range of $190-210 million mainly driven by higher Buell restructuring costs. However, total Buell exit costs are still expected to be $125 million as there was favorability in the gross margin impacts associated with the Buell product line exit. Restructuring savings were $91 million slightly above the high end of our expected range. We now expect total restructuring and impairment costs will be between $430-460 million through 2012 and we continue to expect total cumulative annual savings associated with our restructuring to be between $240-260 million. Expected costs and savings by year are provided on this slide.

On slide 18 you will see gross margin in the quarter decreased to 20.3% of revenue compared to last year. As expected gross margin was negatively impacted primarily by lower shipments and Buell exit costs but also by unfavorable manufacturing costs due to lost absorption. Overall material costs, favorable mix and higher than expected productivity provided some favorable offset. Full year gross margin was 32.3% of revenue and we continue to be very pleased with the gross margin strength of our core business despite volume declines of over 26% from 2008.

On slide 19 operating margin as a percent of revenue for the fourth quarter was a negative 29% which was impacted by lower gross margin of $254 million, restructuring and asset impairments of $120 million and higher SG&A expenses. Full-year operating margin decreased to 7.3% as a result of lower gross margin and restructuring and asset impairment charges. SG&A finished the year down by $91 million driven by an estimated $83 million in restructuring savings.

Now moving onto our financial services segment. During the quarter HDFS reported an operating loss of $7.1 million an improvement of $17.8 million compared to last year. The main drivers of this improvement were income from past off balance sheet securitizations increased by $18.1 million during the quarter. Impairments to retain securitization interest for the fourth quarter 2009 were $9.8 million compared to $25.3 million impairment in the fourth quarter of 2008. The provision for retail loan losses increased by $19.9 million during the quarter primarily due to a higher balance of held for investment receivables versus the prior year.

A provision for wholesale loan losses decreased by $7 million relative to the fourth quarter 2008. This decrease resulted primarily from lower outstanding receivables due to reduced motorcycle inventory in the dealer network from a year ago. It is encouraging that our credit risk assumptions in both the retail and wholesale portfolios did not change significantly from the third quarter of 2009.

The remaining $11.1 million of improvement is primarily the result of a fourth quarter 2008 provision for lower cost or market adjustments on held for sale receivables. There is no comparable item in the fourth quarter 2009 as these receivables were reclassified as held for investment at the end of the second quarter 2009.

On a full year basis HDFS incurred $118 million loss largely due to $101 million of one-time items recorded during the year. In October we said we expect HDFS to incur losses in the next couple of quarters due to seasonality, lower recovery values and higher cost of debt. Since then HDFS continued to access the debt capital markets are relatively attractive cost of funds and repaid the $600 million 15% inter-company loan to Harley-Davidson Inc. Harley-Davidson Inc. will hold the debt and will record remaining interest expense.

Repayment of this debt to HD Inc. positively impacted HDFS’ fourth quarter results and going forward we believe that HDFS’ cost of funds will be more reflective of current market interest rates. We expect the new interest rate structure will assist us in moving to profitability in 2010.

Now Larry will review HDFS’ operations and portfolio performance.

Lawrence Hund

Thanks John. During the fourth quarter HDFS originated $284 million in retail motorcycle loans, down 25% compared to last year primarily due to lower retail sales of Harley-Davidson motorcycles in the US.

For the full year HDFS originated $2 billion in retail motorcycle loans, down 29% compared to 2008. HDFS retail market share of new Harley-Davidson motorcycles sold in the US was down nearly 5 percentage points to 48.8% in 2009 compared to 2008 due to an increase in cash buyers and also due to competition particularly in the prime rated customer segments. At the end of the fourth quarter of the approximately $4.8 billion of receivables classified as held for investment $4 billion were retail and $863 million were wholesale.

We are pleased with the progress resulting from the significant underwriting adjustments we made in 2009. We continue to see improved performance in early stage delinquencies and defaults for loans originated in 2009 compared to the prior year. At the end of 2009 80-85% of our new loan originations were prime compared to approximately 75% in previous years. We continue to monitor the performance of these new originations very closely. We will make changes to our underwriting standards that we deem appropriate.

