Harley-Davidson, Inc. (HOG) Q4 2017 Earnings Report, Transcript and Summary

Good morning. My name is Marcela, and I will be your conference operator today. At this time, I'd like to welcome everyone to the 2017 Fourth Quarter Earnings Conference Call. [Operator Instructions] Thank you. Amy Giuffre, Director of Investor Relations, you may begin your conference.

Thank you, and good morning, everyone. You can access the slides supporting this call on harley-davidson.com. Click About Us at the top right, select Investors from the drop-down and click the Earnings Materials Box in the center of the page. Our comments 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. Joining me this morning are President and CEO, Matt Levatich; and CFO, John Olin. Matt, let's get started.

Thank you, Amy, and good morning, everyone. I'd like to dedicate the bulk of my remarks to how we're approaching 2018 and beyond, but to do so, I'll begin with the context of our challenges in the U.S. industry and in certain international markets that continue to require the best in us as we take decisive action to position our business for performance and strength for the long-term. Our efforts throughout 2017 were geared toward two key imperatives: first, achieving the right balance of new motorcycle quantity and mix at retail; and second, positioning the company's cost structure to better compete in this new reality. In addition, while we directed substantial energy toward addressing the current market conditions, we stayed grounded in our strategy and made good progress on our long-term objective to build riders globally. During the first year of our 10-year journey, we established a foundation and made good initial progress on growing ridership. In the U.S., our disciplined supply management approach supported lean and model year mix appropriate year-end retail inventory. We also saw an improvement in used bike prices, a cornerstone of value for our riders and our dealers, who are such a key part of our business. More importantly, with unwavering brand stewardship as our guide, we respected the premium Harley-Davidson has earned over 115 years, with pivotal moves like the launch of our all-new highly acclaimed Softail motorcycles, improved rider training conversion and expanded international reach. We continue to enhance the Harley-Davidson value proposition and not damage it by implementing shortsighted tactics. Our second imperative in 2017 was bringing increased focus to our resource allocation and cost structure. Our efforts resulted in a $41 million reduction in SG&A and positioned us to better compete in today's environment. We introduced our objectives and strategies to build riders last January and made excellent progress during the first year of execution. A year ago, we began our critical mindset and cultural shift at the company from we build motorcycles to we build riders. We closed 2017 with over 32,000 more Harley-Davidson riders in the United States compared to 1 year ago. These riders were inspired because of efforts, including a more inclusive and welcoming brand promise, All for Freedom, Freedom for All, informed by deep insights about what is the common thread of our brand for both today’s and tomorrow’s riders, improved riding academy conversion, not simply training riders but creating riders. Sales conversions were up, and we gained insights on how to continue to further improve this important capability, increased access to riding through our partnership with EagleRider that enables customers to more readily experience the thrill of Harley-Davidson motorcycles, and importantly, our most exciting and best-performing products ever. In 2017, we leveraged our capabilities and kept our eyes firmly on how to best bring together all our strengths to inspire and nurture people along their journey to riding. We're also delighted to see others in the industry join the march to build ridership in the United States. We'll continue to lead the effort and encourage other manufacturers, the motorcycle media and dealers everywhere to unite and leverage our collective power to inspire future riders to experience the exhilaration and freedom of motorcycles. 2017 was challenging in many ways, but it was also rewarding. I'm pleased with how our actions reflected the reality of the current environment and positioned us well to face it. We continue to lead with strong product and a disciplined approach in all of our operations and actions. The net of all our actions drove another year of strong cash generation and cash returns to our shareholders. With all this in mind, we have much more to do. Looking forward to 2018, we expect international retail growth. However, we don't expect a reprieve from the challenges in the U.S. motorcycle industry. Our global retail expectations and our disciplined supply management strategy are reflected in our guidance for reduced year-over-year shipments. As we navigate ongoing headwinds in 2018, we will keep our attention on the strategic imperative to grow ridership. We'll remain steadfast to our disciplined supply management and step up the intensity of our investment focus, resource allocation and cost management to continue to deliver strong ROIC and cash returns for our shareholders. To further improve our cost structure and maintain our world-class manufacturing operations, we're commencing a significant multi-year manufacturing optimization initiative anchored by the consolidation of our final assembly plant in Kansas City into our plant in York, Pennsylvania. This decision was made after very careful consideration of our manufacturing footprint and the appropriate capacity, given the current business environment. As we consolidate assembly operations, we expect approximately 800 jobs will be eliminated with the closure of Kansas City operations and that approximately 450 jobs will be added in York as we shift capacity there by 2019. This decision was extremely difficult but necessary under