Oct 15, 2009
Executives
Amy Giuffre – Director of Investor Relations Keith E. Wandell – President, Chief Executive Officer & Director John Olin – Chief Financial Officer & Senior Vice President Lawrence G.
Hund – President & Chief Operating Officer Harley-Davidson Financial Services
Analysts
Tim Conder – Wells Fargo Securities Craig Kennison – Robert W. Baird & Company Robin Farley – UBS James Hardiman – FTN Midwest Ed Aaron – RBC Capital Markets Rod Lache – Deutsche Bank
Operator
Amy Giuffre
Welcome to Harley-Davidson’s third quarter 2009 conference call. Today’s call will be webcast live on www.HarleyDavidson.com and supported by visuals that can be accessed by clicking on investor relations and then events and announcements.
To view a larger version of any slide click the expand button on the lower right of your viewing window. Our comments today will include forward-looking statements that are subject to risks that could cause actual results to be materially different.
Those risks include, among others, matters we have noted in our latest earnings release and filings with the SEC. Harley-Davidson disclaims any obligation to update the information in this call.
This morning you’ll hear from Harley-Davidson’s CEO Keith Wandell; CFO John Olin; and President of Harley-Davidson Financial Services Larry Hund. At the close of prepared comments we will open the call for your questions.
Keith E. Wandell
You’ve all seen our news release so you know that we have a lot to talk about today. First, is our results for the third quarter.
We also want to share with you a high level summary of our business strategy that will decide our decision making as we go forward. Our strategy is designed to strengthen the Harley-Davidson brand for the long term future growth and to deliver results through increased focus and there are really two key aspects to that focus.
Number one, we will focus on extending the Harley-Davidson brand by leveraging our unique strengths. We’re concentrating our investment and products and experiences on one of the strongest global brands with the goal of enabling us to continue to expand worldwide, attract new customers everywhere we do business and also reinforce our high commitment to our core customers.
It is in this context of focusing on the Harley-Davidson brand that we have made the decisions announced today to discontinue the Buell product line and to divest our MV Agusta unit. John Olin will go in to additional details related to these decisions.
Secondly, we will focus on continuous improvement in every aspect of our manufacturing, product development and business processes. I’ll be back a little later with a closer look at our strategy but as I turn the call over to John, I just wanted to congratulate him on being named as our Chief Financial Officer last month.
As the interim CFO John showed tremendous leadership during a difficult time for the company. So with that, John I’ll turn it over to you.
John Olin
As most of you know our near term plan has to be to invest in our plan, improve our cost structure and obtain funding for HDFS. These three areas of focus will continue to help us manage through the economic recovery and we have integrated them in to our long term strategy.
The first focus area, investing in our brand, is the cornerstone of the strategy managing the supply of our motorcycles in line with demand is one of the most important things we can do to protect and enhance the brand and as is evidenced by our anticipated significant reduction in fourth quarter shipments versus prior year we remain committed to the brand. Our second area of focus has been to improve our cost structure.
To date we are on track with previously announced restructuring activities. We are working to reduce administrative costs, eliminate excess capacity and exit non-core operations.
This morning we announced additional restructuring actions regarding Buell and MV Agusta. These decisions are in alignment with our long term strategy which is to one, focus on extending the Harley-Davidson brand by leveraging our unique strengths and two, focus on continuous improvement.
Our decision to discontinue Buell and sell MV Agusta takes in to consideration the following: investment in the Harley-Davidson brand has provided greater returns than either the Buell or MV Agusta brand; Harley-Davidson customers have a much higher repeat purchase intent; and our success in attracting new customers to the Harley-Davidson brand indicates the brand is well positioned to grow worldwide in the future. Let’s take a look at Buell.
We will work closely with all our stakeholders to facilitate an orderly departure from the Buell product line over the next several months. The Buell network will continue to sell new motorcycles in to 2010 and provide service in to the future.
We have chosen to discontinue the Buell product line as opposed to selling the business in part because Buell is so integrated in to the Harley-Davidson business systems and distribution network. From an accounting perspective, Buell is not considered a separate and distinct operation and as a result will not be presented separately as a discontinued operation.
The financial results related to Buell will continue to be reported as a component of income from operations. Related discontinuation costs will be recorded as restructuring expenses and gross profit will continue to include earnings on the sale of our remaining Buell inventory.
Of approximately $125 million in total cost associated with the discontinuation of Buell, we expect to incur approximately $55 million of restructuring and impairment costs in 2009 related to contractual requirements, write down of assets and severance benefits. We also expect to reduce our hourly workforce by approximately 80 employees and our non-production, primarily [inaudible] workforce by approximately 100 employees.
During the third quarter we recorded a $14.2 million impairment charge related to the fixed assets associated with Buell. The assets were written down to their estimated fair value and the charge was included within restructuring expense and other impairments line item on our income statement.
In addition to restructuring charges, we anticipate approximately $60 million in costs related to helping our dealers sell their inventory and charges for obsolete inventory which will negatively impact gross margin in the fourth quarter. In addition, we expect approximately $10 million of costs in 2010.
Buell revenue was $134.9 million in 2008 and $59.4 million in 2009 year-to-date. Capital expenditures related to Buell were $6.6 million in 2008 and $3.8 million September year-to-date.