The impact of the recession and high unemployment continue to drive delinquencies and credit losses. The 30-day delinquency rate for managed retail motorcycle loans at December 31, 2009 was 6.51%, up slightly over 2008. Our increased collection staffing levels and modified collections strategies have enabled us to manage delinquency levels close to last year despite increasing unemployment in the US.

Annualized retail credit losses increased to 2.86% for the full year 2008 and were driven by a higher frequency of loss and a decline in the recovery value of repossessed motorcycles.

In conclusion as John mentioned we continue to make significant progress in improving our liquidity position and reducing our cost of funds. As we work through the winter months and given continued high unemployment rates in the US we expect to continue to see higher levels of delinquent loans and retail credit losses in the near-term. We believe our underwriting criteria are appropriate and we will continue to evaluate them on an ongoing basis.

Now let me turn it back to John.

John Olin

Thanks Larry. One of the top areas of focus in 2009 was to obtain funding to support HDFS’ lending activities. During the fourth quarter HDFS obtained $1.8 billion of funding. Last quarter we said we were engaged in reviewing our strategic options to find more diversified and cost effective funding in order to meet HDFS’ goal of providing credit while delivering appropriate returns of profitability.

The process is progressing as we continue our discussions with several institutions. Realistically we recognize this is a challenge, however we remain cautiously optimistic that we can find additional opportunities to improve HDFS’ funding profile. In the meantime we are pleased with HDFS’ fourth quarter results and are seeing some positive signs as we move into 2010.

On slide 24 you will see our overall cash position and liquidity strategy. We ended this quarter with $1.7 billion of cash and marketable securities. This is a significant and welcomed improvement in liquidity from just one year ago and we believe is an appropriate level given the uncertain economy. Of the total $1.7 billion HDFS ended the year with $489 million in cash after repaying Harley-Davidson Inc. the $600 million it borrowed in February 2009. Additionally HDFS has access to approximately $2 billion of available liquidity through bank credit and asset backed conduit facilities.

As of the end of 2009 we believe we have met HDFS’ anticipated 2010 funding needs through our 2009 actions. During the year we expect to pre-fund our 2011 needs through the capital markets and by renewing a portion of the bank credit and asset-backed conduit facilities. Going forward our strategy will be to maintain a minimum of 12 months of liquidity and cash and/or credit facilities.

We will carry higher cash balances until we see stabilization and improvement in the economy, capital and credit markets and our company’s credit ratings. We will continue to try to diversify our funding profile through a combination of short-term and long-term funding vehicles. We do still rely on the term asset backed securitization markets and continue to pursue all avenues to obtain cost effective funding.

Now I will review the remaining Harley-Davidson financials on slide 25. On a continuing basis, Harley-Davidson Inc. 2009 revenue, net income and earnings per share were down compared to last year mainly due to significant one-time items related to restructuring and asset impairment charges and the reclassification of HDFS receivables during the year.

On slide 26 I would like to highlight two items. First with regard to operating cash, despite the large drop in motorcycle shipments and the restructuring spending we incurred, we were able to generate operating cash of over $600 million which included a fourth quarter contribution of $215 million to our pension plan.

Second, our tax rate increased significantly in 2009 relative to 2008 primarily due to a one-time charge for a Wisconsin tax law change and the nondeductible HDFS goodwill write off as well as the impact of reduced earnings. In 2010 we expect the full year effective tax rate will be approximately 36.5% for continuing operations.

We are proceeding with our plan to sell MV Agusta. As a result, MV Agusta’s assets and liabilities have been classified as held for sale and its financial results have been presented as discontinued operations for all periods presented. During the third quarter we wrote down the carrying value of MV Agusta’s assets resulting in a non-cash charge of $53 million net of related tax benefits. For the fourth quarter and full year we recognized a loss from discontinued operations. The details are on slide 27.

Now I would like to talk about two important changes in our financial reporting. First in the first quarter of 2010 FAS 166 and 167 will be adopted and approximately $1.9 billion of receivables and related debt will be brought back onto our balance sheet. The adoption will also result in a small investment to retained earnings. Upon adoption we expect to remain in compliance with all of our debt covenants. We will provide more details in the 2009 10-K.