the circumstances. Our Kansas City assembly operations and our employees there have an impressive tradition of safety, quality, collaboration and manufacturing leadership. I have profound respect for the women and men in that facility, and I thank them and the Kansas City community for their years of support and contribution to serving Harley-Davidson, our dealers and, most importantly, our riders. Another key element of the manufacturing optimization will be the closure of our wheel operations in Adelaide, Australia. For many years, New Castalloy has produced our high finish, contrast and mirror chrome wheels and hubs, but as style preferences shift toward core competencies of other Harley-Davidson wheel suppliers, the utilization of that facility continues to fall. This is another tough decision affecting approximately 100 talented and dedicated Harley-Davidson employees, and I want to thank them as well. Our focus moving forward in 2018 and beyond is to be more aggressive and innovative, leveraging our learnings and capabilities to sharpen our focus and scale our efforts to compete more effectively in every market we're in as we build Harley-Davidson riders. On the momentum created from our years of customer outreach success in the U.S., we made significant investments to establish a knowledge base of the ownership patterns of every rider in the United States how they entered and participated in this work over time. This is not the typical product view of the industry but a unique rider-by-rider view of the sport since 2000. Our recently acquired data assets allow us to draw deeper insights on participation themes, whether individual or generational. We know we must not only inspire and create new riders but also keep riders engaged in the sport and riding longer. Our ridership efforts both building new riders and keeping riders engaged will only intensify as we continue to apply our learnings and dial in our resources on proven methods. Outside the U.S., we'll intensify our efforts to increase the reach and impact of Harley-Davidson. We'll take advantage of the tailwinds from our successful awareness and test ride campaigns and leverage the positive reviews in the media of our new touring and Softail motorcycles. In addition, more customers will gain access to our products as we continue to expand our dealer network outside the U.S. Access and product inspiration are key in the vast and competitive international markets and our access to certain emerging markets is about to see a step change later this year when we begin operations at our new facility in Thailand. Like our facilities in Brazil and India, this plant will support more competitive retail pricing by eliminating much of the tax and tariff burden that fully assembled imports carry in some of these markets. Our plant will leverage existing suppliers and our U.S. plants for component supply. We expect more competitive pricing will drive profitable share and increased demand, volume growth that would not materialize had the motorcycles been shipped from the U.S. and subject to import duties of up to 60%. The clear majority of our operations have been and will continue to be, U.S.-based and our cash comes back here too. The tax reform legislation is intended to benefit companies like Harley-Davidson that are committed to U.S. operations. The positive impact of tax reform on our cash flow will provide additional investment capital to drive our business, and we will continue to apply our discipline to investment decisions and capital allocation principles to drive value for the business and return excess cash to our shareholders. In 2018, a portion of the benefit from the new tax legislation will support our objective to invest in high-impact product, to inspire ridership by continuing to redefine our product in traditional spaces and expand into new spaces to reach new people. One key opportunity is the rapidly evolving electric vehicle landscape. The EV market is in its infancy today and we believe it will drive excitement into our sport globally in both traditional and nontraditional spaces. You've heard us talk about Project LiveWire. LiveWire is an exhilarating, no excuses, electric Harley-Davidson. Over 12,000 riders told us so through the demo rides we provided around the world and it's an active project we're preparing to bring to market within 18 months. This morning, we announced we'll invest more aggressively in our effort to lead in the application of electric technology in premium motorcycles to inspire ridership among new audiences. The more we grow our experience and capability with EV, the more excited we become about the role it will play in growing business, about the additional and region impact electric Harley-Davidson motorcycles will bring as an element of our product portfolio. We expect our increased commitment and investment in EV to help accelerate the development of this market and assure we are the world leader in the electrification motorcycles, along with our continued leadership in premium, classic, custom and touring motorcycles. Our bottom-line will be aggressive in speaking and prioritizing opportunities that drive growth, profitability and cash flow, opportunities that improve the company's growth trajectory and leverage our significant capabilities, assets, dealers and employee -- employees to drive value for all and deliver superior returns to our shareholders. 2018 is our 115th year in business, and we're very proud of that because it takes strength, courage and creativity to persevere for that long no matter what the industry. Our history is rich with episodes of triumph and episodes that challenged prevailing thinking and tested fortitude and resolve. Our focus right here, right now is on our future, and on bringing forward all the substantial strengths of this company to shape that future no matter what our present challenge. So with that in mind, John will walk you through the financial details. Thank you.

