Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Harley-Davidson, Inc. (NYSE:HOG)

Q2 2008 Earnings Call

July 17, 2008 9:00 am ET

Executives

Amy Guiffre – Director of Investor Relations

James L. Ziemer – President, Chief Executive Officer & Director

Saiyid T. Naqvi – President Harley-Davidson Financial Services

Perry Glassgow – Vice President, Treasurer & Acting HDFS Chief Financial Officer

John A. Olin – Vice President & Controller

Analysts

Craig Kennison – Robert W. Baird & Company

Tim Conder – Wachovia

Ed Aaron – RBC Capital Markets

Anthony Powell – Lehman Brothers

Robin Farley – UBS

Patrick Archibold - Goldman Sachs

Tony Gikas – Piper Jaffray

Operator

Welcome to the Harley-Davidson second quarter 2008 earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host Amy Guiffre.

Amy Guiffre

Good morning everyone and welcome to Harley-Davidson’s second quarter 2008 conference call. Today we will comment on our second quarter financial performance, Harley-Davidson motorcycle retail sales, the actions we took last quarter in response to the US economy and other thoughts about our business. Tom Bergmann, Harley-Davidson, Inc.’s CFO will not be participating on the call today as he is attending a funeral so we’ve adjusted the structure of the call slightly.

As usual, CEO Jim Ziemer will provide his comments on the business and today he will share the financial results for the second quarter. Saiyid Naqvi, President of Harley-Davidson Financial Services will talk about the performance of that business unit. Then, Jim will share the consolidated financials, the outlook for the business and some closing thoughts. Harley-Davidson, Inc. Vice President, Treasure and Acting HDFS CFO Perry Glassgow and Harley-Davidson Vice President and Controller John Olin will participate in the Q&A portion of today’s call.

Before we begin please note that this call is being webcast live on www.Harley-Davidson.com and will be available for replay throughout the next several weeks before being archived. It can also be accessed until July 24th by calling 706-645-9291, pin number 50429408#. Our comments today will include forward-looking statements that are subject to risks that could cause actual results to be materially different. Those risks include among others matters we have noted in our latest earnings release and filings with the SEC. Harley-Davidson disclaims any obligation to update the information in this call. Now, I’d like to turn the call over to CEO and President of Harley-Davidson, Inc. Jim Ziemer.

James L. Ziemer

I believe there are three key points to keep in mind about the year so far and the road ahead: first, although the economy continues to make this a very tough operating environment in the US, we believe Harley-Davidson has positioned itself appropriately to deal with this environment based on what we know today; second, we continue to see strength in international retail sales and we believe the international markets will continue to play a growing role in the overall picture for Harley-Davidson; and third, Harley-Davidson has always managed the business for the long term and we’ll continue to do so.

So, let me talk about each of these starting with the current economic environment and what Harley-Davidson is doing to deal with it. We’re now more than half way through 2008. The US economic climate continues to be challenging to put it mildly and it is unclear when the economy or consumer confidence might start turning around. Looking back on April 17th announcement to reduce Harley-Davidson motorcycle shipments, I’m more convinced than ever that we made the right call. The majority of the announced shipment reduction took place during the quarter. To accomplish this we shut down our plants for an average of 15 days. As you know, our April decision to reduce shipments honors our commitment to ship fewer Harley-Davidson motorcycles to dealers worldwide than we anticipate they will see during 2008. This action has done much to position the company and the dealer network for the current climate. While inventory is varies from dealer-to-dealer, in general they are at an appropriate level as we head in to the 2009 model year next week.

I want to acknowledge our dealers and give them credit for everything they are doing to sell Harley-Davidson and deal motorcycles and to fulfill the dreams of the customer’s in today’s economy. Over the years we’ve worked closely with them to make sure they’re the best in the industry and we will continue to do so as we navigate the current uncertain loads. Related to the shipment reduction the work force reduction action plan also announced on April 17th was finalized during the quarter. The targeted reduction of 730 positions will be achieved through a combination of voluntary retirements, elimination of some contract workers, employee terminations, layoffs and attrition. We came in under the expected $20 to $25 million implementation charges, recording a one-time charge of $11.5 million. As a result of the work force reduction we still expect an ongoing angle benefit of $35 to $40 million starting in 2009.

As we said, the decision to reduce shipments with its impact on the workforce has been difficult for everyone at the company. However, I believe these actions were the right ones for the long term interest of all our stakeholders during what we expect to be a continued tough retail environment in the US throughout 2008.

Now, let’s turn to my second key point; international sales. Once again our dealers put up strong retail numbers growing 11.2% for the quarter. Our international growth is the result of the company’s strategic focus and global markets. In June, European dealers sold the first XR1200 units to customers who eagerly anticipated the race inspired motorcycle. Dealer motorcycle sales in Latin America were 67% largely delivered by the soaring retail sales in Brazil. At the same time, we’re keeping a close eye on the health of our international markets for possible changes in economic conditions just as we do in the US. We’ll continue to manage each market in which we do business appropriately.