We estimate that the Buell product line reduced income from operations by approximately $18 million in 2008 and approximately $27 million, including the impairment charge, during the first nine months of 2009. We have not quantified the benefits of increased focus on Harley-Davidson brand as a result of discontinuing Buell nor included any potential savings in our restructuring estimates.
Turning to our plans to divest MV Agusta. Like Buell, ongoing investment in MV Agusta does not align with the company’s long term strategy.
MV Agusta has value driven by its respective heritage, exciting products and passionate workforce. It is a standalone entity with a separate distribution network.
As a result, we expect to report MV Agusta results as a discontinued operation which means MV revenue, costs and earnings will be reported as a separate line item below Harley-Davidson’s income from continuing operations beginning in the fourth quarter. MV Agusta revenue was $15.9 million in 2008 and $42.9 million September year-to-date.
Net losses were $30.1 million in 2008 and $52.6 million through the first nine months of 2009. This includes an $18.9 million impairment charge of goodwill related to the purchase of MV Agusta reported in the third quarter.
The decrease in fair value of the business unit was driven by a number of factors including the recent down turn in the European economy and its impact on the sport bike market. Capital expenditures have been $12.8 million during the first nine months of 2009.
So, with the additional $55 million restructuring and impairment costs associated with Buell, we now expect restructuring and impairment costs will be between $215 and $245 million over the next two years. During the third quarter the motorcycle segment incurred $50.7 million in restructuring and impairment charges versus $0.9 million of restructuring charges in the prior year quarter.
We continue to expect total annual savings associated with restructuring will be between $140 and $150 million upon completion of the announced activities. These estimates do not include any action that may result from the York assessment currently underway.
We expect to provide additional detail regarding York in mid to late December. Our third area of focus has been to obtain funding to support the lending activities of HDFS.
I am very pleased to report that we have exceeded our $1 billion 2009 funding needs by $1.9 billion which will support any 2010 funding needs including the mitigation of 2010 financing risks. Last week we closed a $700 million TALF eligible securitization.
We saw strong demand and the weighted average interest rate dropped to just 1.2% from 2.1% in our July transaction. Now, I’ll comment on the financial results for the motorcycles and related product segment for the third quarter.
Worldwide dealer retail sales of Harley-Davidson motorcycles during the third quarter were down 21.3% compared to down 9.6% in 2008. On a sequential basis, worldwide sales were down less than they were in the second quarter of this year when they were down 30.15.
In the US we continue to perform better than the overall market. During the third quarter US Harley-Davidson motorcycle retail sales decreased 24.3% while the US 651 plus CC motorcycle market dropped 35.9%.
Our market share was up 8.4 percentage points to 53.8% in the quarter versus last year. In international markets we saw a sequential improvement with sales being down 13.1% in the third quarter versus down 18.2% last quarter.
Let’s take a minute to discuss the health of our US dealer network. We remain committed to reducing dealer inventory.
Between 2007 and 2008 we trimmed yearend US dealer inventory by approximately 22,000 units and as you know, we have taken actions in 2009 to reduce shipments which we believe will result in significantly lower inventories at the end of 2009 compared to last year. As retail conditions remain tough, our dealers are taking actions to reduce their expense structures to align with our lower revenues and the appropriate plans in place to manage the expected loss of some dealers as well as encourage the consolidation in select markets to help protect the integrity of our world class dealer network.
To-date four dealers and 10 secondary dealer locations have closed and we expect 15 to 30 dealer points could close during the next six months. Wholesale shipments of Harley-Davidson motorcycles for the third quarter were 54,236 down 20,468 units from the same quarter last year in line with our third quarter shipment guidance and consistent with our previous annual shipment projection of being down 25% to 30% from 2008.
During the third quarter we experienced a stronger mix of touring motorcycles versus the prior year. During the fourth quarter we are planning no sportster motorcycle production and we’ll take advantage of the shutdown to accelerate consolidation of our Wisconsin power train facilities which we expect to complete in mid 2010.
Revenue from Harley-Davidson motorcycles decreased to $803.3 million from the third quarter of 2008 primarily as a result of 27.4% lower shipments of Harley-Davidson motorcycles during the quarter partially offset by favorable shipment mix resulting in an increase average revenue per unit of $1,006. Total revenue for the segment was $1.12 billion, down 21.2% from the third quarter 2008.
Gross margins in the quarter decreased to 33.1% of revenue compared to last year. Gross margin was negatively impacted by lower shipments on favorable foreign currency exchange rates and unfavorable manufacturing costs driven by loss absorption on fewer units shipped partially offset by higher than expected productivity, favorable mix and lower raw material costs.
We are pleased to maintain our expectation of full year gross margin between 30.5% and 31.5% despite the impact from discontinuing the Buell product line. For the fourth quarter, we expect gross margins to be negatively impacted by fixed cost spread over 14,000 to 19,000 fewer units and the impact of approximately $60 million charge resulting from the discontinuation of Buell only partially offset by raw materials favorability, a favorable product mix and expected productivity improvements.
Operating margin for the third quarter 2009 decreased to 9.5% negatively impacted by lower gross margin, restructuring charges and asset and goodwill impairments partially offset by lower SG&A spending. Now, moving on to our financial services segment, during the third quarter HDFS reported an operating loss of $31.5 million, a decrease of $67.1 million compared to last year.
This decrease was driven by several items. First, a $41.4 million increase in the provision for retail loan loss allowance.