The second important change to our financials also involved HDFS. With the complexity and changing dynamics of the financial services business we feel it is important for our stakeholders to see more detail around our motorcycle and financial services segment. Therefore in the 10-K we will begin providing consolidated financial information that will break down the income statement, balance sheet and statement of cash flows for each segment.

All in all 2009 was a challenging year but we are confident we have taken the appropriate actions to restore greater profitability and drive long-term growth. We expect 2010 to be another challenging year. As a result we expect Harley-Davidson motorcycle shipments in 2010 to between 201,000 and 212,000 motorcycles, down 5-10% from 2009 as a result of two key factors.

First, we expect the global economies to remain challenging with continued high unemployment and low consumer confidence in the United States. Second, we expect continued price competition from other manufacturers as they reduce excess inventories. We also anticipate price competition at the local level as retailers discount excess inventory driven by contraction of the dealer network.

In 2010 we will take a conservative approach to shipment volumes as we continue to work with our dealers to aggressively balance supply in line with demand. When demand improves we will be ready to increase production.

We expect gross margins to be between 32-33.5% for the full year. Capital expenditures are expected to be between $235-255 million which includes approximately $95-110 million in restructuring capital.

As we put 2009 behind us it is important to note that despite significantly lower volumes and restructuring spending Harley-Davidson remains a very strong company with an incredibly powerful brand. Our strength is evidenced by our solid gross margin and our ability to generate positive cash from the motorcycle segment in this challenging business environment. We will continue to take the necessary actions to manage through the economic downturn and execute our long-term strategy.

Now let’s open the call to your questions.

Question and Answer Session

Operator

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

Tim Conder – Wells Fargo Securities

Could you break out the amount of restructuring charges if you had to allocate them to cost of sales and operating expenses for the fourth quarter? Then in your restructuring of the costs you have outlined for 2010 the same way?

Keith Wandell

You want those broken out for the fourth quarter?

Tim Conder – Wells Fargo Securities

Just a rough allocation or fourth quarter or more importantly going forward how much of the restructuring would you anticipate would be related to COGS and how much to operating expenses?

Keith Wandell

On the slide on page 17 we have the actuals how they fit in for 2009. For 2009 actual cost of the motorcycle segment was $221 million and that was 55% cash. The savings were $91 million and that was 91% SG&A which equates to $83 million on a full-year basis. Then the slides are posted and you have access to also go through 2010, 2011 and 2012 and give you the amount of cash as well as the split between SG&A and cost of goods sold.

Tim Conder – Wells Fargo Securities

On the savings, right? But as far as the restructuring how those will be flow through? As you reported you show a total and you show how that is in the fourth quarter but going forward how do you expect that? I guess another way to ask it is the 32-33.5% gross margin guidance for the year that does not include any restructuring charges at all correct?

Keith Wandell

Correct. The restructuring, anything classified as restructuring expense is broken out on a separate line item on the P&L underneath SG&A. So we have gross profit, SG&A expenses and then restructuring is broken out separately. So there is no restructuring expense in the cost of goods sold or the gross margin. Now what we did have in the exit of Buell of the $116 million of restructuring expenses $71 million went through the restructuring line and another $45 million not classified as restructuring expense but that money was necessary to move the product.

Basically it was to discount the product as well as take care of obsolete inventory that does go from gross margin. So we will have a one-time gross margin expense in 2009 of $44.8 million that we would not expect to repeat next year.

Tim Conder – Wells Fargo Securities

On HDFS it appears again your delinquencies and credit losses are leveling out at the fourth quarter run rate. Should we perceive that from a reserve standpoint going forward? Is that kind of a fair way to look at it?

John Olin

I don’t think we are giving forward-looking guidance here but I would say certainly we saw some stabilization and recovery values on repossessed motorcycles as we got into the last couple of months of the year. Certainly we are going to be watching it very closely as we get into next year. As you remember we had taken up reserve levels in the third quarter. Based on fourth quarter performance those reserve levels stayed fairly consistent with where they were at the end of the third quarter.