Going forward, Harley-Davidson will continue its investments in international markets to drive future growth and in support of our long term strategy. Last Friday’s announcement of a plan to acquire MV Agusta Group is a prime example of this global strategy in action. This acquisition represents an attractive strategic opportunity to complement the Harley-Davidson and Buell motorcycle family’s presence and for [inaudible] in Europe and deepen our credibility and penetration in to performance motorcycles. This represents over 70% of the European market. It is also a prime example of our long term focus as we do not expect that acquisition to have a immediately impact on the overall HTI business which brings me to my third and final key point.

Harley-Davidson always manages the business for the long term. We will continue to do so. I know it is something I repeat frequently and in the current economy it’s more important than ever to keep in mind. Managing the business for the long term is part and parcel of maintaining a premium brand experience. We have strong fundamentals and are fortunate to be dealing with the current climate from a sound financial position. Economic downturn in the US will end and when it does Harley-Davidson intends to be well positioned to capture future growth opportunities. I’ll say more about this later.

Now, I will discuss the financial results for the second quarter of 2008 for the motorcycles and related product segments compared to the second quarter of 2007. I’ll start by looking at our dealer retailer performance. On a worldwide basis retail sales of Harley-Davidson motorcycles by our dealers were down 3.6% for the quarter compared to a year ago. Retail sales of new Harley-Davidson motorcycles in the US decreased 8.7% in the second quarter of 2008 compared to the same period in 2007. Overall, US 651CC plus motorcycle market increased .8% in the second quarter.

To understand our US dealers’ retail sales performance in the second quarter the numbers on a year ago retail sales were significantly aided by the stick it to the man financing promotion that we offered from late May through the end of July last year. This promotion was initiated to reduce 07 model year carryover inventory resulting from a disappointing start to the calendar year 2007 retail sales. At that time we stated that financing promotions would not play a significant role in selling our motorcycles in the future. This year in April, we reduced production to address the US retail situation. I believe this was the best way to protect the brand and manage the business for the long term. While we have not repeated the year ago financing promotion, our competitors have been busy implementing low financing offers and other promotional activities to sell both new and old model year motorcycles. These promotional devices have appeared to drive unit sales in the US industry this quarter.

As I mentioned earlier our international dealer’s growth continued as second quarter retail sales increased 11.2% compared to the same quarter last year. Retail sales of Harley-Davidson motorcycle sales in Canada were up 8.7%. Europe region was up 9.0% and the Asia Pacific region was up 7.3% and the Latin America region was up 67.1%. Now, looking at the wholesale motorcycle shipments for the quarter, worldwide Harley-Davidson motorcycle shipments were 80,326 units which was a decrease of 15.6% from the second quarter 2007 but slightly exceeded our quarter two shipment guidance of 76,000 to 80,000 units. Domestic shipments of 51,429 units for the quarter were down 24.3% from the second quarter of 2007 reflecting the impact of the shipment reduction we announced on April 17th. The domestic shipping volume represents 64.1% of the total volume shipped to the worldwide dealers down from 71.4% a year ago. International shipments of 28,877 units were up 6.3% compared to the same quarter last year. International shipments increased to 35.9% of our total worldwide second quarter shipment volume compared to 28.6% in second quarter of 2007.

For the third quarter 2008 we expect to ship between 74,000 and 78,000 Harley-Davidson motorcycles. For the full year 2008 we still plan to ship between [inaudible] 7,500 units of Harley-Davidson motorcycles. As you know, I’ve committed to ship fewer motorcycles than we expect our dealers will sell at retail in 2008. Last quarter, based on the retail outlook for the US we made the difficult decision to reduce wholesale shipments. This action was intended to strict a balance between the need for dealers to have an appropriate inventory levels to meet retail demand as they entered the busiest selling part of the year while at the same time to ensure they exit the model year with an appropriate amount of carryover inventory. At the end of the second quarter 2008, US dealer network generally had lower inventory than one year ago. I believe our dealers’ current inventory levels partway position them to begin selling model year 09 motorcycles that will be introduced next week.

Now, let’s turn to mix. As we anticipated, shipment mix was disrupted by the shipment reduction in the second quarter. Touring volume was 31.4% of the total shipments in the second quarter of 2008. That compares to 36.3% in 2007. Custom shipment volume representing our soft-tail, Dyna, VRSC, that’s v-rod liquid cooled motorcycles was 52.2% in the second quarter of 2008 compared to 41.1% for the second quarter 2007. [Inaudible] motorcycle mix was 1116.4% of the total mix for the second quarter 2008 compared to 22.1% in the second quarter last year as we resolve the shipments of our two new soft-tail models, the Rocker and the Crossbones. Additionally shipments of and demand for the Dyna family increased as a result of the fat bottom model and selective MSRP adjustments at the beginning of the model year last year. We will continue to balance shipments between our major motorcycle families based on forecast customer demand.

