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Executives

Amy Giuffre -

Keith E. Wandell - Chairman of The Board, Chief Executive Officer and President

John A. Olin - Chief Financial Officer and Senior Vice President

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

Analysts

Edward Aaron - RBC Capital Markets, LLC, Research Division

Sharon Zackfia - William Blair & Company L.L.C., Research Division

Craig R. Kennison - Robert W. Baird & Co. Incorporated, Research Division

Timothy A. Conder - Wells Fargo Securities, LLC, Research Division

Rod Lache - Deutsche Bank AG, Research Division

Felicia R. Hendrix - Barclays Capital, Research Division

Gerrick L. Johnson - BMO Capital Markets U.S.

Patrick Archambault - Goldman Sachs Group Inc., Research Division

James Hardiman - Longbow Research LLC

Gregory R. Badishkanian - Citigroup Inc, Research Division

Robin M. Farley - UBS Investment Bank, Research Division

Harley-Davidson (HOG) Q1 2012 Earnings Call April 25, 2012 9:00 AM ET

Operator

Good morning. My name is Alicia and I will be your conference operator today. At this time, I would like to welcome everyone to the First Quarter 2012 Earnings Conference Call. [Operator Instructions] Thank you. Amy Giuffre, Director of Investor Relations, you may begin your conference.

Amy Giuffre

Thank you, Beth, and welcome to Harley-Davidson's First Quarter 2012 Earnings Conference Call. The audio for today's call is being webcast live on www.harley-davidson.com. The supporting [Audio Gap] can be accessed by clicking on Company, Investor Relations, then Events and Presentations.

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 information in this call.

This morning, you'll hear from Harley-Davidson's CEO, Keith Wandell; CFO, John Olin; and President of Harley-Davidson Financial Services, Larry Hund. Then we'll open the call -- and then we'll open the call for your questions so let's get started. Keith?

Keith E. Wandell

Thank you, Amy, and good morning and thanks to everyone for joining us on today's call. As we noted in the press release, we're pleased by the strong start to the year and I want to begin with a thanks to all of our employees, our dealers and our suppliers. They're really the frontline in our progress and they continue to do a great job at bringing the Harley-Davidson experience to our customers throughout the world. When I came to Harley-Davidson 3 years ago, I knew that the company had tremendous untapped potential and incredible opportunities and that's never been more true than today. It's through our strategy of transformation that we believe we will exceed the ever-increasing expectations of our customers, we will create opportunities for growth and we will build a sustainable business for the future.

We continue to see the evidence of our progress in the numbers that we reported today. We believe the first quarter retail results and indeed the trend of the past several quarters reflect the outstanding appeal of our products and the efforts of our employees and the more than 1,400 dealers in 79 countries around the world along with the improving macroeconomic conditions in the U.S.

Over the past few years, we have continued to bring out great products that are hitting the mark with our customers. The latest of these are the Seventy-Two and the Softail Slim, both of which were introduced just a couple of months ago. The Seventy-Two is inspired by the early chopper era taking its cues from the custom culture that still exists today along Whittier Boulevard in East LA, also known as Route 72. No one but Harley-Davidson could do a factory custom motorcycle like the Seventy-Two with its unique, big metal flake paint which requires a complex multistep paint process.

Similarly, the Softail Slim returns the Softail motorcycle to its essential elements. With a low seat height, it comfortably fits a wide range of riders. And as with all of our motorcycles, customers can achieve a truly personalized fit through a wide variety of accessories, which is one of our competitive advantages. The Seventy-Two and the Softail Slim are just the latest new motorcycles that are reaching new customers.

The Forty-Eight, which we introduced in early 2010, made the list of the top 10 sellers in Europe last year and that is a first for Harley-Davidson.

The SuperLow, which we introduced in July of 2010, was recently cited by Power Sports Business as the #1 selling cruiser to women.

Earlier this month, Moto-plismo [ph], which is a leading motorcycle publication in Brazil, Latin America and Europe, named the Night Rod Special its Moto de Oro, the top award in the custom category.

These examples all point to the bigger story of Harley-Davidson's growing market leadership in the U.S. and growing strength in the international markets. It's all part of our strategy to increase the relevance of our motorcycles to more riders and it's working.

We now have the 2011 outreach demographics sales data for the U.S. And once again, Harley-Davidson is the leader in on-road motorcycle registrations in all of our target demographic segments. We are the leader in sales to young adults, women, diverse customers, as well as our core customers and not just in the heavyweight segment. Among young adults aged 18 to 34, we captured the market leadership position in all displacements of on-road bikes in 2008 and expanded this leadership in the 2009 to 2011 timeframe.

We are also #1 across all displacements among women, Hispanic and African-American riders. And so, if we look at just the heavyweight segment, in 2011, there's 4 points I'd like to make: number one, nearly half of all heavyweight motorcycles sold to young adults were Harley-Davidson's; number two, nearly 2/3 of heavyweight motorcycles sold to women were Harley's; number three, we also sold more than half of all of our heavyweight motorcycles sold to African-American customers; and number four, nearly 6 in 10 heavyweight motorcycles sold to Hispanic riders.

We also maintained our long-running leadership among U.S. core customers, those being Caucasian men over the age of 34, selling more than 6 in 10 motorcycles in the heavyweight category. And when it comes to new customers, more than 1/3 of our U.S. dealers' new motorcycle sales in 2011 were to customers who were new to the Harley-Davidson brand, customers either buying their first motorcycle or those who previously owned a competitive bike.

