Oct 18, 2011
Executives
John Olin - Chief Financial Officer and Senior Vice President Amy Giuffre - Director, Investor Relations Lawrence G. Hund - President of HDFS and Chief Operating Officer of HDFS Keith E.
Wandell - Chief Executive Officer, President and Director
Analysts
James Hardiman - Longbow Research LLC Timothy A. Conder - Wells Fargo Securities, LLC, Research Division Gerrick L.
Johnson - BMO Capital Markets U.S. Rod Lache - Deutsche Bank AG, Research Division Felicia R.
Hendrix - Barclays Capital, Research Division Sharon Zackfia - William Blair & Company L.L.C., Research Division Joseph D. Hovorka - Raymond James & Associates, Inc., Research Division Robin M.
Farley - UBS Investment Bank, Research Division Craig R. Kennison - Robert W.
Baird & Co. Incorporated, Research Division Edward Aaron - RBC Capital Markets, LLC, Research Division Patrick Archambault - Goldman Sachs Group Inc., Research Division
Operator
Good morning, my name is Melissa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter 2011 Earnings Conference Call.
[Operator Instructions] Ms. Amy Giuffre, Director of Investor Relations, you may begin your conference.
Amy Giuffre
Thank you, Melissa, and welcome to Harley-Davidson's Third Quarter 2011 Earnings Conference Call. The audio for today's call is being webcast live on harley-davidson.com.
The slides, which are generally available at least 30 minutes prior to the call, can be accessed by clicking on company, Investor Relations, investment presentations then Q3 2011 conference call. Our comments today will include forward-looking statements that are subject to risks that could cause actual results to be materially different.
Those risks include, among others, matters we have noted in our latest earnings release and filings with the SEC. Harley-Davidson disclaims any obligation to update information in this call.
This morning, you'll hear from Harley-Davidson CEO, Keith Wandell; CFO, John Olin; and President of Harley-Davidson Financial Services, Larry Hund. Then we'll open the call for questions.
To ensure that we get as many callers as possible, we'll ask the callers ask only one question and return to the queue for follow-up questions. This has worked great for the last few quarters and we appreciate all your help.
I'd also like to note that our IR website has been recently revamped to improve the ease of use and overall appearance. And finally, today, we welcome Rachel Persky to the Harley-Davidson IR Team and extend our gratitude to Travis Thacher for his years of IR service as he moves into a new position here at Harley, so thanks, Travis.
With that, let's get started. Keith?
Keith E. Wandell
Thanks, Amy. Good morning, and thanks to all of you for joining us on the Third Quarter Earnings Call.
Harley-Davidson again turned in a strong performance in the third quarter, with earnings nearly doubled those of the year ago period and worldwide dealer new motorcycle sales up more than 5% from last year's third quarter. The third quarter results reflect our continued progress at implementing our business strategy.
Through this strategy, we are, number one, transforming our production operations into a lean, flexible and best-in-class system; secondly, bringing lean engineering to our product development, significantly reducing the time it takes to bring new motorcycles to market. We are focusing on retail excellence to deliver a personalized, compelling and premium experience for every customer, every time, everywhere.
We're also attracting new groups of customers as we build on our leadership among young adults and other outreach segments, and we're expanding the global reach of Harley-Davidson brand as we become truly multicultural and multi-generational. In short, there's a tremendous amount of transformational work going on throughout the organization.
Each and every one of these strategic initiatives is a major undertaking all on its own. So I can tell you, I'm very proud of the dedication of all of our employees, including our union leadership, and the focus of everyone in the organization to bring these changes to life.
You know, just last week, I spent a day at our final assembly plant in York, Pennsylvania. And the scope of change there is tremendous and there's been a great deal of progress.
From 4 separate assembly lines and operations in more than 20 buildings, we now have a much smaller campus and build all Softail, Touring, CVO, and Trike vehicles on one assembly line in all of the different configurations required for U.S. and international markets.
It's an incredibly complex work and many challenges still lie ahead as we bring the new operating system online. But in spite of the short-term inefficiencies, the attitudes, engagement and pride of everyone in bringing these changes to life is truly energizing.
Similarly, in our Kansas City plant is now well down the path of implementing the changes there to become best in class. And we're looking ahead to the full implementation of the contracts in the first part of the year in Wisconsin that we expect will enable us to realize the transformational opportunity across our entire company.
I also want to acknowledge our dealers for their continued efforts to deliver results at retail, which we are seeing in the sales increases of retail even as challenging economic headwinds continue. On last quarter's call, we talked about Retail 2020, a long-term global initiative to take the Harley-Davidson retail experience, as good as it is, to the next level.
Retail 2020 will provide the overall arching multichannel approach, systems and processes to grow the Harley-Davidson brand at retail and define the Harley-Davidson standard of retail excellence. Just like the work going on in production and product development, Retail 2020 is about being best in class and positioning Harley-Davidson dealers and the company alike to profitably meet the constantly evolving needs of our customers.
Before I wrap it up and turn it over to John for the details of the quarter, let me touch on the current economic climate. We remain cautious about consumer confidence and the economy in general, just as we have been throughout 2011, and we will continue to manage the business prudently.
But through our strategy and actions we've taken, we believe we are restoring Harley-Davidson to a strong foundation and positioning the company to grow and extend the reach of the brand around the world. These are exciting times at Harley-Davidson as we transform our business to be best in class in everything we do that make customers' dreams a reality by delivering remarkable products and extraordinary customer experiences.
I'll be back later for questions, but let me turn it over to John.
John Olin
Thanks Keith. And good morning, everyone.
I'll review the third quarter financial results starting on Slide 10. During the quarter, Harley-Davidson Inc.
consolidated revenue was up 10.9% behind the 15.9% increase in shipments of Harley-Davidson motorcycles. Our third quarter income from continuing operations improved to $183.6 million, an increase of 95.9%.