Thanks Matt. It's clear the U.S. 601+ cc industry continued to face significant challenges in the fourth quarter. In addition, international retail sales finished below our expectations. Considering ongoing challenges, we remain focused on reducing U.S. retail inventory, reducing costs and investing our strategy to drive value for our riders, dealers and shareholders. The summary of our Q4 result is on Slide 10. Revenue was up behind increased shipments compared to last year's fourth quarter. Operating income from both motorcycles and financial services was also up. Net income and earnings per share were both down from last year's fourth quarter, adversely impacted by a write-down of net deferred tax assets. We remain focused on delivering strong margins and strong returns over the long-term despite significant near-term headwinds. On Slide 11, Q4 worldwide retail sales of new Harley-Davidson motorcycles were down 9.6% versus prior year. In the United States, retail sales were significantly lower, driven by ongoing industry weakness, soft market share behind lapping last year's share gains and limited availability. While international retail sales were below our expectations, we continue to believe that our strong brand, products and expanded distribution will drive sustained growth in international markets over time. We remain committed to our long-term international growth strategy. We recognize this was another difficult quarter. However, we are encouraged by the positive response to our new Softail motorcycles, our U.S. dealers' inventory position, the expansion of our international dealer network and certainly by the progress we are making to build riders globally. Let's take a closer look at the U.S. On Slide 12, U.S. retail sales were down 11.1% in Q4. The industry was down 6.5% in the fourth quarter, the ninth consecutive quarter of industry weakness. We believe the new motorcycle industry continued to be adversely impacted by soft used bike prices, but prices improved in the fourth quarter on a year-over-year basis. Bike pricing is a headwind to new bike sales. Year-to-date sales of used Harley-Davidson motorcycles were up through November and continued to perform significantly better than new retail sales in the United States. Year-to-date, total registrations of new and used Harley-Davidson motorcycles combined were down slightly through November. However, our 2017 share of combined registered new and used motorcycles increased for the ninth consecutive year. Key to our focus of driving premium value for our riders, dealers and the brand are strong used bike prices. In Q4, we continued to see positive momentum in used motorcycle pricing. Used Harley-Davidson bike wholesale prices at auction remain above year-ago levels, and pricing services such as NADA and Black Book continue to publish higher retail values year-over-year for Harley-Davidson motorcycles. Finally, for the second consecutive quarter, dealership data indicates that Harley-Davidson prices in the broader used bike market were up in aggregate, particularly in our dealer network. Moving on to new motorcycle market share. Harley-Davidson share in the quarter was down 2.6 percentage points but remained a very healthy 50.8%. We believe our market share was adversely impacted by lapping last year's strong share gain of 2.0 percentage points and by limited availability. On the positive side, our share of large Cruisers was up significantly, driven by the new Softail motorcycles. U.S. retail motorcycle inventory was down nearly 10% to 25% throughout most of the quarter. At the end of the quarter, retail inventory was down approximately 3,000 motorcycles compared to prior year. We believe our discipline to reduce the supply and improve model year mix in the U.S. delivered the intended results, and we were well positioned as we entered 2018. We continue to work hard to protect and reinforce the strength of the Harley-Davidson brand by aggressively managing supply in line with demand. On Slide 13, international retail sales in Q4 were down 7.7%. Overall, it was a tough quarter in most of our international markets. However, there are positive developments – there were positive developments during the quarter. First, the new Softail motorcycles are being very well received by our customers in Europe, Asia and Latin America. In Q4, we experienced strong sell-through rates with limited availability throughout the quarter. We believe the strong customer response to our Softails, coupled with the fact that international retail sales generally skew to a heavier mix of Softails than in the United States, is a good early indicator of the potential impact of the new models. Next, in line with our strategy to increase brand access internationally, we continue to expand our international dealer network. During the quarter, 22 new dealers were added for a full year total of 57. We remain confident in our international growth prospects and expect to return to retail sales growth in 2018. On Slide 14, wholesale motorcycle shipments were up 11.3% in the quarter and within our shipment guidance range. Compared to last year's fourth quarter, Cruisers as a percent of total shipments were up behind the launch of the new Softail motorcycles. On Slide 15, revenue, the motorcycle segment was up in the fourth quarter behind higher year-over-year motorcycle shipments. Q4 average motorcycle revenue per unit was up $835 over last year's fourth quarter. The increase was due to higher pricing and favorable currency exchange, partially offset by unfavorable mix. On Slide 16, gross margin was up in Q4 behind increased shipments, higher pricing and favorable currency exchange, partially offset by higher manufacturing costs, unfavorable mix and rising raw material costs. On Slide 17, operating margin as a percent of revenue for Q4 was 3.6%, up 2.6 percentage points compared to last year. Operating margin percent benefited from slightly higher gross margin percent and lower SG&A spending as a percent of revenue. SG&A was up $7.9 million to prior year, as our aggressive cost-management efforts were offset by a charge of $29.4 million for a voluntary product recall. This voluntary recall addresses an investigation opened by NHTSA in 2016 and involved certain 2008 to 2011 touring and VRSC motorcycles equipped with anti-lock braking systems. Harley-Davidson has a two-year brake fluid replacement interval for ABS-equipped motorcycles, and some customers failed to follow that replacement interval for extended periods. We are committed to providing customers with the quality experience they expect from Harley-Davidson and will be offering a free brake fluid flush and replacement to owners of recalled motorcycles. Our profitability and strong cash flow remain a key focus. It is our aim to further leverage our established capabilities, to continue to drive profit, cash flow and strong ROIC into the future. HDFS's Q4 operating income, shown on Slide 18, increased 5.9% compared to last year. Operating income was positively impacted by a lower provision for retail loan losses of $7.1 million, driven by a smaller increase in the allowance as compared to Q4 2016. The impact of 2017 hurricanes was not as significant as we anticipated. HDFS's operational results are on Slide 19. Originations were down 0.3%, but market share was up 0.3 percentage points during the quarter compared to last year. At the end of the quarter, there was $349.3 million of cash and cash equivalents at HDFS and $887 million of available liquidity through bank credit and conduit facilities. On Slide 20, the 30-day delinquency rate for retail motorcycle loan receivables on balance sheet at the end of December was 4.21% or four basis points lower than Q4 2016. This is the first quarter in 11 quarters that our 30-day delinquency was down on a year-over-year basis. The annual retail credit loss rate for receivables on our balance sheet was 1.90% or only 7 basis points higher than 2016. While credit losses were up for the full year, we are pleased that the rate of increase has tempered quite significantly from last year. HDFS continues to maintain a robust liquidity position and contributed strong profitability to the company. The remaining Harley-Davidson, Inc. financial results are summarized on Slide 21. Our effective tax rate was 91.2% in the fourth quarter and 39.6% for the full year 2017, both considerably higher than our expectations, largely due to the impact of the Tax Cuts and Job Act. Two important components of this legislation are, first, the lowering of the federal corporate income tax rate resulted in the write-down of net