Of that total, $28 million was due to expected higher loss incidents and lower recovery values of repossessed motorcycles in the future. The remaining $13 million was due to credit losses on a higher balances of loans held for investment versus the prior year.
Next, net interest income decreased by $8.7 million between the third quarter of 2008 and the third quarter of 2009 largely resulting from higher interest expense. Increased interest expense was driven by the $600 million unsecured debt which was issued at 15% rate during the disruption in the capital markets in February 2009.
Also driving increased interest expense is the cost of carrying large cash balances to ensure liquidity in these uncertain capital market conditions. HDFS’ wholesale allowance for loan losses increased by $7.1 million relative to the third quarter of 2008.
The increase reflects credit risk in the portfolio from expected dealer closures that I mentioned earlier. Finally, other securitization decreased by $11.3 million during the quarter as a result of fewer off balance sheet securitizations.
This amount includes a $3.4 million impairment to retain securitization interest due to higher actual and projected credit loss assumptions partially offset by slowing actual and projected prepayment speeds. On a year-to-date basis, HDFS has incurred $110.8 million loss largely due to charges recorded last quarter including the loss provision established when we reclassified loans to held for investment and the HDFS goodwill impairment charge.
HDFS continues to be adversely impacted by the current economic environment. We expect HDFS will likely incur losses in the next couple of quarters as a result of four key factors: number one, lower resale values and higher credit losses typically experienced during the cold weather months; number two, continued pressure on incidence of loss as unemployment rates are expected to rise; three, the impact of high cost funding raised during the recent capital market disruption; and four, the impact of carrying large cash balances to minimize refinancing risk of our April maturities.
We expect HDFS will return to profitability as they work through the credit issues associated with pre-2009 retail loan originations and as the economy improves. We continue to believe that HDFS provides an advantage for Harley-Davidson by providing a reliable source of financing for our customers and our dealers.
Because our goal at HDFS is to appropriately balance credit and appropriate returns and profitability, we are currently engaged in reviewing our strategic options to find more diversified and cost effective funding in order to meet our HDFS goals. Now, I’ll turn the call over to Larry who will review HDFS’ operations and portfolio performance for the third quarter.
Lawrence G. Hund
During the third quarter HDFS originated $588 million in retail motorcycle loans compared to $821 million in the third quarter of 2008. This 28% decrease is primarily attributable to lower retail sales of Harley-Davidson motorcycles in the US.
HDFS retail market share of new Harley-Davidson motorcycles sold in the US was 51.2% in the third quarter of 2009 compared to 57.6% in the third quarter of 2008. This decrease in market share shows that there continues to be a competitive market place in retail financing for Harley-Davidson motorcycles.
At the end of the third quarter approximately $5.18 billion of receivables were classified as held for investment. Of these receivables $938.6 million were wholesale and $4.24 billion were retail.
As we have said, we have made significant adjustments to our underwriting criteria earlier this year including requiring increased down payments in certain credit tiers, implementing more conservative loan-to-value requirements, implementing revised customized credit scoring models and modifying certain credit authorities and controls. We are pleased with the progress resulting from these changes and while it is still early, we are seeing improved performance on early stage delinquencies and defaults for loans originated in 2009 compared to the prior year.
In addition, these changes have driven a shift in the mix of new originations to 80% to 85% prime loans compared to approximately 75% in previous years. We continue to monitor the performance of these new originations very closely and we will make additional changes to our underwriting standards that we deem appropriate.
Regarding delinquencies and credit losses, the impact of the recession and high unemployment continue to drive increases. The 30 day delinquency rate for managed retail motorcycle loans at September 27, 2009 was 5.8% compared to 5.59% at the end of the third quarter of 2008.
In managing collections we have increased our staffing levels and modified collection strategies which have enabled us to manage delinquencies close to last year despite increasing unemployment in the US. From a credit loss perspective, annualized retail credit losses totaled 2.7% for the year-to-date versus 1.97% last year.
The year-over-year increases in credit losses continues to be driven by the increase in frequency of loss and a decline in the recovery values on repossessed motorcycles. As we move out of riding season and with unemployment continuing to be very high in the US we expect to continue to see higher levels of delinquent loans and retail credit losses in to the early part of 2010.
So, in conclusion we continue to make significant progress in improving our liquidity position as evidenced by the recent $700 million securitization. We believe we have made appropriate underwriting changes but will continue to evaluate them on an ongoing basis and credit losses will continue to be a challenge in the near term given continuing high unemployment rates.
Now, I will turn it back to John for the remaining Harley-Davidson, Inc. consolidated financial results.
John Olin
Compared to the same quarter last year, Harley-Davidson, Inc. revenue was $1.12 billion down 21.2%.
Net income was $26.5 million down 84.1% and diluted earnings per share were $0.11 down 84.5% from the same quarter last year. This quarter’s EPS includes onetime charges for asset and goodwill impairments of $33.1 million.
Cash and cash equivalents as of the end of the quarter totaled $1.52 billion. For the first nine months of 2009 cash provided by operations was $511.1 million.
Capital expenditures decreased to $89.4 million as we continued to drive productivity and reduce investment in capacity expansion. Depreciation and amortization was $186.8 million.
The third quarter effective income tax rate increased to 61.8% compared to 38.2% in the prior year due primarily to the tax implications of MV Agusta including the non-deductible write down of goodwill and the impact of reduced company earnings. We expect full year 2009 effective tax rate on continuing operations excluding MV Agusta to be approximately 59% due to the previously reported onetime charges for the Wisconsin tax law change and the non-deductable goodwill write off for Harley-Davidson Financial Services as well as the impact of reduced earnings for the remainder of the year.
All-in-all it was another tough quarter and we expect to manage through the challenges for the remainder of the year. We are narrowing our guidance and now expect Harley-Davidson motorcycle shipments to be between 222,000 and 227,000 motorcycles in 2009.
We continue to expect gross margins between 30.5 and 31.5% for the full year and our capital expenditures are now expected to be between $125 and $145 million. We’ll continue to take the necessary actions to manage through the economic down turn and are excited to begin executing our long term strategy which Keith will review in more detail.
Keith E. Wandell
Those are the facts of the third quarter. Now, let me turn to our go forward strategy and what it means.
We organized our strategy around four pillars: growth; continuous improvement; leadership development; and sustainability. First is growth which is the single most critical need for Harley-Davidson right now.
We expect to grow through new innovative products, outstanding experiences and extending the brand among both core customers and outreach demographic segments globally. Continuous improvement in the ongoing process of making all aspects of our business more competitive by improving everything we do every day.
Leadership development within the company is an imperative to create a Harley-Davidson that can compete and win for decades to come. Sustainability is always expanding the ways in which we incorporate social and environmental responsibility in to our business and manufacturing processes and products.
If you look at the work we have done across those pillars you can boil down much of our strategy in to a single word and I mentioned it earlier and that’s focus. It’s all about focusing on the Harley-Davidson brand and driving it to its full potential globally.
In fact, we’re calling our strategy delivering results through focus and today we’re going to talk about our focus on growth and continuous improvement specifically. When it comes to growth, we are intent on extending the Harley-Davidson brand by leveraging our unique strengths.
What do we mean by extending the brand and leveraging our unique strengths? Well, the Harley-Davidson brand is one of the most powerful brands in the world but we also have great conviction that there is much more that we can do to tap in to the power of that brand and expand it even further.
It all starts with our clear strength, products. We are focusing on leveraging our leadership of the custom cruiser and touring segments playing to our natural advantages with the objective about growing our competitors in each of these segments everywhere in the world.
We will continue to own and to define the customization and personalization which is another one of Harley-Davidson’s unique strengths. P&A and general merchandise represent more than 23% of our revenue year-to-date reflecting the importance of custom personalized experiences.
We will build off our unique expertise to develop relevant products that attract even more young adults, woman and other new customers in to the Harley-Davidson brand. We will focus on high impact new product introductions as we hone in on what’s most meaningful to our customers.
We will expand the brand through related products and services like streaming eagle performance parts or finding new ways to enhance the hog experience and broaden it to more riders or creating apparel collections designed specifically for the needs and preferences of outreach segments. Another clear strength is how we connect with customers bringing the Harley-Davidson experience and lifestyle to consumers around the world.
We’re highly focused on expanding our global presence by accelerating our growth in key international markets. We continue to see strong upside potential in established markets and emerging markets alike.
One way we will seek to grow our penetration globally is to increasingly create market specific locally relevant products and services that both embody the essence of the Harley-Davidson brand and appeal to local needs and tastes. That includes the possibility of in market design and manufacturing.
We expect to expand and mature international markets where we already have an established presence and we continue to see opportunities to create and fulfill additional demand for our products and increasingly we have the operational horsepower to do so such as in Europe where we have grown market share for four years running through 2008 holding the number four spot in the heavyweight segment last year and continuing to grow share this year. We also see long term opportunities in developing markets like Latin America, India and China.
A case in point is India where our approach is to lay the groundwork, put our dealer infrastructure in place and align on our product plan. Then, as disposable incomes rise and consumers increasingly look to buy bigger bikes we will be on the leading edge of that opportunity.
We will also be looking for ways to push the envelope when it comes to extending our brand in those regions for example through apparel. We see China in a very similar way.
Between now and 2014 we expect to expand our international dealer network by 100 to 150 dealer points primarily in markets where we already have a presence and see opportunities to create and fulfill additional demand. In Mexico for example we are growing to 13 dealers this year from the eight that we had at the start of 2009.
We are also focusing on extending our effectiveness among new demographic segments and making our brand more accessible to new customers. Our brand is known and revered across a large range of demographic groups and we are focused on providing the products, features and experiences that will convert that admiration for the brand in to purchases.
We’re already seeing the results. For example the Iron 883 motorcycle has done exceedingly well among riders under age 35.
Among these young adults Harley-Davidson is number two in the US market overall market share and we are the market share leader in heavyweight motorcycles among young adults with more than a third of that market. We know from our research that the Harley-Davidson brand is as strong and well accepted among young adults in the US and internationally as it is among our current core customers.
With our product plan we are confident that we will continue to expand the appeal of Harley-Davidson motorcycles to the under 35 age group. We also know Harley-Davidson has strong relevance as a lifestyle brand beyond the dedicated motorcyclist.
Some people may never ride a bike yet are strong enthusiasts. Look for us to push the boundaries when it comes to how we engage with everyone who admires the brand.
Of course, we remain highly committed to our core customers. We are clear about how to continue to growth with them for many years to come.
Ever since we introduced the tri-glide, rider enthusiasm has been outstanding and it has been a real challenge trying to keep up with demand. With the rider response to improvements liked the new touring chasse and products like the 2010 Electra Glide Ultra Limited, we have great confidence about extending the ride and generating ongoing purchases among our most loyal customers.
When it comes to bringing our brand to life in local communities our dealers are critical. I’ve already talked about dealers internationally but just know that in the US everywhere we sell motorcycles, we are focused on helping dealers achieve excellence in all aspects of their operations through robust sustainable business practices.
We are also focused on the financial strength of the dealer network through having the right number of dealers in the right places. Relevant to HDFS while it is going through a difficult period, we intend to continue to provide a reliable source of financing for retail customers and dealers but rest assured we will continue to take the appropriate actions to address profitability.
I’ve covered a lot of ground fairly quickly when it comes to our focus on extending the brand but quite simply it really boils down to this, we firmly believe that $1 invested in going to market with the Harley-Davidson brand delivers much more impact than the same $1 invested elsewhere when it comes to reaching new rider demographics and enriching the experience for current core customers around the world. By focusing on investment behind the Harley-Davidson brand we believe we are substantially improving the brands and the company’s ability to grow.
It’s all about delivering results through focus. Now, let’s just spend a minute on continuous improvement.
As most of you know, the contraction in our business over the past couple of years has prompted us to make major moves in this area already. The reality is that we need to institutionalize continuous improvement in our product development, our business processes and our manufacturing operations as an ongoing way of life at Harley-Davidson and as a way to strengthen our ability to reinvest in our brand.
Through a disciplined approach to continuous improvement, we expect to shorten lead times, reduce complexity and get our motorcycles to market in the most cost effective way possible. We also expect continuous improvement to allow us to become increasingly effective at aggressively managing supply in line with demand an important discipline that you will see us continue to emphasis.
So, to wrap things up, how are we going to measure success and hold ourselves accountable? Our success will be characterized in a number of ways including these long term factors: number one, we expect to outperform the S&P 500 over our planning horizon and longer term.
We also expect to see our international motorcycle sales to grow at a faster rate than domestic sales. We expect to add 100 to 150 international dealer points between 2014 and we expect international retail unit sales to exceed 40% of our total sales by 2014, up from about 31% today.
Third, we expect sales to our core customer base to grow but sales to our outreach customers to grow at a faster rate. We expect earnings to grow at a faster rate than revenue through 2014 including productivity savings net of inflation of $120 to $150 million including the restructuring of our York operations and SG&A to decrease as a percentage of revenue.
With that I’d like to open the call up to your questions. I want to say again thank you for taking the time this morning, we certainly appreciate your interest and your investment in Harley-Davidson.
Operator
(Operator Instructions) Your first question comes from Tim Conder – Wells Fargo Securities.
Tim Conder – Wells Fargo Securities
Keith, could you just clarify one of the last statements you made there, the $120 to $150 million if you could just maybe go through that again and expand on that last statement and was that inclusive of exclusive of what you’re looking to do at York?
Keith E. Wandell
That is inclusive of the restructuring at York and it is net of inflation.
Tim Conder – Wells Fargo Securities
So over $120 to $150 million is you’re already starting post the savings that you’ve already outlined with the restructuring again through ’14 or is that everything collective?
Keith E. Wandell
That’s post.
Tim Conder – Wells Fargo Securities
So the $140 to $150 and then add another $120 to $150 on to that is what you’re saying?
Keith E. Wandell
Yes, sorry for not making that more clear.
Tim Conder – Wells Fargo Securities
The other question is it appears that you all are very comfortable with the sell through that you’re seeing right now or the levels of the inventory in the channel. You narrowed your guidance to the upper half of the range.
Should we anticipate on a go forward basis your production to basically match the sell through that we’re seeing?
Keith E. Wandell
Well, we’ve given for the remainder of this year and beyond this year Tim.
Tim Conder – Wells Fargo Securities
Beyond this year, if you just take looking forward as a general rule do you want to expand basically any supply/demand gap that is there or do you want to kind of keep it where it is and let that fluctuate according to how your sell through goes?
Keith E. Wandell
By the end of the year we are really comfortable where inventory levels are and they will decrease between now and the end of the year as we take our production down. As we move in to 2010 we will look to keep that inventory level tight throughout 2010.
Tim Conder – Wells Fargo Securities
Then maybe a question for Larry or whoever wants to take this. Given what you’ve outlined with HDFS, we’re assuming no further improvement nor deterioration in the current economic environment.
At what point would you anticipate the levels of reserves that you’re taking to moderate or maybe turn positive?
Lawrence G. Hund
Tim, I think really probably two things will be drivers of that. One is obviously we’re looking at unemployment very closely so if we start to see improvement in unemployment I think that’s going to have a positive impact on our portfolio and then the required reserve levels.
I think the second thing as I talked about, is we made significant changes to our underwriting criteria at the beginning of 2009. We’re seeing positive trends there and as those new assets become a greater percentage of the total portfolio over time, today they are not that big a percentage of the total portfolio, but over time as they become a bigger percentage, that should drive better credit performance and lower reserve requirements.
Operator
Your next question comes from Craig Kennison – Robert W. Baird & Company.
Craig Kennison – Robert W. Baird & Company
I don’t think I’ve been part of a quarter packed with more information than this so I’ll try to be brief. With respect to your negotiations in York can you give us an update on your upcoming events as the year concludes?
Keith E. Wandell
We are currently in negotiations with our labor union and I would characterize those as just being sort of in the beginning phases. We do expect and will have an answer and a decision on York sometime between the 1st and 31st of December whereby we will either be staying in York and restructuring that operation in a way that will be sustainable for our company going forward or we will then move the operations to another location.
Craig Kennison – Robert W. Baird & Company
I think big picture a lot of investors are trying to get at the earnings power potential of Harley-Davidson. With so many changes being announced here beyond the charges and divestitures, can you give us a sense for the Harley-Davidson going forward once we get to a normal level of production and growth and a normal level of margin?
Maybe just frame the earnings power potential of the company?
Keith E. Wandell
I’ll let John start off and then I’ll probably come back in on that one a little bit later.
John Olin
Craig, through the last numerous years we’ve had very high margins and a very powerful underlying business in our HD motor company. Today’s announcement is basically to redirect focus to that company and continue to drive forward.
We’ve got plans in place through the restructuring which we talked about before with the $140 to $150 million in place and now as we look forward to 2014 another $120 to $150 million which will bring back our margins in a large respect. So, we’ll continue the focus and we feel great about where we are at with the brand and the consumers liking of the brand.
We’re working through a rough spot here in the economy and we see great things as we move forward with Harley-Davidson.
Keith E. Wandell
I would just add that we do have a very comprehensive strategic plan in place that’s been developed with a whole lot of input from all of our employees in a very collaborative manner. I guess I would characterize as not overly aggressive if you will but we feel very, very good about our ability to deliver the plan and as John mentioned, the upside of the results that we expect to see.
Craig Kennison – Robert W. Baird & Company
Is there an operating margin goal, maybe a 250,000 bikes that you think is achievable in the period you describe?
Keith E. Wandell
Craig we feel great about the future but we can’t get that specific with you at this time.
Craig Kennison – Robert W. Baird & Company
Then just last question on HDFS, any plans at all to add a third party underwriter to that structure?
Keith E. Wandell
As John mentioned or Larry in their comments we are actively engaged in discussions around what are strategic options for that business and certainly there’s a wide range of what those might look like but that’s certainly part of the consideration. As I mentioned in my comments, we are focused on the profitability of this business.
Operator
Your next question comes from Robin Farley – UBS.
Robin Farley – UBS
I had a couple of questions, you mentioned the potential cost savings including the York restructuring or potential move to another location and I wonder if you could sort of talk about timing of that because announcing something in December in the middle of all of your production could potentially be fairly disruptive to 2010 if you were to move to another location. I wonder if you could just put some color around should we be thinking of that as a two year time frame if you were to move from York to another location so those cost savings would be like a 2012 impact jut to sort of get more context with that number you threw out there.
Then I also had a question about your continued margin guidance for the year. You’ve talked before about fixed cost being 25% or so of your cost of goods sold so that would imply much higher margin than the margin guidance that you’re giving even factoring the charges that you’re talking about in Q4.
Just the calculation of your fixed costs imply a much higher gross margin than you are saying, as was the case in Q3 which we delivered today and that’s counting the benefit for [inaudible] or any other things that would help with margins even more. So, I’m just trying to get a sense of why your margin guidance is so low given that your fixed costs are only about 25% of COGS?
Keith E. Wandell
Let me give you sort of an answer to the first part of the question around York. I’ll let John jump in here on the margins.
To be honest with you we didn’t really hear part of what your last question was so we’re sort of struggling here a little bit with that but in terms of York look, clearly if there’s a decision made that we have to move the facility there is no denying that that would be disruptive. We believe that we have contingency plans in place to minimize that disruption.
Again, this is a decision that is being made for the long term health and well being of our business so we cannot get derailed here with the short term concern and it is a concern. But again, we’ve got contingency plans in place to deal with it, get through it.
Our hope, and we’ve stated this publically, our hope and desire is that we will be able to stay in York because of the minimization of that disruption but, we can only stay there if in fact we have a plant and a facility that is sustainable for the long term for this business, under no other conditions.
Robin Farley – UBS
So the time frame thinking just that $120 to $150 million you put out there, the context of that is maybe like late 2011 or 2012? That’s not something we should be thinking about now?
Keith E. Wandell
Well, it depends. It depends on if we stay in York or if we don’t stay in York.
If we stay in York it will probably be sooner than later and if we leave York it will probably be later than sooner but it would be in that time horizon that we talked about.
John Olin
We’ll lay all that out Robin when we make the decision and expect to report on it in December.
Robin Farley – UBS
Then on the margin guidance?
John Olin
Let’s talk a little bit about the third quarter margin and then we’ll talk about the impacts on the fourth quarter. In the third quarter we had a margin of 33.1% which was down nine tenths of a percentage point from the previous quarter so we feel very good about the strength of the margins and how well they held up especially with shipments being down in the quarter 27.4%.
In the quarter margins were aided by favorable mix which we had talked about last quarter and in addition favorable raw material costs partially offset by unfavorable currency and again, the manufacturing side which is very much driven by the loss absorption of being down 27% in shipments. And again, productivity continues to perform very well in our organization.
As we look forward to the fourth quarter, what we are is holding to the guidance of down 30.5% to 31.5% and this is going to imply with volumes being down approximately 50% in the fourth quarter, and there will be a fair amount of lost absorption, we’ll pick back some of that up again with an expectation of continued productivity. But, in addition to that, we will be putting in $60 million of lower revenue as we exit our Buell business.