Similarly, diluted earnings per share rose to $0.78 per share, up from the year ago quarter, which was $0.40 per share. Operating income from the Motorcycle business was up 78% compared to last year's third quarter.
The strong increase in the Motorcycle business was driven by increased motorcycle shipments and lower spending on ongoing restructuring activities, partially offset by a lower gross margin as compared to last year. Operating income at Harley-Davidson Financial Services was up 21.9% behind improved credit loss performance.
Finally, our improved financial performance for the quarter was also driven by a lower year-over-year interest expense as a result of last December's repurchase of $297 million of high-interest notes and a lower effective tax rate as compared to last year. We are very pleased with the third quarter's results and continued progress against our goal strategies and the transformation of our business.
Now let's take a look at retail sales on Slide 11. Overall, worldwide retail sales of new Harley-Davidson motorcycles were up 5.1% in third quarter.
In the U.S., retail sales continue to be strong despite a very challenging economic environment. During the quarter, we introduced our 2012 model year motorcycles and they have been well received by both our dealers and customers.
Market share in the U.S. was 57.9%, up 1.3 percentage points compared to last year's third quarter, as the Harley-Davidson brand continued to show its strength while many of our competitors continue to discount prices to move aging inventory.
Retail sales in the international markets grew 4.4% during the quarter, driven by growth in Latin America, Europe and Asia Pacific regions. The Latin America region was up 27.9%, driven primarily by strength in Mexico and Brazil.
In Brazil, the new dealer network continues to come up to speed. As we have discussed, we closed all 9 dealerships and have appointed 10 new dealers, of which 8 are up and running.
This was planned as part of the agreement that we announced in December 2010 to terminate the exclusive dealer contract that was in place and expand our presence in Brazil. Retail sales in the Europe region were up 4.4% in the quarter compared to 2010.
The Europe region saw strong sales in Northern European countries and in our emerging markets in the region, partially offset by softness in Southern European countries. Retail sales in Asia Pacific region were up 1.8% driven by double-digit gains in Australia and emerging markets, which include India and China.
We continue to experience declines in Japan as that country works to recover from the tragic events earlier this year. On Slide 12, you will see wholesale shipments of Harley-Davidson motorcycles in the quarter were up compared to last year and within our expected range of 60,000 to 65,000 motorcycles for the quarter.
During the quarter, mix shifted from Touring and custom motorcycles to Sportsters, largely due to the York restructuring, which impacted production at that facility. During the quarter, York consolidated Touring, Softail, Trike and CVO production and with single consolidated line.
We expect York motorcycle production to be continue to be affected over the next couple of quarters as the new consolidated line comes up to speed. Sportsters represented 22.3% of total shipments, which was higher than last year's Sportster mix.
We expect Sportsters as a percentage of total shipments will be at the upper end of our historical range of 18% to 22% for the full year. As we noted last quarter, we began shipping 2012 model year Touring and Sportster motorcycles in the U.S.
at the end of June, which was a few weeks earlier than normal. We released these models early as a result of tight retail inventory situation in the U.S..
Shipments of the remaining 2012 models started in late July as they normally do. Slide 13 provides some additional detail on the U.S.
dealer network inventory and strength of our brand as measured by total demand. During the third quarter in the U.S., we shipped about 41,100 Harley-Davidson motorcycles and dealers sold roughly 42,600 at retail.
As a result of strong third quarter retail sales and temperate production constraints experienced at York, U.S. dealer network inventory was drawn down about 1,600 units from the second quarter of 2011 and was down about 1,900 units compared to last year's third quarter.
In addition to overall site inventory, dealers ended the quarter with very low levels of 2011 model year carryover units. We are pleased to report that U.S.
dealer network profit margins have increased behind higher retail sales and prudent management of the cost structures. In light of ongoing uncertain economic challenges, we remain committed to aggressively managing new motorcycle supply in line with demand.
However, we do recognize that aggregate U.S. dealer inventory continues to be below what we believe is an appropriate ongoing level and we will continue to work toward replenishing dealer inventory levels of new motorcycles.
We continue to support the dealer's efforts to sell more used bikes. We believe healthy used bikes sales enhance dealer revenue, maintain resale values and help near the gap between new and used motorcycle pricing.
Used bike sales by the U.S. dealer network continue to be up double digits through August compared to the same period last year.
When used motorcycle sales are combined with new retail sales in the U.S., total demand for Harley-Davidson motorcycles continues to be strong. On Slide 14, you will see revenue for the Motorcycles and Related Products segment was up 13.4% in the third quarter behind strong growth from all our businesses.
Harley-Davidson motorcycle revenue was up 15.5% behind the 15.9% increase of shipments. During the quarter, average motorcycle revenue for Harley-Davidson units shipped decreased $52 from the prior year as a result of unfavorable product mix, partially offset by significant currency exchange favorability in the previously announced price increase on our 2012 model year motorcycles.
Parts and Accessories sales were up 7.6% for the quarter, driven in part by a focus on product availability, high demand for new accessory product offerings and growth and worldwide and used retail motorcycle sales. General Merchandise was up over 8% in the third quarter as a result of sportswear growth and the impact of worldwide new motorcycle sales increases on leather and riding gear.
Turning to restructuring on Slide 15. We are continuing our efforts to improve our cost structure and transform the business to be stronger and more profitable in the future.
York continues to be a key focus of our restructuring activities. As we mentioned, during the third quarter, we combined assembly of all models produced at York and with a single assembly line.
As anticipated, these changes resulted in temporary inefficiencies and temporary capacity constraints. We are pleased to report that all manufacturing at York is now in a single building.