Turning to the markets outside the U.S. In the 15 country European market, more than 2/3 of those who bought a new Harley-Davidson motorcycle in 2011 were first-time Harley buyers. And we gained a point of heavyweight market share strengthening our #2 position in this highly competitive market. In the Latin American region, for the first quarter of 2012, retail gains were led by Brazil where we are starting to see the results of our investments in that market, all to better focus on delivering a great customer experience.

Last month, I and several of the team, we were in Manaus Brazil for the dedication of our relocated CKD assembly operations and then attended the grand opening of a new dealership in São Paulo. There were more than 1,000 people at the dealership party and I'll tell you the buzz and the enthusiasm were just simply incredible.

We continue to make gains in the Asia-Pacific region as well with first quarter new Harley-Davidson motorcycle sales up more than 25% from the year-ago period. And we're very pleased to see double-digit growth in Japan as they recover from last year's tragic events. We also saw a very strong growth in Asia-Pacific's emerging markets including both India and China where retail sales doubled in each of those areas during the quarter compared to last year.

So all in all, it's great to see our strategy come to life. In spite of all the good stuff I just spoke about, the most encouraging part is that I believe the best is yet to come. We believe there are many growth opportunities. In international markets, we believe we have barely half the potential. In the U.S., while we are proud of our market share gains in recent years, we believe there's a lot of room yet to run on the industry's road to the recovery. Industry volumes last year were about half of their pre-recession peak and the industry is still working through the excess of used bikes.

Harley-Davidson is growing outreach faster than core and we expect to further broaden the reach of our products in markets everywhere through these remarkable new motorcycles. When I look at all the exciting products that are in the development pipeline, seeing the results of our changes in the manufacturing and look at all the great things to come through our focus on retail excellence, I believe the opportunities for this company and this brand are tremendous.

And all of us at Harley are working harder than ever to realize these opportunities. So, thank you again for being on the call. Thanks for your continued interest in Harley-Davidson. And now let me turn it over to John Olin.

John A. Olin

Thanks, Keith, and good morning, everyone. I'll review the financial results for the first quarter starting on Slide 11.

During the quarter, Harley-Davidson, Inc. consolidated revenue was up 16.7% behind the 19.4% increase in shipments of Harley-Davidson motorcycles. Our first quarter income from continuing operations improved to $172 million, an increase of $52.8 million. Similarly, diluted earnings per share rose to $0.74 per share, up from $0.51 a share in the year-ago quarter, a 45.1% increase. Operating income from the motorcycle business was $208.1 million, up $83 million or 66.4% compared to last year's first quarter.

The strong increase in the motorcycle business was driven by increased motorcycle shipments, higher gross margin and favorable restructuring spending as compared to last year, partially offset by higher SG&A.

Operating income at Harley-Davidson Financial Services was strong during the quarter, but down slightly compared to last year's first quarter when HDFS's results were favorably impacted by a retail credit loss release of $12.7 million. We're off to a great start this year, delivering strong results as we make progress against our growth strategies and the transformation of our business.

Now let's take a look at retail sales on Slide 12. Overall, worldwide retail sales of new Harley -- of new motorcycles were up over 20% in the first quarter. This represents 11 consecutive quarters of largely improving results as we continue to invest in sustainable growth opportunities around the world. The growth trend in retail sales reflects the strong global brand and product appeal as well as the worldwide dealer efforts Keith just mentioned.

Moving on to Slide 13. Retail sales in the U.S. exceeded our expectations. During the quarter, sales in the U.S. were up 25.5% supported by momentum from the strong affinity for the Harley-Davidson brand, appealing 2012 motorcycles and improving macroeconomic conditions. Also, we believe the unusually mild weather in the first quarter, including the warmest March in 50 years, encouraged early sales to some customers who may have otherwise purchased later in the spring season.

U.S. market share strengthened by 4 percentage points to 57.4% in the first quarter versus prior year. As a result of stronger-than-expected first quarter 2012 retail sales, U.S. retail inventory at the end of the first quarter was down approximately 4,400 units compared to last year. U.S. retail inventory was at its lowest level in many years and we expect retail inventory will remain tight over the next couple of quarters. On a sequential basis, retail inventory during the quarter was up about 1,500 units from the end of last year as dealers prepared for spring.

On Slide 14, you'll see retail sales in international markets for the quarter grew 11.2%, driven by strong growth in Asia-Pacific and Latin America regions. During the first quarter, Latin America was up 85%, driven by strong performance in Brazil as the dealer network continues to gain momentum compared to last year's first quarter when we were starting the process of building a new dealer network. Retail sales in Mexico were also strong during the quarter. Retail sales in Asia-Pacific region were up 25.4%, driven by strong growth across the entire region. Canada was up 1.5% in the quarter and the EMEA region was down 1.1% for the quarter compared to 2011.

We saw year-over-year growth in some major European countries including Germany, France and Switzerland and emerging markets. But that growth was offset by declines in southern Europe and the U.K. Despite challenging retail conditions in Europe, market share continued to strengthen and through February was 13.5%, up 1.4 percentage points.

As we have discussed, international expansion is one of our core areas of investment in future growth. It's our objective to open 100 to 150 new international dealerships between 2009 in 2014. Since 2009, 67 incremental international dealerships have been opened with roughly 2/3 in emerging markets.

On Slide 15, you'll see wholesale motorcycle shipments in the quarter were up 19.4% compared to last year, and 1,300 units above the high end of our expected shipment guidance range as a result of higher-than-expected retail sales. The year-over-year increase in shipments was also aided by 6 additional days included in this year's Q1 fiscal quarter versus last year's. The fourth quarter of this year will include 5 fewer days than last year's. This adjustment is required every several years to sync up our fiscal calendar with the regular calendar.