deferred tax assets in the fourth quarter. Our overall net deferred tax assets were previously valued using a federal tax rate of 35%. Lowering the valuation to a rate of 21% and other reform-related adjustments has resulted in a write-down of $53.1 million. It is important to note that this was a non-cash adjustment to our balance sheet. Second, the new legislation also requires many companies to pay tax on unremitted foreign earnings at rates of either 8% or 15.5%. Given our predominantly U.S. based manufacturing operations we do not expect to be adversely impacted by this provision. However, we will continue to evaluate this complex component of the legislation and expect to refine our assessment as additional information becomes available. And finally, regarding liquidity, the company has and intends to continue to maintain a minimum of 12 months of projected liquidity needs in cash and/or committed credit facilities. Our full year financial results are summarized on Slide 22. We believe the charts on Slide 23 demonstrate that we are in a class of our own when it comes to generating cash. The top left chart illustrates our ability to generate operating cash flow even in very tough business conditions, as was the case in 2017. Last year, net income was down nearly 25%, but operating cash was down only 14.4%. The remaining charts benchmark our cash flow versus previous peer groups. In each case, Harley-Davidson is the clear leader in our ability to generate cash. Slide 24 illustrates our strong history of returning cash to our shareholders. Again, we are a leader in this area across multiple industries. In 2017, we paid dividends of $1.46 per share and repurchased 8.7 million shares for $456.1 million. One of the five objectives guiding our business strategies and execution through 2027 is to deliver superior return on invested capital, as measured by motor company ROIC and the top quartile of the S&P 500 and by best-in-class ROE at HDFS. Harley-Davidson is a leader in ROIC at HDMC and ROE at HDFS. Driving superior value for our shareholders is our top priority. We will continue to look for opportunities to grow value, first and foremost, by disciplined investments to maximize the performance and long-term potential of the company and the brand. We have a robust process for our investment decisions and our discipline to it. After investing in our business, we intend to return excess cash to shareholders in the form of increasing dividends and continued share repurchases. On Slide 25, we have provided a summary of our multi-year manufacturing optimization initiative. We expect this optimization to result in a reduction in operating income of $170 million to $200 million through 2019 of which roughly 30% will be noncash write-downs of existing assets. We also plan to invest approximately $75 million of capital. We expect annual ongoing cash savings to be between $65 million to $75 million after 2020. These actions will eliminate some manufacturing capacity. However, we will still have appropriate headroom for future motorcycle unit growth. We believe these investments have very attractive returns. When completed, we expect this initiative will simplify our manufacturing footprint, provide focus on our operational investments and improve gross margin by approximately 1.25 percentage points. A summary of our expectations for 2018 is on Slide 26. We expect to ship between 231,000 and 236,000 motorcycles, which is down approximately 2% to 4%. Our assumptions include U.S. dealer retail sales to be down. Our assumptions include U.S. retail dealer – retail sales to be down, partially offset by growth in international retail sales. We expect year-end U.S. retail inventory to be flat to 2017 and flat to up in international markets as we continue to add dealers. During 2018, we expect retail sales to be positively impacted by: increased focus and investment on growing global ridership, new product momentum with our 2018 motorcycles and the addition of new high-impact models yet to be introduced, a rebound in emerging market retail sales performance and expansion of the international dealer network. However, we expect these positive to be more than offset by strong headwinds, including a very weak U.S. new industry – new motorcycle industry, driven by flat to declining total demand, which we are focusing on with our ridership efforts and soft but improving Harley-Davidson used bike prices. We also expect pressure from continued new product introductions throughout the world markets, in particular, low-priced small displacement motorcycles. Operating margin as a percent of revenue for the motorcycle segment is expected to be approximately 9.5% to 10.5% for the full year 2018. This reduction of roughly two percentage points to three percentage points compared to 2017 is primarily driven by manufacturing optimization cost of $120 million to $140 million. Also, our operating margin will be reduced by approximately 0.2 percentage points due a new accounting pronouncement related to pension accounting, which requires us to move approximately $10 million of operating income to non-operating income. This adjustment will be made to both 2017 and 2018 actual results when we report first quarter earnings in April. Gross margin as a percent of revenue is expected to benefit from pricing of our model year 2018 and 2019 motorcycles, a more favorable foreign currency exchange environment than last year and positive mix. We expect these positives to be more than offset by rising steel and aluminum costs and increased manufacturing expense. We expect manufacturing expense will be higher in part by increased depreciation from recent investments in our new Softail motorcycles. However, we expect the larger driver of increased manufacturing costs will be due to temporary inefficiencies of $20 million to $25 million related to the consolidation of our two U.S. final assembly plants and the closure of our Australian real operations. In addition to temporary inefficiencies in gross margin, we expect to incur approximately $100 million to $115 million of restructuring costs to execute our manufacturing optimization initiative during the year. Of that total, we expect to incur restructuring charges of approximately $57 million in the first quarter, largely consisting of severance charges and accelerated depreciation. We expect SG&A on an absolute basis to be higher in 2018 versus 2017 as we continue to invest in our long-term strategies, but flat as a percent of revenue. We expect SG&A to be up behind increased investment in marketing and product development as we work to grow ridership globally. As Matt stated, we will increase our investment in electric motorcycle technology and products and infrastructure in an effort to be a world leader in electric motorcycle market. We expect to spend an incremental $25 million to $50 million per year over the next several years. In the first quarter, we expect shipments to be approximately 60,000 to 65,000 motorcycles, which is down approximately 8% to 15%, as we continue our disciplined supply strategy. While we expect U.S. retail inventories will be tighter than Q1 of 2017, we believe the composition of previous and current model year motorcycles will be considerably improved from last year. We expect motorcycle segment operating income as a percent of revenue in Q1 to be down approximately five percentage points behind the $57 million restructuring charge, loss absorption from lower production and higher SG&A as we increase marketing and product development investments. For HDFS, we expect operating income to be down, driven by lower net interest income, partially offset by a favorable provision for credit losses. Capital expenditures in 2018 are expected to be $250 million to $270 million, which includes approximately $50 million to support our manufacturing optimization initiative. Finally, we expect our full year effective tax rate will be approximately 23.5% to 25%, down approximately 10 percentage points from the rate we would have expected before tax reform. This range could change as we continue to analyze the tax act. To wrap up, we're committed to addressing the ongoing weakness in our business by being disciplined in our management of supply, our brand premium and our cash returns amplifying our cost management efforts and relentlessly focusing on our long-term objectives. As we build the next generation of Harley-Davidson riders globally, we will prudently focus on our investments, deliver on strong returns to our investors and sustain the company for the long-term. Thank you. Now let's take your questions.