Now, turning to revenue. Revenue from Harley-Davidson motorcycles was $1.19 billion down 5.3% from the second quarter 2007. Average revenue per Harley-Davidson unit increased $1,594, 12.1% for the year ago quarter. This increase can be primarily attributed to the favorable mix, favorable foreign exchange rates, increased pricing and the absence of spending associated with the second quarter 2007, stick to the main financing promotion.

Revenue from products and accessories was $267.7 million for the quarter which is up .9% over the year ago quarter. This increase was widely driven by increased sales of genuine parts, partially offset by lower general accessory sales. General merchandise revenue was $76.8 million, an increase of 5.6% for $4.1 million. This increase is primarily driven the strong sales of leathers, riding gear and sportswear.

Let’s take a look at gross and operating margins which will adversely impact by shipment reduction. Gross margin in the quarter was 35.78% of revenue down from 37.4% in the second quarter 2007. During the quarter there are a number of factors that negatively affected gross margins. The primary drivers were the allocation of fixed costs, over 15,000 fewer units and increased product costs. Operating margin for the second quarter 2008 decreased to 20.1% from 23.9% during the second quarter of 2007. Operating margins were impacted by lower gross margins and increased SG&A spending on lower revenue. The increase in SG&A spending includes the one-time charge of $11.5 million related to the special determination benefits for those employees who are eligible. Also, international spending was higher.

Now, I’ll review Harley-Davidson Financial Services segment results for the second quarter. H-Davidson Financial Services [inaudible] second quarter operating income of $37.1 million, a decrease of $28.1 million or 43% compared to last year’s second quarter. The decrease is primarily due to a $19.5 million reduction in the securitizations gain, a $6.3 million write down in retained securitization interest and an increase in the provision for credit losses which was partially offset by increases in net interest income. Last year’s second quarter results benefitted from a $950 million securitization transaction which generated $19.5 million securitization gain compared to no securitization gain in the second quarter of 2008.

During the quarter HDFS elected to diversify its financing services through the issuance of medium term notes rather than access the securitization market. HDFS issued $1 billion in 10 year fixed rate unsecured medium term notes in May of 2008 in a transaction that was well received by investors. In addition, yesterday HDI and HDFS entered in to new bank credit facilities totaling $1.9 billion. These facilities are made up of $950 million 364 day and a $950 million three year facility which replaced existing bank facilities which totaled $1.7 billion. The debt capital markets remain challenging. While we’re in the first six months of the year HDFS accessed the securitization medium term note and bank debt markets and HDFS continues to believe these markets will remain available to them in future periods. HDFS’ balance sheet continues to be cap wide with over $900 million of equity and strong balance sheet ratios.

Now, I’ll turn it over to Saiyid who will provide comments on HDFS’ operations and portfolio performance.

Saiyid T. Naqvi

As Jim mentioned, second quarter results were impacted by the decision to diversify our financing sources away from the securitization market as we continue to deal with the challenging economic conditions. For the first six months of 2008 HDFS originated $1.6 billion in retail motorcycle loans compared to $1.7 billion during the first six months of 2007. HDFS’ retail market share of new motorcycles sold in the US was 52.4% for the first six months of 2008 compared to 53.3% in the prior year period. The decrease in market share is attributable to the motor company sponsored stick it to man financing promotion which positively impacted HDFS’ market share in the second quarter of 2007. Partially offsetting the impact in the reduction of market share on HDFS volume was strong growth in the used bike financing activity.

In terms of credit performance, the 30 plus day delinquency rate for managed retail motorcycle loans was 4.65% at the end of the second quarter of 2008 compared to 4.36% at the end of the second quarter of 2007. Consistent with seasonal trends of the past several years, delinquencies decline in the first quarter of 2008. While year-over-year delinquencies rose in the quarter we are encouraged by the slowing rate of increase in this economic environment. Analyzed credit losses on managed retail motorcycle loans were 2.14% for the first six months of 2008 compared to 1.63% for the same period in 2007. The year-over-year increase in losses was driven by a higher instance of loss primarily due to the higher year-over-year delinquencies. However, including recovery values on used Harley-Davidson motorcycles partially offset the higher instance of loss.

As I look at last quarter, we have taken a number of steps to improve the performance of our retail loan portfolio. Although still higher than we would like, the delinquency rates are improving as a result of the changes we have made in our collection and loss mitigation activities. On the other hand, the changes and enhancements we have made in our underwriting criteria will take longer to impact portfolio performance but we are confident those changes will result in improved performance in the future. While we are seeing improved portfolio trends we still expect credit losses in 2008 to exceed prior year levels. During the second quarter we increased our allowance for credit losses by $5.8 million due to our concerns over the ongoing weakness of the US economy.