That will come in the form of lower revenue and higher costs as we write down obsolete inventories and help the dealers move the bikes in dealer inventory. So, with that we expect fourth quarter margins to be down significantly from the prior year but falling in on a full year basis in to our 30.5% to 31.5% range.
Robin Farley – UBS
So it sounds like a lot of the same factors in Q3 are impacting Q4 which is what it looked like to us so that’s great. Just the very last question then, your comments about focusing on the core products and your concern about profitability, when you’re talking about HDFS it seems like you could potentially maybe be interested in selling HDFS, the same as you have done previously with our credit card programs.
In the sort of the spirit of the focus that you’re talking about, is that something being considered?
Keith E. Wandell
Again Robin, and I mentioned this just a little bit ago, we are currently engaged in a process of looking at all options for HDFS. We’re committed to having both retail and wholesale financing for our customers and our dealers.
We understand the issues around HDFS and we’re looking at a broad spectrum of options in order for us to be able to ensure the stability and profitability of that business.
Operator
Your next question comes from James Hardiman – FTN Midwest.
James Hardiman – FTN Midwest
I think most of my questions have been answered. Just a couple clarification questions I guess first on the third quarter.
Obviously, a number of different charges, there was the $18.9, the $14.2 and then whatever is left in the restructuring number there. I guess the question is if we were going to add those numbers back, it seems like the tax treatment of some of those may be sort of different than others.
What would we get to if we added those three numbers back on an EPS basis from your $0.11 GAAP number?
John Olin
I can’t go back and figure out what EPS would or wouldn’t have been. We’ve got earnings per share for the quarter of $0.11.
Clearly, that was impacted by two, probably three big items. One was the $18.9 million non-deductable goodwill charge off for MV Agusta, $14.2 million asset impairment at Buell and then again, the other big piece of our earnings for this was at HDFS which was $28 million of higher loss provision for future losses.
James Hardiman – FTN Midwest
I guess the question then is the $18.9 million doesn’t affect your taxes one way or the other. The $14.2 –
John Olin
It affects that tax rate.
James Hardiman – FTN Midwest
It affects that tax rate but it’s not deductable, right?
John Olin
Correct.
James Hardiman – FTN Midwest
So if I was going to add that back I wouldn’t adjust that for taxes. The 14.2, would I adjust that – I mean that is tax deductible, correct?
John Olin
Yes, it is.
James Hardiman – FTN Midwest
And I guess then what tax rate would I use, it wouldn’t be the 60% plus tax rate that you reported for the quarter, right? I guess one of the questions I’m getting at, what is the go forward tax rate for you guys once all the MV Agusta stuff is behind you?
John Olin
Well, I would expect a more normalized tax rate but we’re not giving guidance on 2010 tax rate. I appreciate given the fact that our income has fallen especially the last couple of quarters and we’ve had some non-deductible items and onetime items for the year has pushed our tax rate up quite significantly.
It actually started in the first quarter with a 422.5 million NOL that we had to write off when the state of Wisconsin changed its laws. So, that’s driven our overall tax rate up but we would expect a more normalized rate as we go forward but absolutely no guidance has been provided at this time on 2010 tax rates.
James Hardiman – FTN Midwest
Is there anything remaining after MV Agusta that would drive it above sort of ’08 or ’07 levels? Is there something that I’m missing there that would continue to make it higher than those levels?
John Olin
I can’t provide any information on that at this time.
James Hardiman – FTN Midwest
In terms of HDFS I think it’s the end of the year, beginning of next year you need to bring the securitized receivables on to your balance sheet. Is that a fourth quarter event or a first quarter event?
And, do you expect any significant charges associated with that?
John Olin
Jim, you’re referring to what previously was FAS 166 and 167. The accounting standards have changed requiring off balance sheet trusts to be brought back on balance sheet and we will do that as of January 1, 2010.
What we expect to have happen and we’re still analyzing the impacts of it is basically we’ve got a special purpose trust, the receivables and debt. The receivables will come back on our balance sheet and be recorded as an asset, as a held for investment receivable and the debt will come back on to our balance sheet as well.
What will happen and the way that they’ll be put back on is as if those were always on run through our held for investment from the start of those loans all the way through. So, what we’ll do is a calculation determining where that was and an adjustment based on what is going to get put back on will fall in to retained earnings.
That’s our understanding of how it will work so there will be no P&L impact, our belief is no P&L impact.
James Hardiman – FTN Midwest
Can you give us the top line and EBIT impact of currency in the quarter?
John Olin
Currency in the quarter was roughly $14 million unfavorable to EBIT and revenue it was a benefit of about $2.5 million.
Operator
Your next question comes from Ed Aaron – RBC Capital Markets.
Ed Aaron – RBC Capital Markets
I just wanted to follow up on HDFS if I may, I’m just starting a little bit to get my head around the change in the expense structure of that business which was bigger than I would have expected given that the funding costs are relatively low incrementally from where they were a quarter or two ago and there seems to be some signs of stability especially on the delinquency rate. So can you just maybe help me understand where the real change came from relative to last quarter?
John Olin
While you say the expense on one hand is relatively low on the new securitizations, we’re carrying right now a lot of cash on our balance sheet so therefore you have interest expense but you don’t really have a related earnings stream from that. So certainly that is a piece of that and then as we discussed the higher provisions relate to a greater incidence of loss and also we saw declining values of repossessed motorcycles in the third quarter and as we’re coming out of riding season our expectation is obviously that we’re looking at a couple of tough quarters on those recovery values and felt it was very prudent to take up those loss provisions in this quarter.
As far as the actual operating expenses of the business in the quarter, those were relatively flat.
Ed Aaron – RBC Capital Markets
A second question, looking out to 2010, I know you’re not prepared to give any guidance yet but just to follow up on I think it was Tim’s question from earlier whether you expect to expand or contract supply in the channel, what’s the approximate rate of retail sales that one would have to assume for you to neither build nor decrease inventories next year in the US?
John Olin
Well one, we don’t provide any retail sales guidance at all and we haven’t provided any shipment guidance. But again, we’re managing the inventories very aggressively and in line with our demand.
Ed Aaron – RBC Capital Markets
So you feel like at the end of the year inventories will be at appropriate levels, is that fair?
John Olin
Yes.
Operator
Your last question comes from Rod Lache – Deutsche Bank.
Rod Lache – Deutsche Bank
I had a couple remaining questions, first on the $120 to $150 million of net additional savings I think you said that that excludes SG&A savings so I was hoping you could comment on how you think about the right level of operating expenses for your business while kind of balancing these efficiency gains and the growth initiatives that you highlighted.
John Olin
You’re correct that SG&A is not included in the $120 to $150. We’ve taken a lot of actions at the company to reduce and to size our SG&A in line with our business that we expect going forward.
We’ve reduced SG&A spending throughout the organization and we feel it’s at a level based on where we’re at to provide us the funds that we need to continue to invest in the brand and in particular our outreach customers, our international investments, as well as new product development. So, we’re feeling comfortable that given what we see the business going forward that we’ve got the right level of spending.
Rod Lache – Deutsche Bank
So should we think about the level of spending that you’ve got today just on an absolute basis as being what you would sustain or are you thinking that there’s kind of a decline as a percentage of sales as sales recover? I’m just not clear on what you’re suggesting the opportunity would be on SG&A.
John Olin
Well certainly as we go forward and as we grow we would expect SG&A to be a smaller percentage of revenue. We do expect that SG&A will grow as we grow and it will grow with us but at a slower rate than revenue.
Rod Lache – Deutsche Bank
Just also to clarify on HDFS, you mentioned $41.4 million increase in provisions, was that the provisions in the quarter or did they rise by that amount? Can you maybe just give us a few other stats there, what were the charge offs in the quarter, what was the allowance?
John Olin
The $41 million has two pieces to it, $28 million as Larry had mentioned is an increase due to higher loss incident rates as well as lower recovery values. Another piece of that is about $13 million is due to the fact that we’ve got more on balance sheet than we did a quarter or a year ago and that’s all the receivables that we brought on as securitizations markets went in to stall last year and if you remember last quarter we brought about $2.4 billion of receivables back on.
So, that’s what makes up the $41 million.
Rod Lache – Deutsche Bank
So that was the total provision in the quarter, am I correct?
John Olin
Yes.
Rod Lache – Deutsche Bank
And what were the charge offs?
John Olin
I’m sorry Rod, just to clarify, that was for retail.
Rod Lache – Deutsche Bank
What were the charge offs in the quarter?
Amy Giuffre
Are you asking about losses?
Rod Lache – Deutsche Bank
The charge offs net of recoveries that you disclose in HDFS?
John Olin
We don’t provide that specifically. To make sure I’m understanding, the year-over-year quarter difference for retail loan portfolio was an increase of $41 million.
Rod Lache – Deutsche Bank
Let me ask it this way then, what was the balance, what was the allowance for credit losses at the end of Q3?
John Olin
Why don’t you get back with Amy, I don’t have that right in front of me. Actually, we do have it, it’s about $150 million.
Rod Lache – Deutsche Bank
So just relative to your receivable balance right now you’re talking about a 2.9% allowance as a percentage of your net receivables. I guess I’m just trying to kind of correlate that with your loss performance.
I know that your losses are pretty low on the wholesale, or at least they have been running at a relative low rate and that’s close to 20% of your book. Should we be thinking that your currently provisioning for something like a 3.5% loss rate on retail?
Is that where you are thinking things are trending right now?
John Olin
I think things are trending probably a little north of 3% because you have to break that total reserve down in to the retail and to the wholesale component. Obviously, retail is going to be higher, wholesale is going to be lower and if you say that we’re at 2.7% year-to-date on losses, and obviously we’re going in to a fourth quarter, you’d expect to finish the year probably somewhere a little closer to 3% and what we’ve provided for here in the third quarter reflects that.
Rod Lache – Deutsche Bank
It just seems like your charge offs are relatively low in order to come up with that $150 million of balance. Maybe I should just follow up with you after the call but if you had $114 million allowance and then you increased it by $41.4 and you’re only down to $150 million, there’s just not a significant uptick in your charge offs.
Is there anything that you would attribute that to?
Lawrence G. Hund
As we’ve said we’ve seen an increasing trend in charge offs in the retail business, we see ourselves coming in to probably some tough winter months in terms of charge offs and then as John mentioned a much smaller component is obviously the increase in wholesale as we manage through a few challenging situations in the dealer network.
Amy Giuffre
Thank you for your time this morning. I appreciate your interest and your investment in Harley=Davidson.
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Operator
This concludes today’s conference call. You may now disconnect.