[Operator Instructions] Your first question comes from the line of Tim Conder from Wells Fargo Securities.

John, just a little bit more clarification on the international retail weakness. It appeared significantly weaker than expected, except for Canada. Color on that. And then just reiterate also your keys of driving your flat U.S. retail expectations for 2018? Thank you.

I'm sorry, the second part of that question?

Why flat retail U.S…

Yes, just the keys driving your flat U.S. retail expectations for '18?

International retail sales were down 7.7% in the fourth quarter. They were down throughout the year 3.9%. We've looked at all of our international businesses. We see nothing in common with the various markets. The brand is fundamentally strong. We don't see any issues. We hear time to time and are asked, is kind of the U.S.A. brand affecting our brand. We don't have any data to that effect. Our brand stands for freedom and independence and personal freedom, and we think the brand is fundamentally sound. What we have internationally is a confluence of things that have come together in 2017. The first half was largely characterized by soft emerging market sales, driven by China and India. In the third quarter, we started to see emerging markets improve, and at that time, we saw a couple other markets go a little bit tilt on us. In particular, in Australia, the industry was down quite significantly. The industry was down in the fourth quarter in Australia as well. Our volumes were down about 23%. But in Australia, we gained market share. So overall, we're very - feel very good about the international business as we move into next year, but it was a tough year in 2017.

Tim, you asked why flat retail sales in the United States? I believe that you're referring to in 2018, we do not expect retail sales to be flat in 2018. We expect retail sales to be down next year, and that's driven by continued soft U.S. industry.

I believe Tim asked about inventory, so if you want to comment on inventory.

With regards to the inventory, on a full year basis, we would expect to end 2018 in the same position that we are today. We feel very good about where inventories are to kind of launch as a preset to the selling season. Within the year of 2018, we would expect inventories to be down in the first half as we continue to keep pressure on the overall system and keep inventories lower. Again, the mix of inventory this year is significantly better than it was last year, where we had a substantial amount of carryover product that we were working through and holding back new product.

Your next question comes from the line of Craig Kennison from Baird. Your line is open.

Matt, I wanted to ask about Kansas City and York. Without realignment, how would you frame the total unit capacity today versus what you will have following the realignment? Thanks.

Well, I don't have a specific figure for you, Craig, but we feel very good about the total footprint over time. We feel that we're in good shape for capacity really for the next decade as far as what we project. And we're investing in York, not just closing Kansas City. We're investing to expand the capacity of York in line with that. So it isn't just one minus one equals - two minus one equals one. It's bigger than that, and so we feel pretty good about the capacity for the next decade.

Your next question comes from the line of James Hardiman from Wedbush Securities. Your line is open.

I wanted to circle back inventory question. So looks like domestic inventories were down about 3,000 units. At some point, you had said you wanted to bring those down double-digits this year. Obviously, we don't know the exact sort of base number there, but it doesn't seem like that's quite double-digits. And I know you pointed to bigger than that over the course of the quarter. I don't know if I should read into that inventories picked up at the very end of the quarter. But I guess, more broadly, retail's down, it seems like significantly more than inventories over the past few years. So I guess, if there's any way that we can think about inventory turns at retail. It seems like even though inventories have come down, retail has maybe come down more. I guess, what gives you confidence that this is the right level of inventory as we exit 2017?

We talked about bringing inventories down in the second quarter and that'd be down double-digit, and we were down very close to double-digit but not quite there, and that was a little bit softer fourth quarter retail sales in the U.S. than we had anticipated. Throughout the quarter, inventories were very tight anywhere from down near the 10% double-digit to down 25%. James, you're right with regards to overall retail sales and inventory. I would say probably the worst time to look at inventory is at year-end, but it is a thing that everyone looks at because it's the end of the year. More importantly, inventory levels are at carryover and when we get into the selling season. And having said that is we need a certain level of inventory so that we can get in supply, the selling season. We're a very seasonal business, and we need a launching spot, even though we've got a lot of flexible manufacturing and we surge our production, we need to have a level of inventory at about this time of the year so that we can gear up and supply the selling season.