In addition, our quarterly review and evaluation of the assumptions used to value our retail securitization interests resulted in a write down this quarter. Due to higher credit losses in certain 2005 and 2006 transactions HDFS recognized a $6.3 million permanent impairment loss during the second quarter of 2008. Even in this tough credit environment, we continue to maintain our commitment to dealers and their customers to lend across a broad credit spectrum. The percentage of subprime loans outstanding remains within our historical range of 30% to 35% of managed retail loan receivables and subprime originations in the second quarter are at lower loan-to-values reflecting a better overall credit profile for new loans.

Clearly, today’s economic environment remains challenging for HDFS as it does for most companies in the financial services sector. However, we continue to believe that we are taking the right actions to meet those challenges. With that, I’ll turn it back to you Jim.

James L. Ziemer

Now shifting gears to Harley-Davidson Inc.’s consolidated financial results. Cash and marketable securities totaled $803.9 million as of June 29, 2008. Cash used by operations was $39 million during the first six months of 2008 compared to $1.06 billion of cash provided during the first half of 2007. This decrease in cash flows from operations was a result of net proceeds from the securitization, the $1.27 billion less in the same period in 2007.

During the first half of 2008 HDFS funded a greater percentage of its business with proceeds from commercial paper and medium term notes than it did in the same period last year. While HDFS’ decision to fund more of its business through commercial paper and medium term notes does have an impact on our operating cash flow it does not impact the overall cash flows of the company. Cash flows related to HDFS’ borrowing activity which are included in the financing cash flows were $1.4 billion higher in the first six months of 2008 than in the same period last year. During the first six months of 2008 depreciation was $102.6 million, capital expenditures were $99.6 million. For the full year 2008, we continue to expect capital expenditures to be between $235 to $250 million.

Turning to our share repurchases for the quarter. The company repurchased 1.3 million shares for $50 million compared to 6.7 million shares for $430 million in the second quarter of last year. We believe share repurchases continue to be a good use of free cash and an efficient way to return value to our shareholders. Our strategy is to continue to opportunistically repurchase shares while we believe they are undervalued and when we have available free cash flow. As of June 29, 2008, there were 235.3 million shares of common stock outstanding and 19.3 million share remaining on the board approved share repurchase authorization. An additional board approved authorization is in place to offset option exercises.

The second quarter effective income tax rate was 36.0% compared to 35.5% in the same quarter last year. This increase was due to the expiration of the federal research and development tax credit as of December 31, 2007. Assuming the retroactive reinstatement of this tax credit, we expect the full year effective income tax rate in 2008 to be 35.5%. So, all in all, net income was $222.8 million in the second quarter, down $67.7 million or 23.3% from the same period last year. Diluted earnings per share for the second quarter were $0.95 a decrease of 16.7% from the year ago quarter. Considering our outlook for the remainder of 2008, combined with our performance for the first six months of the year, we continue to expect that earnings per share for the full year will be between $3.00 and $3.18.

Before I wrap it up, keep in mind my three key points: first, although the economy continues to make this a very tough operating environment in the US we believe Harley-Davidson has positioned itself appropriately to deal with this environment based on what we know today; second, we continue to see strength in international retail sales and we believe the international markets will continue to play a growing role in the overall picture of Harley-Davidson; and third, Harley-Davidson has always managed the business for the long term and we will continue to do so. We will continue to invest in the business and enhance the Harley-Davidson experience for current customers and continue to increase our initiatives to reach new customers.

Just last weekend we celebrated the grand opening of the Harley-Davidson Museum. I’m proud to say that everyone I’ve talked to was absolutely blown away by the quality of the museum experience. The media coverage is flowing in, mostly glowing reports about the fact that the museum is just as fascinating for those who don’t know the first thing about a Harley as it is for those who can recite the technical specifications for a 1964 dual-glide. During the grand opening events I took the next step on my own personal journey with Harley-Davidson by getting my first [crafts last] tattoo. Next time I see you I’ll show you the Harley-Davidson bar and shield that is now part of my right arm.

This coming Tuesday in Las Vegas we unveil the 2009 Harley-Davidson and Buell product line to the worldwide dealer network. The new model launch is always a highlight of every year for the company and the dealers. Then in another month, we’ll be in the thick of our 150th anniversary events. We’re expecting thousands upon thousands of Harley riders to celebrate on the open road and over the course of four days here in Milwaukee with great bands and a full slate of events. Our anniversary celebration is also designed to outreach to new audiences like never before. So, all in all, even though the US economy continues to be tough there’s a great air of excitement around Harley-Davidson these days. With everything we’ve got going for us I continue to be confident about our long term future and all the great opportunities that lay ahead.