The team at York has done an outstanding job of reducing our operating cost structure and increasing our manufacturing flexibility. The focus at York for the next couple of quarters will be to consistently increase our throughput until we reach our targeted lease.
Consequently, during the fourth quarter, we anticipate that there will be continued downtime as workers on a new production lines are trained and production comes up to speed. The next step in the structuring, which will occur in 2012, will be to implement a new ERP system at York, which we expect will give us many new capabilities across the supply chain, including the ability to do more made-to-order production, implement production surge capabilities in 2013 and provide end-to-end supply chain integration.
As we work toward completing our restructuring, we will continue to experience temporary inefficiencies and temporary capacity constraints. We continue to expect the manufacturing restructuring to be largely complete by the end of 2012.
During the third quarter, we incurred $12.4 million in restructuring expenses and $49 million year-to-date. Restructuring activities are largely on plan through the first 9 months of the year and costs are coming in lower than we originally expected.
As you will see, we reduced the expected 2011 restructuring cost by $10 million to a range of $70 million to $80 million. Consequently, we now expect total costs to be between $480 million and $495 million by 2013.
The expected savings in capital spending estimates associated with restructuring activities are unchanged. On Slide 16, you will see gross margin in the quarter was 33.7%, which was lower than last year.
Gross margin for the quarter was impacted by 6 key drivers. First, volume was favorably impacted by increased motorcycle shipments, which were up 15.9% in the quarter, and increased Parts and Accessories and General Merchandise sales compared to last year.
Second, you'll see we've added a motorcycle pricing line to the Slide to reflect our previously announced price increase on 2012 motorcycles. During the quarter, gross margin was improved by $7.7 million as a result of the price increase.
Third, mix was unfavorable by $26.6 million, largely driven by the temporary disruptions at York, which caused temporary capacity constraints and impacted the mix between families, models and the geographic shipments of motorcycles during the third quarter. Fourth, foreign currency exchange during the quarter has positively impacted gross margin by $2.7 million.
While currency exchange during the quarter had a modest favorable impact on profit, currency exchange had an unfavorable impact on gross margin percent of nearly 1 percentage point, largely due to balance sheet revaluations following the significant decline in the Euro, Australian dollar and Rial exchange rates that occurred in the last 3 weeks of the quarter. Next, raw materials were unfavorable $7.9 million due to increase metals and fuel costs.
And finally, manufacturing benefited from restructuring savings and incremental margin on higher volumes, partially offset by approximately $3 million in temporary inefficiencies associated with the transformation underway at our York facility. During the fourth quarter, we expect continued pressure on margins from the currency exchange I mentioned earlier, higher raw material costs and continuing temporary inefficiencies at York.
On Slide 17, operating margin as a percent of revenue for the third quarter was 14.7% versus 9.3% in 2010. Operating margin was favorably impacted by higher gross margin and lower year-over-year restructuring spending.
As expected, SG&A was roughly $11 million higher during the quarter compared to the same period last year as we continue to invest in the future. During the fourth quarter, we expect SG&A to be higher than last year's fourth quarter due in part to our continued investment in our growth initiatives.
We continue to expect SG&A spending to decline as a percent of revenue between 2009 and 2014. Now moving on to our Financial Services segment on Slide 18.
In the third quarter, HDFS operating profit improved $11.1 million, or 21.9%, compared to the last year. The 3 key drivers of the third quarter results were net interest income was $7.9 million lower in the third quarter of 2011 versus third quarter of 2010.
During the quarter, HDFS was able to repurchase at market prices approximately $44 million of the outstanding 2018 medium-term notes originally issued at an interest rate of 6.8%, allowing us to replace this debt with lower interest rate debt. The repurchase of these notes resulted in $8.7 million current period loss.
We will continue to evaluate future debt repurchase opportunities as they arise. Next, the provision for retail credit losses was $15.7 million lower in the third quarter of 2011 versus third quarter 2010, primarily due to improved credit losses as a result of favorable retail receivables performance.
And finally, the provision for wholesale credit losses was $5 million lower in the third quarter of 2011, primarily due to favorable wholesale loss performance. It's important to note that on a year-to-date basis, we've released approximately $37 million of allowance from the balance sheet, given anticipated credit loss performance across the entire portfolio.
While the release of this allowance benefits income this year, we cannot assume a similar financial benefit will occur in 2012. As we look forward to 2012, we believe HDFS's operating income will decrease compared to 2011, primarily due to the lapping of $37 million of 2011 balance sheet allowance releases I just mentioned.
We expect 2012 operating income will also be impacted by lower net interest and the book of retail loans continues to contract, and modest tightening of margins on prime share retail lending. Despite the anticipated decrease in year-over-year HDFS operating income, the business is healthy and expected to be solidly profitable in 2012.
We are very pleased with the performance of the business and believe HDFS provides a competitive advantage for sales of Harley-Davidson motorcycles and related products. Now Larry will provide more detail on HDFS as operations on Slide 19.
Larry?
Lawrence G. Hund
Thanks, John. And good morning.
During the third quarter, HDFS retail motorcycle loan originations increased 14.2%, or $78 million, compared to the same period last year. The increase was driven by higher new motorcycle loan originations behind a strong increase in retail sales and a 2.6 percentage point increase in market share.
Used motorcycle loan originations also increased compared to last year. However, as the higher level of receivables originated prior to the start of the economic downturn roll off the books, finance receivables outstanding decreased 5.5% compared to a year ago.
This decline in receivables pool reflects the lower U.S. retail sales over the last 2 years that will continue to impact HDFS net interest income.
Over the past several quarters, HDFS has been focused on prudently increasing overall credit application approval rates. And we saw a modest increase in the third quarter.
Our goal is to have a portfolio that continues to perform well over time and delivers an appropriate return on equity. We are very pleased with the improved retail delinquency rate and retail credit losses compared to last year, which you will see on Slide 20.