Tim Conder – Wells Fargo Securities

Related to HDFS, you have said that you are looking to diversify your funding. Also could you look at other structures for HDFS while still keeping some of the ownership? Could you maybe give us an update on that? Besides being more transparent which we thank you for on HDFS is that maybe also a precursor to something you may be looking at?

Keith Wandell

Let me answer the second part first. One is a lot of this stuff is coming back on the balance sheet in terms of receivables and debt. We think it is very important for everyone to see the separate businesses and certainly the high margin motorcycle business we have that has very little debt and very high margins and the reinvestment returns or the returns on equity that we got from our financial service business. So we wanted to show the different dynamics of the business. That doesn’t have anything to do with looking forward at HDFS from a strategic standpoint.

But what we have said a couple of quarters ago we were evaluating our strategic options as it relates to obtaining more diversified, low cost funds for HDFS. Our goal at HDFS has been to provide credit while balancing appropriate returns and profitability. In that end we have engaged an advisor and are discussing potential opportunities with several institutions. At this point we are still in the process but we are realistic this is a challenge. There is no cookie cutter model out there that says here is the best way to transfer risk or reduce lower cost of funds. We are working on it as diligently as we can.

We remain cautiously optimistic we can find some additional opportunities out there to improve the funding profile. Let’s be clear, we believe HDFS provides a strategic advantage to Harley-Davidson. We also believe that the company benefited from having HDFS this year. It benefitted both the company and our dealers and any arrangement must be with the company’s long-term interest at heart. That includes underwriting, long-term commitment and certainly a recognition of any of the value that HDFS brings to the organization.

Operator

The next question comes from the line of Sharon Zackfia – William Blair & Co.

Sharon Zackfia – William Blair & Co.

The selling, administrative and engineering bumped up significantly this quarter sequentially. I was wondering if there is anything unusual in that number as we look at the fourth quarter?

John Olin

On a full-year basis we were very pleased SG&A was down $91 million driven by $83 million of restructuring. However as you point out SG&A was up in the fourth quarter and that was driven largely by increased warranty and recall costs. We had several things happening in the quarter with that. As you might remember we had a recall of our FL motorcycles. In addition to that we did what we would call a product program. It is not a safety recall. It is outside of warranty but is something we believe is important to the customer from a quality standpoint and it related to tires for our touring motorcycles and so there was a charge in there for that. Then finally our overall warranty rates were increased as we saw some of our actuals come in a little higher than we expected.

Sharon Zackfia – William Blair & Co.

Do you have the aggregate amount that impacted to selling and admin?

John Olin

That will be broken out in the 10-K but it will be in a range of $15 million year-over-year.

Sharon Zackfia – William Blair & Co.

In total?

John Olin

Yes.

Sharon Zackfia – William Blair & Co.

As we look forward into 2010 understanding you are working on all the restructuring activities, I know you don’t give selling, admin and engineering guidance but are you expecting to see consistent year-over-year improvement throughout 2010? How should we think about that as we embark on the year?

John Olin

As you mentioned we don’t provide SG&A guidance. However, when we look at the restructuring savings again we delivered $83 million of SG&A restructuring and if you look into 2010 we are expecting to deliver additional restructuring savings in the SG&A line. We have given guidance on $135-155 million of which 70-80% of it will be SG&A.

Sharon Zackfia – William Blair & Co.

I know you went over the dealer expenses but there were a lot of numbers given out in the presentation. Did I write down correctly that the quarter there was $116 million in Buell expenses? Can you remind me what the original expectation was? I know you said the full expectation hasn’t changed but maybe the timing had changed differently than you had indicated?

John Olin

What we said last quarter when we announced we were exiting the Buell product line was we expected $125 million of exit costs. That hasn’t changed. Those costs were hitting two lines of our P&L. One is a restructuring cost and the other on gross margin. As I mentioned before the gross margin piece is to discount some of those bikes to clear the market.

During the quarter $71 million hit in restructuring so for the motorcycle segment we had 221 on a full year basis, $71 million of that was for restructuring at Buell. That was about $10 million higher than we originally anticipated. However, the gross margin piece that hit in the fourth quarter was $45 million and that was favorable in the same neighborhood as the unfavorability. Overall the $125 million is on track. However, the restructuring piece is higher.

Operator

The next question comes from the line of Rod Lache – Deutsche Bank.

Rod Lache – Deutsche Bank

Another question on the operating expense, SG&A and engineering, it had been running at $190-200 million a quarter and this $256 million looks like a meaningful uptick even adjusted for that $15 million warranty charge. Can you give us a sense of what we should be thinking going forward for the pace of SG&A considering the headcount reductions and savings you have achieved this year?

John Olin

A couple points. One is SG&A timing always comes into play. So the fourth quarter is a little bit higher. The other thing is there may be a little bit of confusion because through the first three quarters we had SG&A expenses for MV Agusta and they have now been pulled back. But other than what we have provided as far as the restructuring savings going forward I can’t provide a whole lot more than that.

Rod Lache – Deutsche Bank

But the MV Agusta if you are pulling that out now. I would imagine that would lower the pace of that operating expense and it looks like historically it has ticked up maybe $5-10 million in the fourth quarter. It is a little bit larger. Is there anything else you can point out as unusual?

John Olin

Nothing beyond the regular timing things that happen in any given quarter. I would suggest looking at the full-year number going forward and again some of the restructuring savings we expect to get next year out of SG&A.

Rod Lache – Deutsche Bank

This year you produced 223,000 bikes and you sold 243,000 and you talked about a 5-10% decline in production but for this year you produced 8-9% fewer motorcycles than you sold. Are you suggesting you are anticipating a double digit decline in sales next year? Could you just maybe elaborate a little bit on that?

Keith Wandell

We don’t provide any forward-looking information on retail sales. What I can say is we ended the year where we wanted to be in retail inventory in the United States. We feel we are at the right inventory level for the size of business we have. We will continue to adjust going forward and we will manage supply in line with demand. Your point is valid. I can’t help you out but the base is very different between our shipment base versus our retail sales base. So that will have some play in percentages.

Rod Lache – Deutsche Bank

It just looks like accounting for that inventory correction you have a pretty conservative or pessimistic view on the outlook for sales this year.

Keith Wandell

We believe the 5-10% is an appropriate look given what we see in the economy and the price competition we would expect in 2010.

Rod Lache – Deutsche Bank

On the HDFS business could you tell us what your allowance for losses was as a percentage of receivables in the quarter? Is it the same on a managed basis including the off balance sheet receivables?

Lawrence Hund

The allowance at the end of the quarter is $150 million or about 3% of the on balance sheet receivables, pretty consistent with where it was at the end of the third quarter. The provision in the quarter was about $31 million and we had about $30 million of charge offs so not a lot of change in that allowance balance. Now remember in the off-balance sheet we don’t provide a reserve per se. What we do have is the retained securitization interest and obviously we have underlying assumptions for credit losses related to that. That is entirely different. What John talked about with FAS 166 and 167, in the first quarter those off balance sheet and we will be providing a reserve against them.

Rod Lache – Deutsche Bank

Can you tell us what the book value was of HDFS and also what happens to the MV debt at this point?

Lawrence Hund

The book value was in the neighborhood of $8.70 and again when you get the 10-K that will be broken out and will be extremely clear. What was the second question?

Rod Lache – Deutsche Bank

The MV August debt. Does that get classified as discontinued ops or is that retained?

Lawrence Hund

Let me get back to you on that.

Rod Lache – Deutsche Bank

Do you have the cash from operations from the industrial business, or the motorcycle business specifically? I know you said you are going to be publishing that in your K.

John Olin

We are going to separate it all out and I didn’t write it all down. If the cash from the operating business was in the range of $540 million of the $600 million, in the range and that will be broken out in the 10-K.

Rod Lache – Deutsche Bank

I assume the 117 of CapEx was in that business?

John Olin

Yes. Again I would like to say that certainly one of the indicators of a tough year, a positive indicator is the ability of a motor company to generate that much cash when we had net income of $70 million is a tribute to an incredibly powerful business model.

Rod Lache – Deutsche Bank

That is net of your pension contribution and restructuring right?

John Olin

Yes.

Rod Lache – Deutsche Bank

What was the restructuring cash this year?