During the first quarter, Touring as a percent of total shipments, was up versus prior year and all categories were within their historical mix ranges. As of the end of the quarter, we continue to hold a higher-than-normal level of motorcycles in our company inventory to support shipments during the ERP implementation.

On Slide 16, you'll see revenue for the Motorcycle and Related Products segment was up 19.8% in the first quarter behind strong growth from all our businesses. Motorcycle revenue was up 19.5%, behind a 19.4% increase in shipments during the first quarter. Parts and Accessories sales were up 21.1% and General Merchandise was 19.2% in the quarter driven by improved product availability, strong international sales and improved worldwide retail motorcycle sales.

On Slide 17, we have laid out the expected restructuring activities along with the impact of resulting temporary inefficiencies. This slide is intended to provide a clear view of our restructuring activities, the cadence and the impact as we head into the final innings of the restructuring plan.

As we have discussed, we're in the process of exiting our Australian wheel manufacturing operation. We are also implementing our new 7-year labor agreement and continuous improvement system at Kansas City and in Wisconsin. Also, during the quarter, we completed the consolidation of our General Merchandise and parts and accessories distribution with a third party logistics partner.

During the last call, we stated that we expected to launch our ERP implementation at York in the second quarter. We also stated that a quality launch was our top priority and that we would not launch unless we were absolutely ready. During our extensive systems test, we uncovered opportunities to further improve the design of the system and further reduce the expected downtime during launch. As a result of these learnings, we have decided to adjust the timing of the launch and now plan to launch the system in early July.

While we are anxious to complete the implementation, the new learnings and the adjusted timing provide some benefits. First, the July launch allows us to continue to produce motorcycles without the ERP production disruption during the height of the spring selling season. This is particularly attractive given the very strong first quarter retail sales. Second, the July launch is expected to slightly reduce production downtime and given the improved solution has increased our confidence in a smooth implementation with less risk. And, finally, the July implementation allows us to sync up the ERP systems launch with the start of the 2013 model year motorcycle production, which provides for a more efficient use of the normal transition period to the new model year.

As a result of the adjusted timing of the ERP, we will reallocate approximately $10 million of total expected capital to support restructuring. However, this does not change our full-year restructuring timing, cost or savings expectations.

We experienced approximately $7 million in temporary inefficiencies during the quarter and continue to expect temporary inefficiencies in 2012 to be generally in line with 2011 which were $32 million. The expected ranges for the remaining quarters are noted on the slide. Year-over-year production in the third quarter will now be negatively impacted by the ERP implementation downtime. We also expect production to be lower in Q4 than prior year due to our ability to flex production in York in the first half of 2013.

Turning to restructuring costs and savings on Slide 18. We experienced $11.5 million in restructuring expenses during the quarter and continue to expect to spend $50 million to $60 million for the full-year. We also continue to expect total ongoing annual savings of between $315 million and $335 million upon completion of our restructuring activities.

On Slide 19, you'll see gross margin in the quarter was 35.9%, which was 2.8 percentage points higher than last year. Manufacturing benefited from restructuring savings and incremental margin on higher production and foreign exchange benefited gross margin by $11 million driven by favorable hedge positions. Raw materials were negatively impacted by rising fuel and a slight increase in steel costs.

On Slide 20, operating margin as a percent of revenue for the first quarter was 16.3%, up 4.5 percentage points compared to last year's first quarter. Operating margin was favorably impacted by higher gross margin and favorable restructuring, partially offset by higher SG&A. SG&A was up roughly $33 million or 16.3% higher during the quarter compared to the same period last year. This increase was primarily driven by 6 extra days included in this year's first quarter compared to last year's fiscal calendar. Conversely, the fourth quarter of this year will have 5 fewer days compared to last year's fourth quarter and therefore, we expect Q4 SG&A to be favorable compared to last year.

This quarter's SG&A increase was also a result of investment in our growth initiatives and timing of spend within the year. As a percent of revenue, SG&A was 18.6% versus 19.2% in the same quarter last year. We continue to expect SG&A spending will increase on a year-over-year basis as we invest in growth, but will decrease as a percent of revenue through 2014.

Now, moving onto our Financial Services segment on Slide 21. HDFS operating profit decreased $0.5 million or 0.8% compared to last year's first quarter. The key drivers of the first quarter results were net interest was up $1.3 million due to favorable borrowing costs partially offset by lower revenues as our book of retail loans continues to shrink, reflecting lower motorcycle sales during the downturn. Second, the provision for retail credit losses was $6.6 million higher in the first quarter of 2012 versus the first quarter of 2011, primarily due to a $12.7 million 2011 credit loss reserve release versus a $2 million 2012 release, partially offset by lower credit losses. And finally, the provision for wholesale credit losses was $1.9 million lower in the first quarter of 2012 and operating expenses were $1.7 million lower than the same period last year.

We're very pleased with the performance of the business and believe HDFS provides a competitive advantage for sales of Harley-Davidson motorcycles and related products. Now, Larry provide more detail on HDFS' operations on Slide 22. Larry?

Lawrence G. Hund

Thanks, John, and good morning. During the first quarter, HDFS retail motorcycle loan originations increased 22.1%, or $100 million compared to the same period last year. The increase was driven by higher new motorcycle loan originations partially offset by a 0.4 percentage point decrease in retail market share of new Harley-Davidson motorcycle financing. Additionally, used motorcycle loan originations increased during the quarter. Total finance receivables outstanding decreased 3% compared to a year ago, as runoff of older retail loans exceeded new originations.

HDFS has focused on prudently increasing credit application approval rates for near prime and subprime customers over the last several quarters. The objective is to use our analytics from 20 years of motorcycle lending to approve more credit applications in well-structured loans. Our goal is to have a portfolio that continues to perform well over time and delivers an appropriate return on equity. We are very pleased with the improved retail delinquency rate and retail credit losses compared to last year, which you will see on Slide 23.

The 30-day delinquency rate for retail motorcycle loans at the end of the first quarter 2012 was 2.56% or 112 basis points better than the same date last year. Annualized retail credit losses improved by 58 basis points to 1% for the first quarter compared to last year, primarily driven by our continued strong underwriting, collection and loss mitigation efforts, as well as improving consumer credit behavior and macroeconomic conditions in the U.S.

While we [Audio Gap] disciplined in how we manage the loan portfolio and the overall business, we have no assurance that current consumer behavior will continue. At some point, shifting consumer behavior may temper the strong credit performance we have experienced. We are pleased with the continued progress at HDFS. We remain focused on enabling sales of Harley-Davidson motorcycles while providing an attractive return to Harley-Davidson Inc.

Now, I'll turn it back to John.

Keith E. Wandell

Thanks, Larry. Now let's take a look at cash and liquidity on Slide 24. You will see at the end of the quarter, we had $1.4 billion of cash and marketable securities. During the quarter, HDFS completed a $400 million medium-term note issuance at a rate of 2.7% and we contributed $200 million to our qualified pension plans. Also, as we noted on the last call, HDFS paid a $225 million dividend to Harley-Davidson Inc.

In addition, HDFS had $1.1 billion of available liquidity through bank, credit and conduit facilities. We currently have and intend to continue to maintain a minimum of 12 months of projected liquidity, these in cash and/or credit facilities. During the first quarter, we increased the quarterly dividend of $0.125 a share to $0.155 a share, a 24% increase. In addition, we repurchased approximately 254,000 shares of Harley-Davidson stock for $11.3 million during the quarter.

Our first quarter repurchase activity was lower than we had planned. Due to uncertainty around the timing of our ERP launch, we believe that it was prudent to suspend share repurchase activity until we determine the new launch timing and communicated the plan to all stakeholders. We anticipate reinitiating share repurchase activity during the second quarter.

As we have stated, returning value to our shareholders through dividends and share repurchases is a top priority. We will continue to evaluate opportunities to enhance value for our shareholders.

Now, I'll review the remaining HDFS, Inc. Financials on Slide 25. I would like to highlight one item on this slide. With regards to continuing operations, the company used operating cash of $74 million during the first quarter, compared to $105 million used in 2011. The Motorcycle business generated operating cash of $21 million during the first quarter, even after a $200 million contribution to our pension plans.

On Slide 26, you'll see that for 2012, we now expect Harley-Davidson motorcycle shipments to be between 245,000 and 250,000 motorcycles on a worldwide basis, up 5% to 7% from 2011 compared to prior guidance of up 3% to 5%. Our revised full year 2012 shipment estimate takes into account slightly improved capacity at York and increased production at Kansas City.

We continue to be committed to aggressively managing supply of new motorcycles in line with demand. In the U.S., we expect our dealers to retail more units than we ship in 2012, thereby lowering year end retail inventories in the U.S. given our flexible manufacturing capability, which we expect will be online in the first half of next year.

During the second quarter, we expect to ship between 79,000 and 84,000 units. In anticipation of the planned ERP launch and our 2013 model year cut over in July, we will significantly draw down company-owned inventory in the second quarter. In fact, production will actually be slightly lower in Q2 than in Q1 due to fewer production days.

We continue to expect full-year 2012 gross margin will be between 34 3/4% to 35 3/4% percent. We expect gross margin will be positively impacted by incremental restructuring savings, increased productivity from everyday continuous improvement and the 2012 model year pricing announced in July of 2011. We believe that raw materials surcharge and temporary inefficiencies from our restructuring activities will be comparable to 2011 levels. We expect currency to be a headwind in 2012 and now expected product mix will be slightly unfavorable for the full-year.

Finally, we expect capital expenditures to be between $190 million and $210 million, which now includes approximately $35 million of capital related to restructuring.

As we look back on the first quarter of 2012, we are very pleased to deliver strong results and progress on many fronts. Worldwide retail sales were extremely strong, driven by sales in the U.S. and regained market share in key markets. An increasing number of diverse customers are being drawn to Harley-Davidson [Audio Gap].

We increased our 2012 shipment guidance and our quarterly dividend was increased by 24% while we continue to repurchase shares. We continue to make progress toward our transformation to a world-class manufacturing and product development and the entire organization has sharpened its focus on continuous improvement across all areas of our business. We remain focused on executing against our strategies as we complete the final activities in our manufacturing restructuring. We continue to transform our organization and grow our business while delivering strong margins, strong returns and value to our shareholders. Thank you for your continued confidence and investment in Harley-Davidson.

And now, let's open the call up to your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Ed Aaron from RBC Capital Markets.

Edward Aaron - RBC Capital Markets, LLC, Research Division

You mentioned in your prepared remarks that the industry is still working off used inventory and I was hoping you could maybe just give us some color on where you are with your used situation versus your competitors. Because it does seem like your used inventory has really dried up, and I'm wondering if you having a cleaner inventory mix out there might have driven some of the market share gain in the quarter. So, I was hoping you could also maybe comment on how your used growth compares to your new bike growth for Q1.

Keith E. Wandell

When we look at Harley-Davidson in particular, in the quarter, we saw basically pricing flat or stable versus prior year and we also saw that in the fourth quarter. So we saw a lot of gains prior to that, probably 4 or 5 straight quarters and a much more flat performance in the fourth quarter and the first quarter here. When we look at overall used bike sales or kind of the growth between used and new, we did see -- would look to be an inflection point in the fourth quarter of last year where we saw, actually, new start to exceed the growth of used. And in the fourth quarter, new was up about 12% and used was up by just shy of 6%. Last year total demand for new and used was up 81.1%. And as we look in the first 2 months of this year, our data is on a month lag, so through February, total demand for Harley-Davidson motorcycles was up 22.5%. With new slightly exceeding the used growth rate, so we're pretty pleased with that and the used to new ratio was flat on a year-over-year basis.

Edward Aaron - RBC Capital Markets, LLC, Research Division

Great, that's helpful. And then just one quick follow-up and then I'll pass it on. But the change in the timing of the ERP roll out, did that affect how many bikes you kind of prebuilt in the first quarter versus what you might have expected to prebuild previously?

Keith E. Wandell

Not the changing of the ERP. In the first quarter, let's kind of take a step back in the conference call. We talked about we entered the quarter with 7,000 excess units. And at that time, we had intended to build our company-owned inventory in anticipation of the ERP launch and we also expected to build retail inventories a little bit. Moving the ERP launch did not have any impact but as we dialed forward 3 months, what we did see is that we were able to maintain the excess inventory that we had built in the fourth quarter of 2011. We still have approximately 7,000 units of excess inventory. However, our company inventory fell by 4,400 units but the movement of the ERP did not affect that. What it does affect is our ability to continue to produce throughout the second quarter in the height of the selling season, so as we looked at inventories while they're down coming into it, we have the excess inventory that we would expect to release in the quarter and feel that pretty much for the second quarter we'll be at year ago inventory levels.

Operator

And your next question comes from the line of Sharon Zackfia from William Blair.

Sharon Zackfia - William Blair & Company L.L.C., Research Division

I had a couple of questions on cadence. I think, John, you mentioned that shipments would be down in the fourth quarter year-over-year as you prepare for surge capacity in 2013. So does that still imply that you expect shipments to be positive in the third quarter with ERP? And then just secondarily on gross margin, should we assume peak gross margins then in the second quarter as well given the shipments to cadence in the second quarter?

John A. Olin

Okay, Sharon. So, kind of let's talk about the cadence driven by the ERP move. So, we had first anticipated that production would fall in the second quarter as we implemented the ERP system. Now we'll move that to July and so we would expect production to kind of continue throughout the second quarter. But that production will be down a little bit in the second quarter versus the first quarter. What we've done now is push that kind of the production out, the production reduction to July. And in doing that, we're also syncing it up with our model year 2013 product. So, when we look at the second quarter, we will have very healthy shipments into the trade. We're looking to ship in 79,000 to 84,000 units which well exceeds our year ago second quarter which was 64,000 and a lot of that is coming from inventory. So as we proceed through the second quarter, which we're starting out at very low levels of inventory, we'll ship in the vast majority of the excess 7,000 units and we'll ship out most all of the remaining 2012 product prior to July. The reason being is that, we have the new model year coming right behind ERP launch, so what we want to do is get that out into the trade. Now, the nice thing about moving the ERP system back is this is a time when dealers are typically used to having inventories that run low in anticipation of the new model year. So we've got -- we have pretty strong production in the first quarter, will be slightly down in the second quarter, it will be down in the third quarter and the fourth quarter, down in the third quarter because of the ERP launch and in the fourth quarter, because of the ability to surge up capacity at York in the first half of 2013.

Sharon Zackfia - William Blair & Company L.L.C., Research Division

And then on gross margins?

John A. Olin

Your question on gross margin was we would expect gross margin to be better in the second quarter than the third quarter because of the shift in the production. When you look quarter-over-quarter, production is down slightly from first quarter to second quarter, so gross margin would probably be pretty much in line with what we saw in the first quarter.

Operator

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

Craig R. Kennison - Robert W. Baird & Co. Incorporated, Research Division

John, what's the motivation to further de-stock your dealers? Is it to drive up residual values of your used bikes and if so, are you seeing the trade-in customer come back now that his bike is worth a little bit more?

John A. Olin

Craig, we are not motivated to further de-stock the retail trade. It certainly went down in the second quarter because of the very high retail sales in the first quarter and actually that's why we shipped a little bit over our first quarter guidance. That volume came from the fact that we're expecting to put more in inventory in anticipation of the ERP. We shipped that instead. As we said last year, we felt that as we looked at the end of the quarters 1, 2 and 3, inventories were lower than we would like on an ongoing basis and in the first quarter, we stated we like to increase inventories a bit. That was just the strong retail sales that brought retail inventories down. We do expect to have inventories tight but it is not our expectation to further de-stock the trade in the United States.

Craig R. Kennison - Robert W. Baird & Co. Incorporated, Research Division

So just to be clear, on a full-year basis, you think retail and wholesale in the U.S. will be close to 1-1?

John A. Olin

No. We will retail more than we ship. But that will happen in the fourth quarter as we get ready for the surge and our capability for flexible manufacturing in the first half of next year.

Craig R. Kennison - Robert W. Baird & Co. Incorporated, Research Division

Okay, got it. And then just on the international side if I may, you're at 67 dealers, your plan was 100 to 150 over a period of time. How many more do you think you can do in 2012? And do you ultimately think you'll be closer to that 100 or that 150 number?

Keith E. Wandell

Craig, at this point, we're just providing guidance that will be between about 100-150. We're right on plan with what we set up a couple of years ago. And we're putting up dealers every quarter but we feel great about where we're at.

Operator

And your next question comes from the line of Tim Conder from Wells Fargo Securities.

Timothy A. Conder - Wells Fargo Securities, LLC, Research Division

First of all, John, any color you can give us on the level of overtime that you've worked in the first quarter? And then, would that -- I would anticipate that that would continue in the second quarter versus what you would view as a normalized rate?

John A. Olin

We were working overtime in the first quarter. What I would characterize it was would be not full out, but we were working a fair amount of overtime. We don't believe that that's sustainable for long periods of times. We will expect to work a little bit of overtime in the second quarter as well.

Timothy A. Conder - Wells Fargo Securities, LLC, Research Division

Any quantification on that that you can give us, John, just a sort of on an ongoing basis to look at it? What -- was it kind of more of a normal rate, or how much it cost you, so to speak?

John A. Olin

No. Again, it was a moderate amount of overtime and we don't expect to do that on an ongoing basis but given the tight inventories, we're able to work it. Beyond that, not really prepared to give much more, Tim.

Timothy A. Conder - Wells Fargo Securities, LLC, Research Division

Okay, and then back to this growing gap or below where you have the -- where you would desire the U.S. channel inventories. As you alluded to earlier, you entered 2011 saying, hey we're a little bit below our ideal levels. We want to have shipments exceed retail on '11. Well, that didn't happen because of the stronger retail. The same thing you wanted to do this year, as you've already said, well, that's not going to happen now given the strength of retail. Any quantification or guidance as to where -- are you 5,000 units or so under where you ideally would like to be, whatever the base level is in the U.S. channel?

John A. Olin

Well I think overall, we're going to continue to aggressively manage supply in line with demand. So a year ago, we felt we were a little bit light and we wanted to put some more in. And, I would say a moderate amount. We're going to continue to be very prudent in what we put in the trade. But last year, it was low. Now, in the first quarter, we're 4,400 lower than we were at that point. So we would expect a fair amount to be put in. I did not say that we felt we would be done on the year. I did say that we would be tight for the remainder of the year. When we look at the second quarter which is the height of our selling season, we do have the 7,000 excess inventory. We would expect to put it into the trade in the second quarter. And I would expect most of the second quarter to be in line with year ago inventories and as we end the quarter, the second quarter, I would expect retail inventories to be higher as we ship out everything and the cadence of the timing of our model year launch is pushed back a couple of month or a couple of weeks this year. So I think we'll end the second quarter with higher inventories and that will ready us for the ERP launch and the model year switch over.

Timothy A. Conder - Wells Fargo Securities, LLC, Research Division

Okay, and so being down, retailing more than shipped, that was within a fourth quarter comment?

John A. Olin

Yes, on a full-year basis, because of the inventory, the retail inventories that we'll take down in the fourth quarter, we would expect to have our dealers retail more than we ship. That is in the fourth quarter where we don't have the pressure on sales and we'll have the fire power coming out of York given our new search capability to make the units closer to customer demand.

Timothy A. Conder - Wells Fargo Securities, LLC, Research Division

Okay, and then lastly, any type of pickup rate once you get everything implemented here? What type pick up rate that you could see on incremental sales on a go-forward basis once we see everything implemented here, say by the end of '12? Pickup rate to the operating margin, gross margin, however you want to characterize it.

John A. Olin

Well, look on the -- the Slide 12, I believe, is we would expect additional restructuring savings coming in. We're expecting restructuring savings of $58 million to $78 million incremental this year and then another $20-or so million next year. So we would expect those savings to come in according to plan as well as our spending on restructuring which is $50 million to $60 million this year, dropping off in 2013. So that should both widen gross margins as well as operating margins.

Operator

And your next question comes from the line of Rod Lache from Deutsche Bank.

Rod Lache - Deutsche Bank AG, Research Division

I was wondering, just a couple of questions still on the inventory and production and sales. At what point do you believe inventories would actually start to constrain sales or market share? And then on the production, you've produced above the high end of your expected range this quarter. Can you just kind of give us what some of the gating factors would be that would allow you to get more units out over the next couple of quarters? Is there potential to get more out if the ERP implementation goes as planned? And just lastly on the production, you've mentioned before that you won't have full flex capacity throughout the network until 2014. Can you give us a sense of where your network's capacity will be at in 2013?

Keith E. Wandell

Can you repeat the first question?

Rod Lache - Deutsche Bank AG, Research Division

Well, the first question was just when does the inventory situation start to constrain sales? Are you getting close to that point or are you still far away from it?

John A. Olin

Rod, we are -- the inventories are tight and customers coming in at this time may have to wait for a particular color or for a particular model our dealers are trading out there. We do not think that it's costing us lost sales, but in some cases, it's delaying the sale to our customers, something that we don't want on an ongoing basis, but that's where it's at. So when you say constrained sales, I don't think that we're at that point. There is inventory in the system and the dealers are working diligently to get the customer the model and the color that they want. So overall, I don't think that we're in that area, but the customers are having to wait and we don't think that they're switching brands because of that wait. And again, we're working as diligently as we can to get more production and to meet that demand, which leads me to your second question is in terms of production. We were able to exceed the guidance for the quarter, but that did not come necessarily from a lot of production, more production than we expected. We eked out a little bit more in York, but we're talking hundreds of units. Most of that came from -- we were expecting to build an excess and put it in inventory in anticipation of the ERP launch and instead, we shipped that out. So production is very tight. If the ERP implementation goes better than expectation, we could see a little bit of the capacity freed up at that time. And then, the next opportunity for production coming out of York is not until late in the fourth quarter. We do have capacity at Kansas City and as we raised our overall shipment guidance from 3% to 5% to 5% to 7%, the vast majority of that additional volume is coming out of Kansas City. So we are very constrained at York until the fourth quarter of this year.

Rod Lache - Deutsche Bank AG, Research Division

And what's the trajectory of your capacity growth? We've -- you've talked about getting to your historical peak if you look out to 2014, but is it sort of the midpoint between that and where you are this year is what you would expect to be at for 2013?

John A. Olin

Well, in terms of capacity in 2013, the constraint is at York. And in the first half we'll be able to flex production so we will be able to meet the demand of what we have in sales in 2013 through the ability to flex our production at York. We're not concerned about production or capacity in 2013.

Rod Lache - Deutsche Bank AG, Research Division

So you -- there isn't really the limitation in 2013? You're going to be at your full flex capacity in that timeframe?

John A. Olin

Well, we are looking to surge at York only. We still have the other plants to do it. But right now, capacity, there's plenty of capacity at Kansas City. So again, we will have the capacity to meet the needs of 2013.

Rod Lache - Deutsche Bank AG, Research Division

Okay, and then just last 2 things, are you still expecting this decline in HDFS. You had a $48 million decline in this releases expected, or are those expectations changing now given what you see happening in losses? And have you done any -- you're sort of modeling about just the overall weather impact maybe just by looking at the warmer states where whether is less of a factor?

Lawrence G. Hund

Rod, this is Larry. Let me take the HDFS question. I would say, we had a, as John talked about, a modest decrease in reserves here in the first quarter compared to last year. We have a very disciplined process we go through every quarter and we'll continue to evaluate that. Obviously, I think as we stated previously, we expect any reserve reductions this year to be significantly lower than the nearly $40 million that we realized last year.

Amy Giuffre

This is Amy. [Operator Instructions].

Operator

And your next question comes from the line of Felicia Hendrix from Barclays.

Felicia R. Hendrix - Barclays Capital, Research Division

Just getting another question on your flex capacity, but more from an inventory perspective. As we think about your getting to that point where you can flex your capacity at York, just wondering on a going forward basis, how we should think about inventory levels. Obviously we can't look at history to help us model this so I was just wondering if you could give us any color because your manufacturing is going to be very different now.

John A. Olin

Yes, as far as overall inventory levels, it doesn't affect really company inventory too much. But what it does affect is really trade inventory levels in the fourth quarter. So, historically, Felicia, we would start building in October, on a level basis, and a trajectory and what we would do is put that inventory in the trade and our dealers would hold it until it was alleviated in the springtime. Now, what we'll be able to do is to bring those levels down and produce when the customer wants it. And we'll be able to start surging in the beginning of the next model year. And so we'll just produce closer to demand. So the biggest change in terms of retail inventory is less inventory in the field in the fourth quarter.

Felicia R. Hendrix - Barclays Capital, Research Division

Okay, yes, that was specifically what I was asking. And so, I mean, should we think about it as having just a slight cushion built upon what we would estimate for your production? Or is it as someone said before more one-to-one?

John A. Olin

We're going to ease into this capability, so we would expect the inventories to come down a little bit in the fourth quarter, not anything huge and we'll continue to work on it. We won't be fully capable until 2014 across all of our plants. But we would expect to step down inventory in the fourth quarter and produce closer to sales in the first half.

Felicia R. Hendrix - Barclays Capital, Research Division

Okay. And just a different question than what's been asked so far. You've been getting market share. It's been very nice and very impressive. Just give if you're seeing anything from your competitors that might skew the sustainability of these market share gains?

John A. Olin

Well, I don't think we would expect to hold on to a four-point game for the entire year. We're very pleased in what we see. We know that the brand appeal is very strong. We also know that the model year 2012 product is being very well received and the 103 engine is certainly working to close that value gap between new and used. So we're going to continue to work on our side of it and develop great products and the market shall take care of itself.

Operator

And your next question comes from the line of Gerrick Johnson from BMO Capital Markets.

Gerrick L. Johnson - BMO Capital Markets U.S.

Latin America, other Asia, very big numbers there. Can you discuss maybe in a little bit more granularity the number of dealers that you have in those geographies now compared to say a year ago? And also, if you expect this kind of growth to continue or sort of moderate through the year?

John A. Olin

Well in terms of -- again, we're very pleased with what we're seeing in Asia Pacific, up 25% versus down on a year ago period, Japan is popping back after obviously the tragic events there. And then our growth in emerging markets, India and China, were up over double. When we look at the overall dealership, the incremental dealerships, Gerrick, we put in probably 30 dealers last year on a year-over-year basis. 2/3 of them are in emerging markets so they are in places like China and India, Indonesia and some in Latin America. Those, are not included, the ones in Brazil because those were replacement dealerships. So they are ending up in those areas, they're driving great growth, our emerging growth markets -- or emerging growth markets are growing at a much faster rate than the rest of Europe, easy for me to say so, and they are partially driven by the incremental dealerships.

Operator

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

Patrick Archambault - Goldman Sachs Group Inc., Research Division

I just wanted one clarification in terms of the decision to move the York, the SAP implementation at York. I mean, the 3 reasons you outlined seem highly logical. Was it just kind of opportunistic to do it at a better time? Or were there any other issues where you thought that maybe the preparedness wasn't where you needed it to be to do it in Q2 that also led to that decision? And then, I guess just on the back of that, in terms of Q3, can you help us think a little bit about how -- I mean you've said something already on it, but I think you were talking about one month that was going to be down 40% at York previously at the peak of the implementation, is that still the kind of production cadence we should be thinking about for Q3 now?