Now, Saiyid, Perry and John will join me and we’ll open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is coming from Craig Kennison – Robert W. Baird & Company.

Craig Kennison – Robert W. Baird & Company

A question on dealer inventory, it dropped in the US to 52 bikes per dealer according to our math versus 71 last year. A couple of questions there, first of all are you seeing correlation to price? In other words are you seeing price improve in the channel?

James L. Ziemer

Number one you are right that average inventories at the dealers in the US significantly dropped. I won’t comment on your math but it significantly dropped. And, as we watch it, our thing again is to make sure that in a challenging economic environment that we have low inventory, that was our goal, so that the dealers can deal with the market forces and that does reflect in the prices. I mean, on the average new bike sales are occurring at or above MSRP, on average. Now, that’s average, there may be some below that and some above it but on average it’s at or above and, used bike sales are very robust.

Craig Kennison – Robert W. Baird & Company

And then could you comment on the new allocation process and the role that’s playing in pricing as well?

James L. Ziemer

The allocation process has been out there for about nine months. Unfortunately, we’ve disrupted it twice with a shutdown in production both in December and one in June. That causes, as this is formula driven, it causes disruptions in the formulas. But, with that being said, we’re in a better position than we were last year and that’s in total dealer inventory. The disruptions occurred on a dealer-by-dealer basis. Some dealers have a more appropriate level of inventories, actually some dealers are short on different models. So, as this thing plays out and we are appropriately positioned for the current economy this will work its way out and we will be better positioned as we go forward.

Craig Kennison – Robert W. Baird & Company

Relative to average selling prices at the wholesale level, they were up 12%. I know a lot of that is mix but would you expect a reversal on that trend as the mix shifts back to a normal level? Or, might we see average selling prices much higher this year?

James L. Ziemer

Although we don’t forecast it, there’s no doubt that as I said in my commentary we did disrupt the normal shipment pattern and [inaudible] are both attributed to by the shut down as well as we’re trying to get some new models out there, the Crossbones and the Rocker which came out in January so they weren’t in dealer inventories at all. So, both those things did skew greatly in spite the mix and I expect it to come back closer to historical levels as we go forward.

Craig Kennison – Robert W. Baird & Company

But you wouldn’t necessarily expect a meaningful drop in that metric to offset the meaningful gain in the second quarter?

James L. Ziemer

I’d expect a drop and it probably wouldn’t seem meaningful but, it’s going to drop quite a bit.

Operator

Our next question comes from Tim Conder – Wachovia.

Tim Conder – Wachovia

A couple of items here, a little more color on the margins. Jim you commented about the severance how that impacted the overall operating margin here and the overhead absorption and you talked about mix. Was there also an inventory parts reserve that you took in the quarter? It seems like I remember you commenting on that in your last call. And then also you alluded to some higher input costs. What were those year-over-year material surcharges in the quarter?

James L. Ziemer

Several things, pretty much the tone of my preamble here, as for inventory whenever you cut off production earlier than expected, you’re going to have some outsources. It was minimal so that was not a big impact on the quarter. There’s always some adjustments in reserves in parts as you may have a little more than you need as you cut off production but that was not a materially big number. For surcharges in the quarter, I’ll compare surcharges this year versus last year. In the quarter surcharges were about $2.3 million higher than they were last year. Material, when I talk about material I’m looking at product content, future changes year-over-year and you always have those but that contributed a significant increase in the average costs of the motorcycles especially in some of the models that we had a greater percentage mix on. We can maybe talk later on what that number was. But, as I said, the two primary drivers were again the 15,000 share units on overhead, that is a significant, the biggest impact of anything but there were many drivers. Then, I look at the year-over-year comparison of features on the motorcycles and that drove some significant product cost increases so we’re talking about mainly our feature changes year-over-year.

Tim Conder – Wachovia

Regarding HDFS and your ability on the balance sheet, if the securitization market remains closed, what do you view the company’s capacity to bring loans and keep those on the balance sheet as you did in the second quarter? I mean, how far given cash flow and access to the markets, I guess how well can you go without maybe impairing a credit rating of not only HDFS but Harley-Davidson Corp.

Saiyid T. Naqvi

Well, we’ve taken a look at our production numbers and one of the reasons I went out and secured additional liquidity was to not be subject just to the securities market. We feel comfortable that we have the capacity to certainly go through this year and potentially even next year but the securities market is still available to us, we just don’t particularly like the spreads that it’s commanding. So, we are really not concerned about the liquidity issue per say because we can always go to the securities market and plus we have plenty of liquidity to carry us in to next year.

Tim Conder – Wachovia

So basically, if I’m hearing you right you’re fine at least this year, maybe through early next year without going to the securities market and without impairing the credit rating?

Saiyid T. Naqvi

Yes.