John Olin

I don’t have that number. The overall restructuring expense was 221 for the motorcycle segment and an additional $3 million at HDFS. Out of the cash we did have $230 million of pension contributions, $215 million in the fourth quarter.

Operator

The next question comes from the line of Craig Kennison – Robert W. Baird & Company.

Craig Kennison – Robert W. Baird & Company

If I could go at the shipment guidance question again in the past you have disclosed whether you plan to ship more or less or reduce inventory in the channel. What is your view on that going into 2010?

Keith Wandell

I don’t know if we specifically provided that guidance but right now again all I can say is that we ended the year right where we wanted to be. We will continue to adjust aggressively the supply in line with demand. We do expect shipments to be down but we are not going to give guidance on where we expect to end inventories in the dealer network. You can be very assured we will be managing it or working it very closely.

Craig Kennison – Robert W. Baird & Company

What was the dealer point count at the end of 2009 and what would you expect it to be at the end of 2010?

Keith Wandell

The dealer count is on slide 12. It is 757 dealer points which are mainline dealers as well as secondary retail locations. We do not provide guidance as to that number on a full-year basis for 2010 but what we have said is in the next quarter, the first quarter of this year we expect to lose approximately 15 dealerships close in the first quarter.

Craig Kennison – Robert W. Baird & Company

Shifting to Buell Dealers that carry Buell will have excess working capital dollars. How would you expect those dealers to allocate those dollars? Do you have a product in mind that they might carry to fill that gap?

Keith Wandell

We have the Harley-Davidson brand that is best in the world. They are going to sell through their units. The typical dealership did not have a tremendous floor plan of Buell but we certainly expect and hope they would invest that money in the Harley-Davidson brand.

Craig Kennison – Robert W. Baird & Company

You are going to add I think over time up to 150 international dealers. To what extent is there a channel fill opportunity to get those dealers up to speed with inventory?

Keith Wandell

We don’t break out what that would be and quite frankly I don’t know what that number would be. When you look at Europe we feel pretty good about the dealer network. We have some dealership to fill in here and there in Western Europe but when you look into moving into new countries, India we will obviously have some dealer stuff that goes in there and this year we expect to open up five dealerships in India. So if you look at some of the countries that will have distribution expansion and there will be some fill but that is not a large percentage of the shipments by any means.

Internationally we specifically pipeline the inventory is sent to a warehouse and the dealers draw from it. Typically the dealer shops are smaller and just keep 20-ish bikes on the floor and then when they sell them they draw from the warehouse. So there is not a lot to put in the dealerships.

Operator

The next question comes from the line of Robin Farley – UBS.

Robin Farley – UBS

I have a couple of questions on margins and your guidance in the last few quarters, gross margin has seemed very low and then you have beaten that target. It is not surprising. I am trying to understand how to view your 2010 margin guidance. I wonder if you could tell us a little bit about what surprised you in your fourth quarter gross margin that they came in so much higher than your guidance? Which again seemed very low. So what is factored in your guidance that helped gross margin this quarter to be above that? Also I wonder if you could give us some sense of what your sportster mix might look like in 2010 given the production shut down in 2009. I am trying to think about how that mix will look on a year-over-year basis.

Keith Wandell

In general we are very pleased with the overall margin strength we have had at the company and as we look at margins we were down a couple percentage points year-over-year and taking out the one-time items that hit Buell in the fourth quarter overall margins for the year were only down 1.2 percentage points. Again we feel extremely pleased of our ability to hold up gross margins despite a 26% decline in shipments.

Specifically in answer to your question is our guidance has been below where we have come in actual. I think it is largely driven by the incredible productivity that the operations organization has generated. I couldn’t be happier with the organization and buckling down and pulling forward productivity projects and they will be focusing on continuous improvement every day. That is really what has been delivering more than what we expected. In the fourth quarter specifically a little bit of it was the Buell piece. So we expected a larger cost in gross margin in the fourth quarter and again as I mentioned we got a higher cost in restructuring but a lower cost in gross margin.

Robin Farley – UBS

That would have only been 100 of the 300 basis points higher. On the sportster mix? Can you address where you expect that to come in?

Keith Wandell

We don’t specifically give mix out by family. We again feel good about our overall inventory but we are probably a little bit heavier on sportster inventories at this point. All in all we feel real good about where the inventories ended the year.

Robin Farley – UBS

Without putting a specific number on it can you just make a general comment about the sportster family and how you think about that in terms of the long-term strategy? I am trying to get a sense of whether we will see something different. Obviously 2009 the timing of the production shut down and all that was probably a one-time kind of thing so I am trying to get a sense of whether we will see similar mix as we have seen over the last 10 years. Just a general comment like that even if you don’t put a number on it.

Keith Wandell

We continue to see the sportster being an important part of the lineup. Obviously we announced today we are launching a new model called the 48 which is another extension if you will of that line, sort of in the dark custom family that is intended to reach out to younger riders. We have had tremendous success with the dark custom lineup in terms of attracting young buyers to the Harley-Davidson brand.

Unfortunately because of the economy the way it is and maybe some of the younger folks having more difficulty having access to capital or borrowing I am sure it is impacted in some way but overall we feel pretty encouraged and we continue to see that as an very important part of our lineup going forward.

Robin Farley – UBS

In terms of gross margin going forward with the closure of Buell can you quantify what impact on gross margin that would have? If you didn’t do anything else differently just sort of what your benefit to margin would be just from closing Buell. Also trying to think about you have talked about…I don’t know if you have given the exact timing about when all of the cost saves will be in place. I know your initial target was by 2014 for the specific December announcement and I am just wondering when you expect the full cost savings to be in place by?

John Olin

With regard to Buell next year our margins we expect to be between 32-33.5%. Buell will be a very small part of that. We still have Buell's to sell through. I don’t know the impact year-over-year. Buell had a lower gross margin but it was a very small part of the overall business so I don’t know the quantification of that but I don’t think it would be all that great. With regard to York we expect savings to start coming through this year. The bulk of the savings will begin towards the back half of 2011 and certainly into 2012. We have some York restructuring still happening in the very beginning of 2012 but the vast majority of all expenses will be in the 2012 actuals. Again you can see the rollout in the restructuring slides we have given in terms of what we expect the overall savings and certainly York is a big driver of the overall piece.

Operator

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

James Hardiman – FTN Midwest

Just to ask a little bit more about the gross margin guidance for 2010 basically you are looking for flat maybe even a little bit down to up a little bit despite you mentioned I think $45 million of the Buell stuff not repeating in 2009 and then the restructuring savings which I think based on the math is $30 million plus of restructuring savings that should hit the gross margin. What are the negatives to think about? Obviously assuming down shipments there is a little bit of de-leverage there but are there other negatives that get in the way of the gross margin to not being a little bit better than what you are guiding to? How should I think about that?

John Olin

When we look at the margins you are thinking about it the right way. Certainly productivity which is made up of restructuring savings and continuous improvement savings partially offset by lost absorption. With shipments being down 5-10% that will certainly be a negative and in any given year we have cost inflation in the plans and so on and so forth. The bigger piece would be lost absorption on lower volumes.

James Hardiman – FTN Midwest

Two quick housekeeping questions. It looks like you are no longer separating out corporate expense as a separate line item. Does now show up in SG&A? Then just in terms of interest expense you kind of touched on interest expense was higher in the quarter. Normally a majority of that is in HDFS. How should we think about that going forward?

John Olin

The corporate expenses yes, they are now in SG&A. When you get the 10-K we will break out the two business segments and the corporate expenses will largely fall into the motorcycle segment. You are absolutely right, the way we are presenting it now does not have corporate expenses and we won’t break out corporate expenses but those expenses will be in the motorcycle segment when we break it out in the 10-K.

James Hardiman – FTN Midwest

SO that is at least part of the reason why the SG&A was a little bit inflated versus prior quarters and prior years. How about on the interest expense side? Should we expect the interest expense to continue at the ink level going forward at current rates? How should we think about that?

John Olin

Let’s spend a minute on that. As mentioned in the preamble HDFS repaid $600 million of the high interest debt we took out in February. As you recall in February the company made the decision to borrow $600 million in order to continue to lend to our credit worthy customers as well as to our dealers for floor planning. The debt was issued at the ink level and the funds were pushed down to HDFS. We have always managed HDFS as a standalone entity which means we expect HDFS to fund themselves and we expect appropriate returns on equity. It was done with the understanding that they would repay the funds back when liquidity improves. It was basically a bridge in an illiquid market.

In the end the repayment of the [HEI] debt does not impact our consolidated earnings at all but it will more accurately reflect the economics of HDFS going forward. Consequently beneath operating income or beneath EBIT will be the interest expense which will be much higher year-over-year in 2010 because it will include the interest from that $600 million.

James Hardiman – FTN Midwest

In terms of India you got the emissions restrictions pulled. Can you talk about the likelihood of getting the tariffs pulled and how you think about this market sort of besides the market without the current tariff structure?

Keith Wandell

The only thing we can say about the tariffs is we are actively engaged with all of our contracts in Washington and working and trying to do everything we can to get those either reduced or removed. I think we feel good about the Indian market in general. The excitement of the consumer there is a high level. When you look at the recent auto show where we displayed the interest in the product and the brand was just incredible. We are in the process of setting up our first five dealerships. We hope to have those executing mid-year timeframe. We have high expectations for that market over the long term.

Operator

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

Ed Aaron – RBC Capital Markets

Can you maybe talk about your forward outlook now versus 90 days ago? The reason I ask the question is last quarter you tightened the 2009 production range towards the upper end of where you had it before. Then you kind of came in toward the lower end of that and guided production down for 2010. I am wondering if your big picture view of the world has changed much in the last 3 months?

Keith Wandell

Not a lot. I think as we have sort of indicated through the whole call we tend to be somewhat conservative in our outlook. I think that is because we just have a lot of uncertainty around the consumer coming back into the marketplace in the near-term. I will tell you this if you set aside the economy and the uncertainty in the economy I couldn’t feel better about where we are at.

We have accomplished a lot. I can’t even tell you how proud I am of the whole team here, not just here in Milwaukee but throughout the whole system. I think we have done a lot of the heavy lifting that needs to be done. I think we have made a lot of the tough decisions that need to be made. I think we are putting a foundation in place that I certainly feel good about and we all feel good about. The outlook in that respect I feel better than I did 90 days ago. In terms of the economy and where the consumer is I probably feel about the same.

Ed Aaron – RBC Capital Markets

I don’t know if this is more of a question or comment on the operating expense issue but that line item in your P&L has been really very predictable in the context of the P&L but in the context of the last year or two has not been predictable at all. The surprise there was pretty significant this quarter and the explanation of the $15 million warranty really only explains somewhere in the neighborhood of 1/3 of the delta between what you reported and what I think a person could have reasonably expected based on how those numbers have flowed over the last few quarters. It seems a little bit difficult to reconcile. Anything you could do to help us understand I think would be very helpful. You mentioned being comfortable with US dealer inventory levels. Do you feel the same way about international?

John Olin

Again going back to the expense I think you should look at it on a full-year basis and again we are right where we expected to be and are pleased with our ability to take out a fair amount of expenses on a full-year basis. International inventory we feel fine with. We have always felt pretty comfortable with where we are. Again the distribution system is a little bit different but we feel very good we are ready to service those markets.

Ed Aaron – RBC Capital Markets

So if you are comfortable with where the turns are on the US and worldwide basis, I know you don’t want to talk about retail sales assumptions but by definition doesn’t that imply something that is down at least in the mid-teen range in terms of retail sales in 2010?

John Olin

I am sorry. I can’t give any forward-looking information on retail sales.

Keith Wandell

Thank you for your time this morning. We appreciate your investment in Harley-Davidson.

Amy Giuffre

The audio visual report for today’s call will be available at HarleyDavidson.com and the audio can also be accessed until January 29th by calling 706-645-9291 or 800-642-1687 in the US. The pin number is 48828696#. If you have any questions please contact the office of Investor Relations at 414-343-8002. Thank you.

Operator

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

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Source: Harley-Davidson Inc. Q4 2009 Earnings Call Transcript
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