The 30-day delinquency rate for retail motorcycle loans at the end of the third quarter was 3.73%, or 110 basis points better than the same date last year. Annualized retail credit losses improved by 93 basis points to 1.11% in the first 9 months compared to the first 9 months of last year.
This improvement was driven by the impact of changes in underwriting implemented 2 years ago, as well as a lower frequency of loss and improvement in the recovery values of repossessed motorcycles. As John mentioned, during the quarter, we reduced the total allowance for credit losses by $11.8 million to reflect lower anticipated credit losses and lower receivable balances.
We will continue to evaluate the allowance each quarter using our disciplined process and make adjustments as appropriate. We are pleased with the continued improvement in credit performance and we will continue to monitor the unemployment picture, motorcycle recovery values, and the overall U.S.
economic environment and manage HDFS appropriately. During the third quarter, HDFS delivered increased profits and maintained a strong liquidity position.
We remain focused on enabling retail sales of Harley-Davidson motorcycles while providing an attractive return to Harley-Davidson Inc. Now let me turn it back to John.
John Olin
Thanks, Larry. Now let's take a look at cash and liquidity on Slide 21.
You will see that at the end of the quarter, we had just over $1.6 billion of cash and marketable securities. In addition, HDFS had approximately $980 million of available liquidity through bank, credit and conduit facilities.
We currently have and will continue to maintain a minimum of 12 months of projected liquidity needs in cash and/or committed credit facilities. During the quarter, we completed a $600 million term securitization transaction at a weighted average rate of 0.84% and renewed $600 million conduit facility.
I am also very pleased to report that we repurchased approximately 2.5 million shares of Harley-Davidson stock for $91 million. This is in addition to the 25% second quarter dividend increase.
As we have stated, returning value to our shareholders through dividend and share repurchases is a top priority. Looking forward, we will continue to evaluate opportunities to enhance value to our shareholders.
Now I'll review the remaining Harley-Davidson financials on Slide 22. I would like to highlight 2 items on this slide.
First, with regards to continuing operations, the company generated operating cash of $902 million during the first 9 months of 2011, which included a $200 million contribution to our pension plans. And second, through 9 months, the company's effective tax rate was 30.4%, compared to 34.0% in the year ago period.
The 2011 effective tax rate in the third quarter was favorably impacted by settlement of an IRS audit, as well as a change in the Wisconsin income tax law associated with certain net operating losses. Last year, the effective tax rate through the third quarter was negatively impacted by the Health Care Reform Legislation offset by a favorable settlement of an IRS audit.
We now expect the full year effective income tax rate will be approximately 31% for 2011. Now turning to guidance on Slide 23.
We continue to expect full year 2011 Harley-Davidson motorcycle shipments to be between 228,000 and 235,000 units, up 8% to 12% from 2010. During the fourth quarter, we expect to ship between 45,500 and 52,500 units.
We now expect full year 2011 gross margin will be between 33.5% and 34.5%. The guidance has been adjusted to account for the additional pressure we now expect from foreign currency exchange as a result of the significant decrease in valuation of our key currencies that started to occur at the end of the third quarter.
We continue to expect capital expenditures to be between $210 million and $230 million, which includes between $70 million and $85 million of capital related to restructuring. As we look back on the third quarter of 2011, we are pleased to deliver another strong quarter of results.
We continue to be encouraged by the strength of our brand, which is demonstrated in part by a great response to our 2012 model year motorcycles and strong total demand for new and used Harley-Davidson motorcycles. We are also pleased to report that we repurchased $91 million of our stock during the quarter.
While delivering another strong quarter, we recognize the many challenges that lie ahead of us and our customers, and therefore, will continue to manage the business prudently as we navigate through any uncertainties that the future might bring. Overall, the fundamentals of our business are strong and we are excited about the long term.
We continue to build a solid foundation for sustainable growth. We remain focused on executing against our strategies to complete the transformation of our organization and grow our business while delivering strong margins, strong returns and value to our shareholders.
Thank you for your continued confidence and investment in Harley-Davidson. And now, I'll open the call up to your questions.
Operator
[Operator Instructions] Your first question comes from the line of Tim Conder from Wells Fargo Securities.
Timothy A. Conder - Wells Fargo Securities, LLC, Research Division
Thank you. John, I just wanted to revisit here the gross margin and the top line.
It seems like you're saying that the gross margin change in the guidance there is largely related to the FX, so just clarity on that. And then, yet even though your production in the third quarter was lower, in the lower half of your guidance range, did that impact the gross margin or -- and I guess, in relation to that, is the impact there -- were the inefficiencies at York greater than anticipated during the third quarter.
So I guess, that's several pieces to a broader gross margin question there. And it appears you're going to make up that production because you didn't change your overall guidance for the year.
John Olin
Okay, Tim. Well, I'm going to start with the second question first, is the impact of the York transformation on the third quarter, and then we'll talk a little bit about the guidance that we presented.
When we look at gross margin, the story in the third quarter really comes in 2 areas. One is in the impact of the York transformation and the other is in the currency.
Certainly, the transformation and the aspects included in that were expected. They came in 2 flavors.
One was mix was impacted, so we saw unfavorable mix in the quarter of $26.6 million due to the disruption in the temporary capacity constraints due to York restructuring. And when we look at that, several things happened in mix.
One is that, given the temporary capacity constraints, we relied more on product coming out of our Kansas City facility, which typically have lower margins. So we shipped less as a percent in Touring and custom motorcycles than we did our Sportsters.
And the temporary capacity constraints also affected our model mix. And within the quarter, we shipped lower content in lower priced bikes and, again, that was due to all the activities that we were going on in this facility.
And finally, our geographic shipment mix was affected by the magnitude of change at York. And just one second on that, again, Keith had mentioned we took 4 families of motorcycles, some 22 models and put them all under the same line so all our employees are building all of our bikes.
And within that change, we had 95% of our hourly employees are in or will be in new jobs in a short period of time. So again, we experienced a lot of downtime.
So a lot of it manifested itself in mix. And in the second piece where it manifested itself was on the manufacturing line.
And we saw the manufacturing temporary inefficiencies on a year-over-year basis were unfavorable by $3 million. I would like to point out, though, on the manufacturing line, we did deliver $20 million of favorability.
And if you look back in the first quarter, that was actually a negative $21 million improved to a favorable $7 million in the second quarter. And then, again, this quarter at $20 million.
So the second part of your question, Tim, was on the gross margin guidance. So as we look at gross margin, as we sit through 3 quarters, we are at 34.0% and the gross margin guidance that we had was 34% to 35%.
So with roughly 80% of the revenue behind us and the uncertainty related to the currency situation, we felt it was prudent to lower the range by half a percentage point. It's important to note here that there is nothing concerning to us about our core business or the restructuring.
We're very pleased with the retail sales, our shipments and certainly the restructuring.
Timothy A. Conder - Wells Fargo Securities, LLC, Research Division
Okay. So York, in and of itself, your plan disruptions, they were neither greater nor less than the plan during the third quarter, is that -- am I interpreting that correctly?
John Olin
Yes.
Operator
Your next question comes from the line of Ed Aaron from RBC Capital Markets.
Edward Aaron - RBC Capital Markets, LLC, Research Division
Actually, we all wanted to ask the question on HDFS, if I could. You made a comment about tightening margins on time lending.
Is that to suggest that the lending environment now with those customers is becoming more competitive? And then just kind of a quick HDFS follow-up, it sounds like you released a little bit less in terms of reserves in the third quarter versus what you were doing on a per quarter basis in the first half of the year.
Does that relate to any sort of change in kind of how you're kind of viewing where credit's gone?
John Olin
So as far as the first question, Ed, I would say, yes, we are seeing more competition in the prime lending space and that has put a little bit of pressure on margins in that area. Regarding the allowance release, I wouldn't say it's so much a change in the -- what we expect going forward, as it's the release was probably bigger in the first quarter.
The improvement relative to previous quarters is less dramatic sort of as you go through each quarter. We'll continue to use pretty disciplined process each quarter and evaluate it going forward.
But there's really no change in the performance or the outlook.
Operator
Your next question comes from the line of Sharon Zackfia from William Blair.
Sharon Zackfia - William Blair & Company L.L.C., Research Division
I wanted to talk a little bit about what's going on at York and I guess, I think it's no mystery that all of us are here, and as the dealers want more Touring bikes, I understand there's some constraints with that currently at York. So if you could kind of help us understand the timeline, I guess, more granularly as to kind of when you can get back to, I guess, more normalized production of some of the families that are in high demand, and what your capacity constraints are from a manufacturing perspective next year versus this year?
John Olin
Okay. With regards to getting back to more normalcy, we are going to experience temporary capacity constraints until the restructuring is done.
I think in the third quarter, we certainly experienced it more than we had in previous quarters, and we expect that to loosen up a little bit in the fourth quarter. So when we look at overall mix, we do expect mix to improve a bit in the third -- in the fourth quarter, given the fact that the temporary capacity constraints are not as significant at that time.
But as I said, Sharon, we will continue to experience the temporary inefficiencies and capacity constraints until the restructuring is complete on a systemwide basis toward the end of 2013. So while we're not providing shipment guidance at this point for next year, we do believe that there is modest opportunity for increases in production next year despite the temporary constraints.
Operator
Your next question comes from the line of Felicia Hendrix from Barclays Capital.
Felicia R. Hendrix - Barclays Capital, Research Division
Just getting back to the gross margin. I just want to understand or clarify which part -- you missed the gross margin expectations, you missed guidance.
What part of that was a surprise to you? Was that just driven by FX or was it anything else?
And then, I have a housekeeping question.
John Olin
Well, the currency was certainly not expected. And what we saw in overall currency -- first of all, currency benefited in revenue by about $31 million, $31.5 million.
And what happens there is we take the average currency rates for this quarter versus last quarter and apply it to revenue and that's the impact of on revenue. So that $31.5 million did not cascade down to P&L.
We only realized the benefit of $2.7 million. And what happened there, Felicia, is that there was a precipitous fall in the exchange rates, largely in the euro, the real and the Australian dollar in the last 3 weeks of the quarter.
In the last 3 weeks of -- or in the last day of the quarter, we revalue our balance sheet accounts, assets and liabilities, and that was quite unfavorable from what we would have expected going into the quarter. And it brought down in aggregate, overall gross margin for the quarter, by about 4 percentage point.
Felicia R. Hendrix - Barclays Capital, Research Division
Okay. So that was -- because everything else you talked about mix, that you all saw, and that was in your prior guidance, correct?
John Olin
Right.
Felicia R. Hendrix - Barclays Capital, Research Division
So when we look at your implied fourth quarter guidance, other than FX, they probably shouldn't be that much variability?
John Olin
Correct.
Felicia R. Hendrix - Barclays Capital, Research Division
Okay. And then just on housekeeping.
When you talked about SG&A higher year-over-year on the quarter, is that before after that one-time item that was in fourth quarter '10?
John Olin
Felicia, that's all-in. So, right, when you look at the actual results from last year's fourth quarter, we expect SG&A to be up a little bit from that in the fourth quarter of this year.
Operator
Your next question comes from the line of Craig Kennison from Robert W. Baird.
Craig R. Kennison - Robert W. Baird & Co. Incorporated, Research Division
I'm going to push on York just one more time. How many bikes would you have shipped if the York disruption had not impacted production?