John A. Olin

Great, Patrick. With regards to the ERP launch, no, it was driven by the testing that we were doing. We do all kinds of tests and one of the tests that we do is the shop floor test. And basically what we do is disconnect all the old systems, put the new system in and they are able to test that system along with the operational processes. And what we discovered is that in the parts and handling area, we had basically more complexity than we needed. And that complexity didn't come with the commensurate benefit. So as we said before, we are not launching this thing until absolutely ready. So we stepped back and took the time to change a few things in the design, which will take complexity out and therefore, de-risk it a little bit. And given that, we've pushed it back and then we talked about the 3 or so benefits that are associated with that, one being more confidence in our launch and less time to ramp it up. So we will reach that a little bit more on production coming out. And that leads to your next question is in the third quarter, it's still in the 40% range. I mean, we're hoping to get a little bit more capacity out because we've got an improved solution, but we are still in the range of 40% of one month's production being down because of the ERP implementation.

Operator

And your next question comes from the line of James Hardiman from Longbow Research.

James Hardiman - Longbow Research LLC

My question is surrounding the guidance. I think the similar question was asked coming out of the fourth quarter when 245,000 units was the high end of your guidance and the question was asked to the extent that you need to go above that, would you be able to -- does that represent the upper ceiling or could you get beyond that. And the answer at that time was that maybe, come the fourth quarter, once things are behind us, you could get above that 245,000. Fast forward to today, the upper end is 250,000 and at the same time, you've pushed back the SAP implementation. But ultimately, the same question, if retail is such that you're exceedingly low in terms of retail level inventories in the fourth quarter, is there still an opportunity to do some catch-up and is there still potentially some upside to that 250 based on how retail trends play out?

Keith E. Wandell

Yes, so let's talk about getting to the 250,000. So we boosted couple of percentage points of about 5,000 units. The vast majority of that is coming from Kansas City products. And we couldn't be more thrilled that the demand for those products, which are largely directed at outreach customers are doing very well and so we got strong demand. So we are taking the volume up, but the vast majority of it is coming from Kansas City. As I said we're eking out a little bit more production out of York. We do have more capacity in DC. So that's not an issue. And when we looked at York, we are running very tight and we'll continue to do so into the fourth quarter. However, in the fourth quarter, we do have some down days planned that we could run and we could generate capacity in the fourth quarter. The question at that time is, really looking at the overall trade because we'll have the capacity -- the capability to flex our production up even closer to when of those units are going to want to be consumed in the spring given our surge capability at York and we'll evaluate that at that time.

Operator

And your next question comes from the line of Greg Badishkanian from Citigroup.

Gregory R. Badishkanian - Citigroup Inc, Research Division

Just in terms of, I mean, the retail was so strong in the first quarter. I know you pulled forward some demand but I'm guessing that there's still some strength underlying fundamental strength. Any way to kind of break that out and quantify that at all?

John A. Olin

Well, we think it's clearly an extension of what we've been seeing on the improving retail sales trends. And it was largely driven by incredible feel for the brand. Again our share was up, we're up 25.5% in the U.S. and the industry was up 17.5%, that means all of our competition was up just over 8%. So a lot of it, it's been driven by again a strong brand. We talked about the new model year, the 103 engine is pulling a lot and then the improving underlying macroeconomic trends in the U.S. We do believe that some of it, to a lesser extent, was driven by the very favorable weather conditions and spring started a little bit early. We've done the analysis of looking at northern states versus southern states and we do see a slight improvement in growth rate in the northern states. I don't think it's anything huge, but there is a weather effect that we saw in the first quarter. And so, we would expect retail sales to moderate a little bit as we move into the spring selling season.

Operator

And your final question comes from the line of Robin Farley from UBS.

Robin M. Farley - UBS Investment Bank, Research Division

I wanted to ask a question about HDFS and something related to the change in prime versus subprime versus the last couple of quarters you reported. But I also wanted to clarify your comments about the production that you're doing in advance and holding onto and not shipping because during the call, you said that you maintained that excess of 7,000 bikes in inventory. But then you also made a comment that company inventory fell by 4,400 units so I just wanted to clarify kind of which of those things -- just to get a sense of where that bikes built but not shipped stands cumulatively from both Q4 and Q1 at this point. And then also just to sort of understand how, although you can hold those and ship them later, if you're doing that ahead of Q3 but your new model year starts in July, you'll be shipping old model year bikes after the new model year starts? Or you'll be delaying the new model year start? Just trying to understand how the bikes built in previous quarters can be held over once the new model year starts?

Keith E. Wandell

Robin, the 7,000 units we brought into the year, we held through the first quarter and we still have them. What I referred to is that retail inventory, the field inventory fell by 4,400 units. Our company inventory is still up. I also said that given the fact that we now moved the ERP to July and we synced that up with the model year 2013 new product launch that we will release those 7,000 prior to the third quarter, we will release them in the second quarter and that's what's driving some of our shipment in the second quarter so high is they're coming out of inventory. So in the U.S., we will ship as much as we can of model year 2012 product out in the second quarter versus the third quarter because when we cut the system over, we will begin making 2013 product and we want to get everything out so that the dealers can sell them down in anticipation of the new model year.

Lawrence G. Hund

And regarding the HDFS mix, I'd say what we saw this quarter was a slight shift towards more subprime in our mix. We have in previous quarters talked about it being 80% to 85% prime. This quarter was more around 80%. And 2 things going on there, the first is as we've talked about is our efforts to improve our analytical modeling to be able to approve more new prime and subprime customers and then we continue to see increasing competition in the prime lending space.

Keith E. Wandell

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

Amy Giuffre

The audio and visuals supporting today's call will be available at www.harley-davidson.com. The audio can be accessed until May 8 by calling (404) 537-3406 or (855) 859-2056 in the U.S. The pin number is 65016753#.

We expect to report our second quarter earnings on July 31, 2012 and we'll publish a reminder notice about one month prior to that date. If you have any questions, contact us at (414) 343-8002. Thanks.

Operator

And this concludes today's conference call. You may now disconnect.

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