Tim Conder – Wachovia

And a long that line Saiyid, the new bank line that you guys mentioned here, is there anything at the end of the quarter drawn on that line?

Perry Glassgow

Typically drawn facilities they’re to support our Canadian international operation [inaudible] prior years. But, that’s usually what we use it for. It’s primarily a backup liquidity facility for our commercial paper program.

Tim Conder – Wachovia

What’s the balance on that Perry?

Perry Glassgow

The balance of the availability at the end of the quarter was about $1 billion if you add back the excess cash at the HDFS level.

Tim Conder – Wachovia

So about $1 billion available?

Perry Glassgow

Yes.

Tim Conder – Wachovia

Two last questions, one on HDFS also here, Saiyid you mentioned an increase in used as a percent of your total loans. What is the mix there during the quarter or kind of ongoing basis of new versus used loans?

Saiyid T. Naqvi

We generally don’t break it out that way. But, I will tell you that we had approximately a 10% increase in our used volume year-over-year from a financing standpoint. The trend in the used market is very strong, HD values have been going up. In fact, they’ve seen used bike values go up every month for the last four months and that’s a very positive trend for the brand and for our portfolio.

Tim Conder – Wachovia

We’ve heard many dealers looking for additional used inventory also. Finally, Jim back to the quarter, how much did foreign ex contribute to the sales and the EBIT line in the quarter?

James L. Ziemer

When we look at foreign exchange for the quarter on the revenue line it was about $48 million and for the EBIT line it was approximately just shy of $20 million so it was a very strong quarter in foreign exchange driven a lot by the Euro and secondarily by the Yen.

Operator

Your next question comes from Ed Aaron – RBC Capital Markets.

Ed Aaron – RBC Capital Markets

A couple of questions, I wanted to follow up on Craig’s earlier question about mix. You mentioned expectations for it to revert to a more normal level but it seems like in the motorcycle market in general the trends are more favorable at lower price points. I was wondering if first if you shared that thought? And then secondly, if you think that might cause the mix to revert somewhat below the historical mean as we go forward here?

James L. Ziemer

My response to Craig, I said that we had some rather abnormal mix levels this quarter and we would go closer to historical, I didn’t say we’d go back to historical. We’re going to continue to monitor what’s going on in the field and support the demand the best we can based on balancing our factories and suppliers with trying to get back. There’s no doubt as we go through this economic times in the US that as we see strength in used bike sales that’s a great indication that there is some price pressure out there. As we’ve seen that our competition has had some success this quarter by their significant financing offers and rebate offers, that there is some price sensitivity so we’ll continue to look at that. That will play itself out not just in mix between the families but it will play itself out within our models within the family so we’ll continue to watch that. We may not even see so much of a change driven between families but we may see the change play out in the models within the family.

Ed Aaron – RBC Capital Markets

Then on HDFS Tim had asked a question about how much capacity is there on the balance sheet to put additional loans on there. When you look at similar businesses what’s an acceptable or normal leverage ratio for this type of business? And, where do you stand today relative to that leverage ratio? And then also just to discuss the cash from operations I know that obviously keeping these loans on the balance sheet affected that number. Could you give us some idea what the cash from operations would have looked like on the year-over-year basis without that dynamic in place because I think in the press release there’s only a consolidated operating cash flow number.

James L. Ziemer

I’ll let Saiyid take the first question on the typical capitalization measurement. They’re always unique and there’s nothing exactly like our company whether it be the motorcycle company or finance company but I think we can give you a range of what would be an appropriate capitalization.

Saiyid T. Naqvi

As you know, we have different products that we offer out there. We have wholesale product and we have certainly the retail product so when you look at leverage overall, I think nine to one is going to be a pretty good number. And as far the cash utilization, I’ll let Perry respond to that aspect of it in terms of what we have.

Perry Glassgow

I believe the question was what would the cash levels look like if a securitization had occurred in the first quarter. If you ignore the securitization impact and the retail loan activity impact the cash flow of the corporation would have been slightly lower than this time last year. That’s the easy answer to that question.

James L. Ziemer

So cash flow would not have changed.

Perry Glassgow

Correct.

James L. Ziemer

Ed’s question was basically on the operation line which is the financing line and that was significantly different, what I think my commentary said was about $1.3 or $1.2 billion dollars different, it would be higher this year than last year.

Operator

Our next question is coming from Anthony Powell – Lehman Brothers.

Anthony Powell – Lehman Brothers

I have a question on the restructure charge, it came in less than we expected this quarter, do you expect any of that in the third quarter or is that it for the restructure charges?

James L. Ziemer

This is our best effort on the restructure charges, we have a very good feel for it and we don’t anticipate anything in the future quarters.

Anthony Powell – Lehman Brothers

You also mentioned that in Europe you’re modeling the macro environment as you do in the US. What are you biggest markets in Europe by country? And, what do you see in the macroeconomic outlook for those particular countries?