Did you work any overtime in York to offset some of that impact? And then, finally, to what extent were you able to leverage the new temporary workforce that's a new feature in the labor agreement that you've got?
John Olin
We do not work -- we worked a lot of overtime during the quarter. Again, with all of the change and people moving in positions, the lines were down a fair amount, which we expected and was planned.
At this point, we are not leveraging the temporary workforce. That will come in 2013 when we begin to surge capacity.
Right now, again, it is all to consolidate the lines onto a single line, and it'll take this quarter and next quarter to gain stability from that. And we'll see continually improving throughput against that objective.
Operator
Your next question comes from the line of Rod Lache from Deutsche Bank.
Rod Lache - Deutsche Bank AG, Research Division
Just wanted to get a little bit of clarification on the Sportster mix. Could you clarify for us what percentage of your retail sales at this point are Sportster mix?
And I'm still, I guess, trying to get my arms around the impact of this, the York transformation. Presumably, you're going to have some additional capacity next year, that should be helpful.
Could you also -- and presumably, the restructuring expense is going to go down and you'll have the savings that you've outlined. What is the amount of inefficiency that, separately from that, that you're kind of flowing through the P&L this year that would not recur next year?
John Olin
Rod, we do not provide Sportster mix or any family mix as a percentage of retail sales. We only do it with regards to shipment mix.
Sportsters during the quarter was 22.3% of our shipments. And on a year-to-date basis, was 22% of the overall shipment mix.
The second question with regards to the transformation, is the transformation expense so far this year, we had in temporary inefficiencies, $11 million in the first quarter, I believe it was $8 million in the second quarter and on a year-over-year basis, $3 million in the third quarter. That would have been gross inefficiencies of $7 million.
And we're lapping last year's fourth quarter -- I'm sorry, third quarter results, which was $4 million. Now we'll move into the next quarter, we expect the temporary inefficiencies to continue.
And next quarter we will be lapping a year ago number of $5 million. And then as we get into 2012, we're not providing guidance at this time on gross margin or temporary inefficiencies.
However, we will begin to lap the temporary inefficiencies that we had this year, again $11 million, $8 million and $3 million, through the first 3 quarters.
Rod Lache - Deutsche Bank AG, Research Division
Okay. And can you give us any kind of color on what you would anticipate as additional capacity out of the York facility for the higher end lines next year versus this year?
John Olin
Again, that's what I mentioned earlier, there's still going to be temporary capacity constraints as we get through the different phases of this. The next -- the big phase in 2012 will be to put in a fully integrated ERP system in York, and that will also put some pressure on downtime.
We do expect there to be additional capacity in the modest realm at this point. Again, we look to provide shipment guidance on the first quarter.
Rod Lache - Deutsche Bank AG, Research Division
Okay. And then just lastly, any updated thoughts on capital allocation?
And specifically, over time, what is the level of cash that you want to have on the balance sheet just on an ongoing basis?
John Olin
Well, with regards to cash on the balance sheet, we're committed to keeping 12 months of liquidity at all times. And that can either be either be through cash or committed credit facilities, through our bank facilities and our conduit.
We will continue to look and evaluate that cash situation in light of the opportunities to increase dividends and repurchase shares as we go forward.
Operator
Your next question comes from the line of James Hardiman from Longbow Research.
James Hardiman - Longbow Research LLC
I wanted to continue to drill down on some of these gross margin items just because I think that's probably the biggest reason why your stock is getting beaten up this morning. You mentioned really that the 3 major items.
Mix in the third quarter was a significant negative. You said that, that should improve in the fourth quarter.
Does that mean that $27 million is just going to be less negative or should we expect a positive in the fourth quarter? And then currency, it sounds like, is getting worse.
Should we expect a meaningful negative there? And then just finally on manufacturing, you talked about that $3 million.
Is that a fair run rate going forward? Obviously, you're lapping an even bigger number so, I guess, that question comes down to the remaining restructuring activities that are taking place at York.
Are we going to see those costs ramp up, or do they continue to be where they are now even get a little bit less?
John Olin
As we look forward to the fourth quarter, we expect the temporary inefficiencies and temporary capacity constraints to continue as we continue to come up to speed, but we expect that they will significantly improve as we move forward. As we look at the fourth quarter, we expect mix to improve modestly, but to continue to be pressured by the continuing restructuring that we have at York.
With regards to the currency, it all depends on what happens to our currency exchange rates. They are significantly lower today than they were a quarter ago.
And in the near term, we do have some of that hedged. And again, the acute thing that happened in the third quarter was revaluation of our balance sheet assets and liability as that's kind of a low point of currencies and given the situation that we see in Europe.
So making no forward projection with regards to what's going to happen to currency exchange rates, but they are lower today than they were as we started out the third quarter. And finally, James, the last question was on the $3 million of temporary inefficiencies, I believe in the third quarter, and how do they look going forward.
Again, with the activities that have taken place at York, we expect that to continue to get better and improve. And it just takes a lot of time when you're moving all the assets that we've got and retraining all the workers that are out there and the magnitude of activity that's going on.
So we expect that to be better in future quarters and better in the fourth quarter. Fourth quarter a year ago, we had temporary inefficiencies at that time, which were driven by us outsourcing all the things that we used to make, the non-core parts, and the excess overheads that we were carrying, and that was a $5 million hit a year ago.
So we will be lapping that in the fourth quarter, and would expect overall improvement in temporary inefficiencies as we move forward.
James Hardiman - Longbow Research LLC
Great. And just to clarify, and then I'll hop back in the queue.
When you say mix is expected to improve modestly in the fourth quarter, are we actually going to see mix be a benefit to gross margins or is it just going to be less than a drag -- less of a drag than the $27 million that we saw in the third quarter?