Your next question comes from the line of Seth Woolf from Northcoast Research. Your line is open.

I guess, wanted to dig into the international business. I know it's been -- you talked about how it's been challenging. But I think if we look at the last two years, we've added almost 100 locations, and shipments are the same. So what gives you confidence that we can, in fact, see the growth that we've been talking about for a while? And then secondly, you talk about used prices getting better. Have you considered that it could be a function of dealers buying more aggressively as they plan to allocate more of their showroom to used bikes going forward?

With regards to the international business, you're absolutely right. We've added in this year, largely toward the end of this year, so we didn't get the full benefit, about 6% more dealerships in our international business, and we believe those additions will serve us well. We'll continue to add dealerships in 2018. We've not seen the full benefit of those dealerships. Those incremental dealerships are selling incremental product. But the headwinds internationally have been pretty strong this year. Again, we don't believe there's anything fundamentally wrong with the business. And as we look forward, what will drive the business is partly that distribution gains. Secondly is product. When we look at our Softail product, very well received, and it skews to a heavier mix internationally than it does in the United States. So we believe that new Softails will benefit our international business more. Again, we're seeing the emerging markets turn, and we're very excited about that. And overall, we'll be spending more money in marketing to drive that business forward. So again, we expect retail sales growth to return in our international markets. Next question was with regards to used prices and the allocation of floor space. Over the last -- actually, over the last 12 quarters, used bike inventory in our dealerships have been down, and three quarters they've been up. One of those quarters has been up, has been the fourth quarter of this year. But overall, we're very positive on and sell our dealer selling used motorcycles. We want our dealers to sell it in balance, the ratio of new to used to be balanced. But a lot of people enter the brand on our used motorcycles. As dealers go out and pick up used motorcycles, it does put upward pressure on used bike pricing, which is very important to the brand as well.

[Operator Instructions] Your next question comes from the line of David Beckel from Bernstein. Your line is open.

I was wondering, sort of a high level, have the declines you've experienced since your Investor Day last February in any way caused you to rethink or recalibrate your 10-year plan or otherwise given you a stronger sense of urgency?

I would say no to the first question and yes to the second question. We actually feel even more strongly about our objectives and their appropriateness, certainly, the importance of growing ridership, delivering high ROIC and strong cash flow, how we use high-impact product to do that and kind of tying to the last question about used bike prices [Audio Gap]. So we feel stronger than ever about appropriateness of those objectives, and we feel, importantly, that we have to dial up our intensity and get sharper in our focus. And I think I referenced the knowledge base of rider patterns in the United States. It's providing us a tremendous amount of insight about how to focus our efforts, and we're frontloading a lot of effort this spring to really test some assumptions and dial up our efforts to move the needle on ridership and grow the total business in the United States. So, yes, the strategy is strong, and yes, our intensity is increasing.

Your next question comes from the line of Gerrick Johnson from BMO Capital Markets. Your line is open.

You mentioned a couple of times, limited availability impacting retail and market share. So can you quantify the limited availability and how that did impact both of those metrics? And basically, what your – what drove that? Or actually, what was the quantitative amount of shipments you cut back on? Thanks.

We saw our weakest retail sales in that quarter – in that month as well. As inventories improved, we saw retail sales improve throughout the quarter, but we ended up nearly down 10% as we exited the overall quarter. So it's hard to quantify exactly how many people were not able to buy and that will buy in the spring or in the first quarter of this year. Again, when we have limited availability, we do not think that anyone is coming into our showrooms and then going over to Honda or Suzuki and buying another motorcycle. Our dealers are very good at getting them on the right color and model that they need and want. Overall, share loss in the quarter, we expected shares to be down, and that was a bigger function of the fact that a year ago, we came out with the new Milwaukee-Eight engine on touring, which represents over 50% of our U.S. sales and as well as the 2016 models were being discounted by the dealer network, because there was an oversupply. And so overall, market share was 2 points up a year ago and we had to lap that, and that's the biggest driver of share being down.

Your next question comes from the line of Joseph Spak from RBC Capital Markets. Your line is open.

Happy to see the restructuring. I guess, I'm wondering if you think there is some other efficiencies in the business. Like, have you benchmarked engineering versus some other competitors or industries? And then, Matt, on the 10-year plan, glad to hear there's sort of this greater sense of urgency. But with sort of all these changes, I was wondering if you could help us with some more near-term metrics to sort of help us better gauge whether you're on track for that plan. Thanks.

I’ll do - it's John, I think - except now I can't remember the first question.

Benchmark against engineers.

Yes. Actually - thanks, Joe. We put this under the line of manufacturing optimization because those are the big movers, but it's actually a pretty comprehensive cost view of the core components of our business. So those are the design and supply management and many different facets of the business, and we're going to continue to look for opportunities to be more focused with our resources, and we've alluded to that both in my comments and John's comments. So look for that going forward. As it relates to how we're doing, right? And so clearly, the top line measures of sales and market share and stuff, we'll continue to talk about that. You're going to hear us talk more and more about how we're doing with riders. Very pleased that in 2017, we grew the net number of total Harley-Davidson riders in the United States by 32,000. That's important. We're finding from the rider migration database that there's quite a lot more flow, if you will, within the U.S. markets than we expected. We had quite a large number of new to the sport people joining on Harley in 2017 more than we thought would be naturally coming in and through our efforts. And actually, we had quite a few more exit than we expected, too. So the flux within the industry is higher than we thought. That's important insights as we figure out how to dial in our efforts, and we're going to be talking more about that as we go forward because clearly, the total demand for Harley-Davidson, the total number of active participating motorcyclists in the United States is a key measure for the strength of this and the vitality of this industry in the United States is so important to our overall business. So we'll talk more about those things as we roll forward, but we're excited to be able to share just the top line information today.

Your next question comes from the line of Rod Lache from Deutsche Bank. Your line is open.

Just following up on that. Maybe can you tell us what you think the number of new riders you need to create is in order to achieve flat retail sales because I presume that 32,000 is not enough because you put 148,000 into the park. And also, just secondly, can you just clarify what - maybe just repeat what you said about the commodity impact and the pension impact and whether there's some CapEx savings that you're targeting from this restructuring?

Thanks, Rod. It's Matt. I'll do part one, and John will do part two. We're actually – the other side of that equation is very interesting as well, and we don't have a lot of specific details of the composition. But while we added 32,000 riders to the Harley-Davidson University in the United States, the net increase in the number of our registered motorcycles was only about 23,000. So, on a base of 3.4 million motorcycles in the market, some exited - some motorcycles exited the market in 2017 as well. So the net increase was 23,000 bikes against a net increase of riders of 32,000. So when you look at that very high level motorcycle rider ecosystem, that's what we're really focusing in on. And how that will unfold over time based on generational trends and so forth is what we're modeling to drive the numbers that you referenced of how aggressive we need to be in growing the sport to stay ahead of our riders than motorcycles.

Rod, you'd asked about, I believe, the gross margin and as we look forward, you'd mentioned commodity costs and whatnot. Overall gross margin, we expect to be down on a year-over-year basis, largely driven by higher manufacturing expense. That manufacturing expense will be driven by the temporary inefficiencies to consolidate Casey into the York facility. And then we expect about $15 million to $20 million of debt expense. Aside from that, and taking out the manufacturing optimization, we expect our margins – both gross margin, SG&A as a percent of revenue and operating margin to be largely flat year-over-year on lower volumes.

Your next question comes from the line of Sharon Zackfia from William Blair. Your line is open.

A lot of questions have been asked and answered, but I guess, I'm wondering on the marketing. I know you guys have invested a lot in marketing over the last few years, and that's been a key driver. And I'm wondering how you're assessing the ROI on that marketing spend and the effectiveness and whether kind of a shift is needed and how you're trying to drive those new riders or those new motorcycle sales?

I would say that there's a level of intensity to that very subject that exists day-to-day in the organization. So you hear the terms around precision marketing, how are we leveraging our customer knowledge center, which is the hand razors that we collect every year, for example, that express interest in the sport or in the band, how are we qualifying those leads and making sure that the dealers get high-quality leads and do high-quality follow-ups. So there's a lot of effort in that space in how we deploy our marketing investment to drive the outcomes that we need, whether those are sales outcomes or ridership growth outcomes. The team is very tight on it. We're frontloading a lot of the investment. A lot of the investment this year is also being directed towards some very controlled experiments, see how we can do things like change the conversion rate more quickly in Riding Academy, how can we turn qualified leads into real riders quickly and effectively. So we're going to be right out of the gate with some very strong regional focused accelerants that drive our learning and drive our performance. So the marketing mix is being assessed constantly on that basis according to our strategy, and I think the team is energized actually by the opportunity to do that.

Your next question comes from the line of Felicia Hendrix from Barclays. Your line is open.

I just also wanted you to know that there's just been some technical difficulties throughout the call, Matt. You've been popping in and out, and we didn't hear the whole first answer to Gerrick's question, but just so you know. To start, just wondering in your down 2% to 4% guidance, how should we think about U.S. – the mix U.S. shipments and international shipments, will they be both down? But just stepping back bigger picture, in August, you guys announced what, in my view, was one of the most exciting new model launches in the history of the company. Retail registrations in the fourth quarter were negative globally. You've talked about that. You first quarter unit shipment guidance is down in the mid-teens at the midpoint, and the full year is down. We all know that the industry as a whole is challenged, and we're trying to keep inventory levels low. And you've kind of - we understand that well. But what I'm really trying to understand is if retail registrations were negative following such an incredible new product launch and your unit shipments for these bikes are down arguably for the remainder of the 2018 model year cycle, then where is the gap coming from? It seems like there might be a gap between what you're making and what the consumer wants. Maybe it's product. Maybe it's price. But thinking about that, how can we expect to see accelerated growth if it didn't come in this fantastic new model year?