James L. Ziemer

Our biggest countries in Europe would be the biggest one is Germany followed very closely by Italy and then UK and France and that’s heavyweight motorcycle markets for us which pretty much mirrors what it is for the industry. As we look at the economy we see, as everybody else reads, UK and Spain are feeling some softness in various parts of the economic parts of their markets driven by different reasons and we see some impact on us, not a direct relationship between what’s going on in the economy and our sales. I haven’t seen anything – we’ve seen something in the UK and basically Spain a little bit but other than that the rest of the markets remain strong. As indicated, we’re up 9% versus last year for the same quarters so we’re still going good. But, there was a little softness in the UK.

Anthony Powell – Lehman Brothers

Just on the custom 52% number this quarter, I guess a lot of it was driven by the new products. Do you see an opportunity to grow your shipment of your new bikes in the next few quarters or do you want to get back to the more normalized mix of bikes?

James L. Ziemer

Well, we’ve got, as I mentioned also, we’ve got a new model year announcement for worldwide delivery that comes up next Tuesday in Las Vegas. [Inaudible] 6,000 of my closet friends and we have some exciting products and unfortunately timing of this call and that I can’t tell you today what those products are but that will have an impact on our mix also. As we come out with some exciting products, that’s always the case.

Operator

Our next question is coming from Robin Farley – UBS.

Robin Farley – UBS

I wanted to ask about HDFS, I think at the February call you said you were comfortable having a billion dollars on the balance sheet to support the retail loans during securitization markets being more difficult and I guess your comments now about continuing to do that in to early 09 that’s obviously going to be a higher dollar amount but I guess what is that dollar amount we should think of that you’re willing to support? Then I have one or two questions after that.

James L. Ziemer

I think I’ll let Saiyid take that now and then we’ll entertain the rest of your questions.

Saiyid T. Naqvi

I think we are thinking about that is to create the ability to hold more loans on the balance sheet until we are more comfortable with the spreads in the securities market. And, I think that rough number will be about $1.2 billion, $1.3 billion, somewhere in that range that we’d be comfortable with. But, that’s a moving number and it’s not something that we nearing one way or another.

James L. Ziemer

The good news is we’re financially strong whether at Inc or HDFS and we’ve got many options to deal with the current market and as we look at what’s going on in the securitization market as well as our own ability to carry debt, that as Saiyid pointed out, that will change from time-to-time depending on what’s going on in the environment. But, we’ve got a lot of flexibility right now.

Robin Farley – UBS

I guess that kind of leads to my next question which is when you look historically in your securitizations it was 25% to 30% of loans were subprime bike buyers and is there a plan to keep making loans across the same credit quality base? Or, is there a point where you say no maybe the lowest five percentage points of those FICO scores, we won’t loan to you at the same rate? I wonder if you can give us a little insight in to your strategy there?

Saiyid T. Naqvi

We’ve made several adjustments as I said in my comments to our underwriting criteria. Our commitment is to the dealers as we will continue to lend across a broad credit spectrum. The changes that we have made are resulting in a better quality loan review. These are not just underwriting changes but also process changes are being made including things like verification of employment on a [inaudible] basis and so on. So we intend to continue to have that 25% to 30% range of subprime in our new originations and we also feel confident that the quality of that subprime loan will be better than some of what we are seeing play out in our delinquencies at this time.

James L. Ziemer

At the end of the day when we talk about subprime it’s a matter of managing the risk and pricing appropriately and it’s a very profitable business if it’s managed right and HDFS is doing an outstanding job of doing that.

Robin Farley – UBS

I wondered if that was tied to the decline of the retail sales or whether that was a result of tightening at the lowest center but it sounds like that’s not the case then and that’s not the plan going forward.

James L. Ziemer

Good question but no, I agree with your conclusion.

Robin Farley – UBS

And then just to clarify one other comment actually that Saiyid that you made earlier. You mentioned used bike sales are doing very well and I just kind of want to square that with the idea that in previous calls there’s been discussion that the loan loss rates were higher because the repo values were lower where the bike would be repo’d and auctioned off to the dealer networks. And I’m just trying to square if that’s the flavor of your comment about used bike sales being positive means that those repo values are no longer down?

Saiyid T. Naqvi

Let me just walk you through. First of all, whenever you repossess a motorcycle you don’t fully recover the loan. Typically it is a loss anywhere from 30% to 35% on the loan value. So on our repossessions we are looking at how to reinstate people under those without having repossession of the bikes. Having said that, on the used bike market we have seen improvements in the value that we are getting for our repossessed bikes, so yes our losses on a per bike basis are being vividly impacted by that trend. We don’t do it as much as we did when it continued the way it was in 07 and 06.

Operator

Our next question comes from Patrick Archibold - Goldman Sachs.