John Olin
No, we would expect it to be positive. On a year-to-date basis, mix is flat.
And the third quarter was hit hard by the 3 things that are happening, or the 3 areas of mix that were impacted, family, geographic and model mix, due to the restructuring at York. We expect the restructuring to continue to progress and improve at York and, therefore, we would expect mix to be a benefit in the fourth quarter, not a less of a negative but a benefit in the fourth quarter.
And all along, we said that we expected mix on a full year basis to be modestly favorable.
Operator
Your next question comes from the line of Patrick Archambault from Goldman Sachs.
Patrick Archambault - Goldman Sachs Group Inc., Research Division
I just wanted to dig in a little bit on the currency issue. I mean, it sounds like looking through your deck, it looks like this quarter, it was dilutive.
Even though currency was a positive, obviously, the incremental margin on that is lower than your industry margins, so it's dilutive. I guess, next quarter, is it that impact, because it also sounded like you mentioned there was some kind of a reevaluation effect, I think you mentioned on balance sheet items, that might be there as well.
So just wanted a little bit more granularity on sort of how that's expected to mechanically impact the P&L in the fourth quarter.
John Olin
Right. Well, Patrick, you're absolutely right that the currency was dilutive.
As far as a percentage of our gross margin percent, it impacted overall gross margins by nearly a percentage point. And that was due to the favorable revenue side of it, and much less favorable on the profit side.
The profit side was brought down quite considerably as we revalued. So every quarter we've got to revalue our foreign assets, given the currency exchange rates, and that happens at the exchange rate at the end of the quarter.
And so they drop significantly from the beginning of the quarter. The euro fell 5%, Australian dollars fell 7% and the real fell 14% from the beginning of the quarter.
So we don't know what will happen in the fourth quarter. If currency exchange rates improve, the revaluation will be favorable if they're higher than they were in the first -- beginning of the fourth quarter.
So we don't know what that is. But overall, the euro, Australian dollar and real are lower than they were, that we enjoyed on an average basis in the third quarter.
And so we're cautious about currency at this point. But we don't know where it's going to end up.
And all as we know is it's been hit largely by events taking place in Europe.
Patrick Archambault - Goldman Sachs Group Inc., Research Division
Got you. So basically, if it just stayed where it was, that would -- you're not taking a directional view, you're just assuming if it stayed where it was now, your new guidance is where you would wind up?
John Olin
Yes.
Operator
Your next question comes from the line of Robin Farley from UBS.
Robin M. Farley - UBS Investment Bank, Research Division
Two questions. First, I just wanted to try and quantify.
I assume the IRS settlement in your tax line is a one-time benefit. I'm just trying to quantify what that is, to think about what earnings would have been without the IRS settlement.
And then also, completely unrelated, just looking at used bike prices. Can you give us a sense of what you think used bike prices are selling at as a discount to the price of a new bike, just any kind of ballpark range where you think that is right now?
John Olin
Okay. Robin, the -- we're favorably impacted by 2 things that happened in the quarter with regards to our tax line item.
First is we settled an audit with the IRS for tax years 2005 to 2008, and we had a favorable position on our domestic manufacturing credit, as well as the R&D credit. And we released some of the reserves that we have placed against that, and that provided favorability.
The other thing is, is that the Wisconsin tax law changed with regards to net operating losses. If you remember back to the first quarter of 2009, we took a fairly big hit and, at that time, they wiped out the use of NOLs and now they've restored that.
So we brought that back on to the benefits of the company. So those 2 together took down our quarterly tax rate to about 21.5% versus what the expectations were at about 35%.
Robin M. Farley - UBS Investment Bank, Research Division
But the use of NOLs is going to be an ongoing benefit, I guess, for you. But I'm just wondering what was the -- was it $0.07 or $0.08 of EPS that was just a one-time thing from the IRS settlement?
John Olin
I don't have it translated to an impact on earnings per share, Robin. Again, the tax rate for the quarter was 21.5% versus the guidance before that was 35%, and you would have to calculate it out.
I don't know what it is in terms of EPS.
Robin M. Farley - UBS Investment Bank, Research Division
Okay. And then on used bike pricing?
John Olin
Yes. During the quarter, we've seen the trend continue, is that we've seen used bike prices generally firm during the quarter.
Believe that our strategy of managing the supply of motorcycles is working well. We've seen total demand increase during the quarter.
And again, used bike price is firm. In terms of a percentage of where we are today versus where we were before, we don't provide that granular of information on used bike pricing.
Operator
Your next question comes from the line of Joe Hovorka from Raymond James.
Joseph D. Hovorka - Raymond James & Associates, Inc., Research Division
I just wanted to talk a little bit more about mix. I understand the impact it has on gross margin, but I was actually kind of surprised at the magnitude of the impact.
So if I look at your incremental gross margins in total for the quarter, they're about 24%, 24.5%. And even if I add back FX, you're still only about 25.5%.
That would imply that you're selling some of the incremental bikes sold in the quarter were at gross margins that were, I mean, at best, low-20s and probably in the teens. I guess, I wasn't -- first, is that number right?
And secondly, what bikes have margins that are that low?
John Olin
That's not necessarily correct. Remember, when we've said numerous times in the past, mix is affected by family mix, model mix, geographic mix, option mix and mix within P&A and General Merchandise.
During the third quarter, we had impacts for many of these factors and with many of them being unfavorable, largely driven by the events at York. So let's go through some of them.
Is family mix perspective, that was unfavorable. And that was straight family on a shift between lower-priced bikes and higher-priced bikes.
Largely because York produces most of our higher margin bikes, which are the Touring and Softail line. So we have a couple of percentage point shift between our production at York and in Kansas City.
The -- also were affected by the model mix. So for most of the year, we've had favorable model mix.
And that is people trading up to higher-priced bikes within a family. And given the activities at York, the model mix was also unfavorable this quarter as the Touring and Softail families reproduced motorcycles with lower content and, therefore, lower-priced bikes during the quarter.
And finally, the third piece of the York effect was normal shipping patterns were disrupted due to the magnitude of change that was occurring in York. And that had an impact in our geographic mix, or the shipment to various countries, and shipping bikes to lower-margin countries.
And even outside the motorcycle mix, we had unfavorable mix in our P&A business. And as we work to increase our share of the consumables line of products, which includes oils and tires, they're at a lower margin than our parts and accessories, so we had a little bit unfavorable mix there.
So it's not only motorcycle, it's across all of the revenue base. And so you can't apply it all to motorcycle margins, Joe.
Joseph D. Hovorka - Raymond James & Associates, Inc., Research Division
So part of the mix is, actually, you're saying the mix shifting away from General Merchandise and P&A as well?
John Olin
Well, no, I didn't say that. I said that was unfavorable mix driven by increased shipments of our consumable product.
As we increase our share of that market share of that business, it just happens to be at a lower margin than the others. We've seen very good growth in both of our General Merchandise and Parts and Accessories business, both at about 8% for the quarter.
Keith E. Wandell
It's a focus on additional product line and our parts and accessories business.
Operator
Your next question comes from the line of Ed Aaron from RBC Capital markets.
Edward Aaron - RBC Capital Markets, LLC, Research Division
Just one more clarification on kind of near-term York issues. It sounds like from your perspective the line rates are about where you would have expected them to be.
But you did ship kind of toward the lower end of guidance this quarter and it's a relatively wide range of production expected for the fourth quarter. So just at the margin, it kind of seems like maybe it's -- the line rates are maybe a little lower than where you would ideally think that they would be at this point.
Can you just help me reconcile that a little bit with your commentary that it -- you're where you expected to be?
Keith E. Wandell
This is Keith. There have been a lot of questions on York.
And so if we just sort of go back about a year, I mean, I don't think anything's a whole lot different than what we've said. We said all along that first of all, the transformation that we were going to go through, not only in York but also in Milwaukee and Tomahawk and Kansas City, is big.
So this is not us just sort of shuffling people around. You've got to remember, we outsource over half of the work in terms of people that were in the York facility.
So we're just now going through the belly of that whole transition and coming out of that. And as John mentioned, so what that means is, is that a lot of people that worked in stamping or plating or grinding or wherever are now -- have now been shifted over to the new assembly line.
So they're all going through massive training and learning on the job. In addition to that, we've taken the dedicated assembly lines where we would produce just one family of products, sort of a repetitive manufacturing process, that we move now to the flexible manufacturing line whereby all those products can be built on the same line, which introduces a lot of complexity in terms of production planning, component planning and those kinds of things.
And in addition to that, you can imagine the amount of systems work and software involved in the guided robotic systems that we now produce all of our products on. So it's like a massive amount of change.
And we've said all along that we would be out of this part of the change, at least in York, at the end of 2012. So we're still a year away.
So it's hard for us to predict, quite frankly, from day-to-day, what kind of issues we're going to have. Now if you go back in time about a month, we had some -- a lot of significant issues with downtime because we had outsourced a lot of our subassembly work and we we're having some problems with getting the right parts to the line at the right time.
And all those issues now have been, I would say, resolved 95%. Our run rates have come up significantly in the last month.
We're hitting more of our schedule on a daily basis. And so, I mean, are we disappointed that things haven't been perfect?
Yes. But I will tell you that we're pleased with where we are in this transformation, given the magnitude of the work.
And so I think it will only get better. And again, we're running one shift because we just could not -- we cannot absorb that amount of retraining and training on more than one shift at this point in time.
So any concerns about capacity in the future, there are 3 shifts in a day, right? So, I mean, and we've said this all along, capacity is not going to be an issue.
And the ability for us to get our mix back in line isn't going to be an issue in the future. And we will be able to produce at line rates, et cetera.
Now is that going to be 3 days from now or 10 days from now or 18 days from now? I mean, it's hard for me to say.
But I hope that helps clarify that what we're doing here is, if you go back to our strategic plan and you go back to our transformation plan, what we're doing is putting in a flexible, world-class, manufacturing process, which, when completed, will give us the flexibility to be closer to our customer, to be much more cost effective, and to be able to move more toward customization of production in the plant. So this is a little bit longer term solution that we're looking at here and we have a lot of great people on-site, working through these issues every day and we feel good about where we're at.
Operator
Your last question comes from the line of Gerrick Johnson from BMO Capital Markets.
Gerrick L. Johnson - BMO Capital Markets U.S.
I apologize if you addressed this already, couple of calls here, but can you break down your retail sales through the quarter, how they trend through each month? Is that something you can discuss?
John Olin
We don't provide or comment on inter-quarter retail sales, Gerrick. The reason being is there's too many factors that could affect monthly comparisons, such as timing, product availability, weather, promotional activity.
For example, in the third quarter of this year, we released our model year 2012 product one month early that we have a significant impact on year-over-year monthly comparisons. The important thing to note is that Harley-Davidson has posted improved retail results for the last 9 quarters and we continue to build the fundamental building blocks for sustainable growth.
And so we're not focused on any particular month. We're looking off into the future and doing what is necessary to provide a base for sustainable growth going forward.
Operator
There are no further questions at this time.
Keith E. Wandell
Thank you for your time this morning. We appreciate your investment in Harley-Davidson.
Amy Giuffre
The audiovisual support for today's call will be available at harley-davidson.com. The audio can also be accessed until November 1 by calling (404) 537-3406 or (855) 859-2056.
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Operator
Ladies and gentlemen, this concludes today's conference call. You may now disconnect.