Felicia, the first question with regards to shipments being down 2% to 4%, as we look into 2018, we expect U.S. retail sales to be down. And consequently – and with inventories flat on a year-over-year basis, consequently, shipments will be down in the United States. Internationally, we expect retail sales to grow, and we expect inventories to be flat to rising, so we would be shipping an increase in the international markets. Secondly, with regards to the new model launch in Softail, certainly, we would love to see positive retail sales growth overall. What we are seeing from Softail is fantastic results. Up -- market share of the large Cruiser segment was up five percentage points in the quarter. So the product is very well received. It's driving its indented result, but it is facing a huge headwind with regards to the overall industry being down on a full year basis of 7.3%. And so our product is hit in the mark, but it is not enough to turn the inventory or the industry headwinds.

Your next question comes from the line of David Tamberrino from Goldman Sachs. Your line is open.

Clarifying this of the 32,000 more Harley riders that you quoted, one, what percentage purchased a new bike as opposed to a used bike this year? And two, what do you estimate your acquisition cost or dollar investment is per new Harley rider?

The breakdown of the 32,000, I don't have that answer in our fingertips. Of course, when you look at overall new and used motorcycles, about 2.5 times are used or 2.5 times more are used than new. And I'm sorry, the second question was? The acquisition cost per riders, we do not provide a breakdown of our marketing spending in that level of detail.

Your next question comes from the line of Jaime Katz from Morningstar. Your line is open.

So I'm curious how you guys are now perceiving the total overall market potential for touring versus custom and then what you think the market potential for electric bikes is, given the announcement of the faster push into the electric bike market as you try to sort of fill that gap to get those two million new riders over the next 10 years? Thanks.

I think I won't give you specific numbers, if you will. But we look at our products in the sense of how do they appeal to different types of markets spaces, what different types of riders are looking for in a product. And our investment decisions, for example, to continue to invest in touring, how we balance that against investment decisions to, for example, redo the Softail platform, how we balance that, for example, with our investment in electric is all driven around markets spaces that we see, the mentality, if you will, different types of riders across the entire spectrum of riders and how we balance those investments to grow the company, to grow profitably, to continue to deliver the cash as we do that. We see electric as being particularly exciting for not just new riders, not just young people. The demo ride that I referenced, 12,000 people around the world, the composition of those customers was all over the map for age and riding experience and even their look. The universal appeal of that product was what was the most astounding aspect of that initiative, and it gave us a lot of confidence that electric motorcycles have broad-based appeal, different used occasion. They are going to sit alongside existing Harleys and garages as much as they're going to create new interest in the sport and in the brand with new types of riders. And so that's how we're – why we're providing the opportunity for the company long term.

Your next question comes from the line of David MacGregor from Longbow Research. Your line is open.

I guess, just wanted to ask my question on your relationship with the dealers and their frustrations. When you hold calls with your dealers, what do you hear back from them in terms of what they would like to see you do to turn this around?

I think we have a lot of engagement opportunities with our dealers. And in fact, I was just at our retail readiness event in Nashville last week and spent a lot of time talking with dealers. We have formal meetings, we have informal meetings. I think the mentality shift that we're going through as a company is part of the shift that is happening as well in the dealer network, and that mentality shift [Audio Gap] build motorcycles or, if you're a dealer, we sell motorcycles. Together, we build riders. Really, we used to be the uptake in the interest of the part of the dealers in the house of that shift, how can Riding Academy be better leveraged? How can dealers get into it if they're not into it already? So there's a lot of really good positive energy in that space. I think they're all in on this business. They've got their livelihood and their personal pattern on the line in the business, and the ideas are flowing from the dealer network. Sometimes, we have a calibration discussion about whether those ideas are the right ideas. For example, would a cheap motorcycle, a small motorcycle fix the problem or not? How do we think about that? How do we leverage their knowledge of retail to inform our product investments? So we have, first of all, first and foremost, the most passionate, active, talented dealer network on the planet. They are actively invested in our business and invested in us and giving us the feedback we need to drive the business and it's a great moment actually right not to be leveraging that.

Your next question comes from the line of Joe Altobello from Raymond James. Your line is open.

This is Krystyna on for Joe. Can you talk to us about the overall promotional intensity that you're seeing? And related to that, if the weaker U.S. dollar is giving foreign competitors greater ability for heightened promotions? Thanks.

When we look at the fourth quarter, overall, promotional activity by the competition is similar as it was in the third quarter and similar on a year-over-year basis. We're not seeing a lot of change. We are starting to see certainly the euro strengthen, which we hope will lead to less discounting by Europeans manufacturers as we go forward. But overall, in the fourth quarter, the level of promotional intensity was similar to what we've seen in the past.

Your last question comes from the line of Greg Badishkanian from Citi. Your line is open.

Just a follow-up question to Gerrick's who did miss a bit of that the first part. If you look out -- I think you mentioned that you didn't lose any sales to competitors. But when do you think those sales will be normalized? And do you -- would you expect to see some pent-up demand here in the first and second quarter from some of the scarcity or not?

Greg, we believe that we will pick up sales that we didn't have in the fourth quarter, in the first quarter through the selling season. When you talk about pent-up demand, I'm not sure how to answer that question. We got overall headwinds. The industry is still very weak, and we expect that they would be continue to be weak in the United States next year. So, those sales that we didn't get in the fourth quarter will certainly help out as we move through the selling season, but we still expect U.S. retail sales to be down in 2018.

All right. Thanks, everyone. The audio and slides will be available at harley-davidson.com or for the audio, you can call 855-859-2056 or 404-537-3406, until February 13. The ID is 5287227. We appreciate your investment in Harley-Davidson.

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