Patrick Archibold - Goldman Sachs

I wanted to go back to the issue of market share that was touched on earlier. Clearly part of that you guys attributed to fairly aggressive promotions by some competing bike manufacturers and I guess with inventory constraints from the production reductions you guys had also have been a potential driver of that share decline, and what other buckets might I be leaving out?

James L. Ziemer

As we commented, our competition - I’m not going to talk too much about our competition - has aggressively since kind of early on in the year gone the route of, and this is most of our larger competition, aggressively giving customer rebates and really financing them. The fact is we’ve gathered some data, a significant portion of their sales are all prior year models so they’ve got a backlog and there’s certainly incentive from their factory or company standpoint to start moving these and that contributes why some of their rebates are so aggressive in fact and over the top. So that is truly a fact; it’s not speculation. We’ve very thoroughly researched that one. And aside from that as we look at ours and we certainly as we address our production based on the first quarter, we did that in April and trying to get ready and set ourselves and very well position ourselves in the current year model as we entered in the new model year. There’s some models that as sales trends were coming out as we entered the summer season may have some dealers - we did have some dealers that ran out of some models. Overall though I don’t think that had a big impact on our market share performance for the quarter. Certainly having none in some dealerships we lost some retail sales but I think in the scheme of things that would not make a significant impact on market share.

Patrick Archibold - Goldman Sachs

And not to get you to talk too much about your competitors but is it your sense that post these promos they’ve worked through a lot of their excess inventory or is this kind of sort of a competitive pressure you would expect to persist for another quarter or two?

James L. Ziemer

Yes I wish I had that much good competitive information. We’ve really struggled to get what we have and through some great resources we’ve been able to get some information but to know what their inventory position is, we’re not that smart. Our information isn’t that good. I wish it was.

Patrick Archibold - Goldman Sachs

I guess on raw materials you said that you did see a step up I think in surcharges of a couple million this quarter. Can you just give us a little bit of the lay of the land of those steel costs? You know you’re hearing in other industries that people or some of the steel companies have started to layer on surcharges. I mean some of them are asking $200 to $300 a ton sort of thing. Can you give us a sense of how the contracts work, if any of that might be forthcoming in the back half or maybe based on the steel you buy, it may not even be the same thing?

James L. Ziemer

We have a strategy but I’m going to give you to John Olin our crack Vice President and Controller.

John A. Olin

You’re absolutely right. Steel prices have been surging the last several months and we expect the surcharges that we pay to continue to rise until we start to see that market mitigate.

Patrick Archibold - Goldman Sachs

And just for my understanding, is it mostly like hot rope steel or is there kind of like a - what should we look at to sort of get a sense of where those could go when we’re trying to track?

John A. Olin

All I can say Patrick is the entire steel market is rising We have all sorts of types of steel that go into the product, whether it be hot rolled or tooled or whatever. I mean if you look at the motorcycle there’s a substantial amount of metal inside electronics and for the tires. We have great motorcycles that are mostly metal. The good news is it makes up a small percentage of the total cost. Total cost is the machining and the finishing and the cosmetics and the engineering that have a bigger portion of that cost but metals are sufficient.

Operator

Our final question comes from Tony Gikas – Piper Jaffray.

Tony Gikas – Piper Jaffray

Actually I was wondering if you could just comment on how international shipments affect ASPs and who’s taking share and why?

James L. Ziemer

In actual shipments I mean talking about the ASP and the wholesale shipments? I guess on international it’s certainly different mix issues from market-to-market and so depending on the market, our independent distributors would get a discount that adversely affects their SP. Some of our wholly-owned distributors have a positive impact especially when you include foreign exchange in there. And then there’s a mix because the mix that we ship in the US certainly is not reflective and each market is certainly different. So markets are stronger in sportsters and markets are stronger in customs significantly. So in total it depends on our mix from our sales but stronger in the quarter. So generically I think we’d have to study that question a little more deeper, I don’t let it get to you but I mean at the end of the day we’re continuing to try to grow our international business faster than the domestic business, not just this year or last year but that is where we’re trying to push it. We have great opportunities in the international market so if your question is driving toward what impact does this have, international as we go forward we’ll have a bigger portion of the business as we go forward. And we could probably follow up on any information on that. Hopefully I got your question. Like I said the background noise or whatever it is really, really difficult.

With that, we’ve kind of gone over our timeline. I want to thank everybody for their time this morning. I appreciate your interest and your investment in Harley-Davidson. And I’m going to turn it back over to Amy for some final logistics.

Amy Guiffre

If you’d like to hear a reply of this conference, call 706-645-9291 and enter PIN number 50429408# until July 24 or access the conference at harleydavidson.com. If you have any questions please contact Harley-Davidson’s office Investor Relations at 414-343-8002. Have a great day everyone.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Harley-Davidson, Inc. Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts