Amy Giuffre - Director-Investor Relations Matthew S. Levatich - President, Chief Executive Officer & Director John A. Olin - Chief Financial Officer & Senior Vice President.

Craig R. Kennison - Robert W. Baird & Co., Inc. (Broker) Sharon M. Zackfia - William Blair & Co. LLC Felicia Hendrix - Barclays Capital, Inc. Tim A. Conder - Wells Fargo Securities LLC Gregory Robert Badishkanian - Citigroup Global Markets, Inc. (Broker) James Hardiman - Wedbush Securities, Inc. Jaime Katz - Morningstar, Inc. (Research) David S.

MacGregor - Longbow Research LLC Scott W. Hamann - KeyBanc Capital Markets, Inc..

Good morning. My name is Amy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Harley-Davidson Second Quarter 2016 Earnings Conference Call. Thank you. Amy Giuffre, Director of Investor Relations, you may begin your conference..

Thank you, Amy, and good morning, everyone. You can access the slides supporting this call on the harley-davidson.com. Click Company at the top of the homepage, then Investor Relations and Events and Presentations. If you had any troubles downloading this morning, please try again as the link has been fixed.

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.

This morning, our President and CEO, Matt Levatich and CFO, John Olin will be hosting. So, Matt, let's get started..

increasing product and brand awareness; growing new ridership in the United States; increasing and enhancing brand access; and accelerating the cadence and impact of new products.

Our teams across the globe launched several initiatives behind these investments with precision and effectiveness, delivering solid results in our international markets and driving the market share gains in the United States.

Looking internationally, our retail sales were up 4.3%, driven by continued growth in Asia, Canada and Mexico, and our best ever quarter for Harley-Davidson in our EMEA region.

Our investments to increase demo rides in EMEA for example, was a major contributor to our growth in the region in Q2, nothing seals a deal better for a new customer than experiencing one of our great bikes firsthand.

In Asia, where we maintained our number one market share in Australia, India and Japan, we focused our investments on demo rides and growing ridership.

And in the U.S., the Live Your Legend campaign and other demand-driving investments built significant relevance and helped drive a 30% increase in demo rides so far this year and a 40% increase in the number of students trained through the Harley-Davidson Riding Academy.

There are also some real positives in the nature of retail sales and market share gains that further reinforce the strength of our work, both near- and long-term. Notably, we are very pleased to have growth year-to-date in the all important young adult segment in the United States.

The young adult segment is not only important for the long-term, it's the most competitive market segment in the U.S. All of these initiatives combined represent an important long-term play as we seek to grow this sport in the U.S. and bring new customers into the brand in all of our markets.

I'm encouraged that the actions that we've taken so far this year have enabled us to make progress on our long-term growth strategy. However worldwide sales for the quarter were down due to significant declines in the U.S. industry which was far weaker than expected.

We expected the industry to be down in the first half of the year, as we lapped industry growth in 2015 that was stimulated by the shift in currency and the resulting competitive discounting, and as we also expected by continued weakness in the oil-dependent areas. We did not however expect the industry as a whole would be as soft as it is.

While our share gains helped to blunt the full impact of this weak market, lackluster industry sales have had a significant impact on our results and our forward expectations. As a result, we're taking the prudent step to lower expected 2016 shipments. This is largely due to what we believe will be continued pressure on industry growth in the U.S.

coupled with caution as we consider the potential impact of the macro economic uncertainty on sales globally.

We remain steadfast in our commitment to keep supply in line with demand to protect the premium nature of the brand, and we believe the steps we're taking will ensure dealer inventory is in line by year-end to support the expected sales environment.

All in, we now plan to ship fewer motorcycles for the full year, and are revising our shipment guidance from 1% to 3% growth to approximately down 1% to up 1% from 2015. Our production plans and shipment expectations are intended to drive a flat inventory at year-end even with our expanded model range.

These actions will have a drag on earnings for the full year, so we're revising our full year expected operating margin down one percentage point to 15% to 16%. Without question, we must assure inventory balance for our long-term competitiveness and profitability for both the company and our incredible dealers.

Now, shifting from market to company performance, you'll see that gross margin declined in the quarter. There are a number of factors here that both John and I will address. As we've discussed in prior calls, we expected higher manufacturing costs due to the significant investments we're making to advance our flexible manufacturing strategy.

These investments are complex and require discipline, planning, and execution, including numerous down days, inventory bridges and careful ramp plans. The net impact can be seen in changes to gross margin, shipments and inventory patterns in the second quarter, and the impact will continue in Q3 as we ramp back to full production.

The investments are part of the manufacturing flexibility strategy that will enhance cost-effective flexibility now at our Kansas City plant.

Another factor in gross margin performance in Q2 is the impact of volume and mix adjustments we made to capture the demand lift from the Cruiser success we experienced in the quarter, while also adjusting downward the total volume in the softer than expected U.S. industry. The U.S. industry turned swiftly in the second quarter.

We responded with discipline and commitment in an effort to keep supply in line with demand, and these actions also impacted our gross margin in the quarter. While difficult, these actions were necessary to set us up for success for our model year launch and also for 2017 and beyond.

And speaking of new products, in our new model launch, I'm incredibly excited about our lineup, which we will unveil to our global dealer network at the end of August. We'll add to the stable of products driving our current success and we've got some incredible products in the pipeline for 2018, our 115th anniversary and beyond.

Before I turn it over to John, I want to take this opportunity to thank everyone associated with this great company; employees, dealers, suppliers and our passionate riders. I'm proud of our team and all the work that's been done at Harley-Davidson. We're in challenging times.

Political, economic and cultural forces are all working against confidence and security for people everywhere in the world. Everyone in our company is aware and attuned to what we need to do. We have a 113-year history of challenges we've stood up to and faced down.

The power of personal freedom for our riders is stronger than ever, and we all aim to deliver for them. We understand the intense need to manage through these challenges effectively and deliver results. We're stewards of this incredible brand and of your investment, and we do not take that responsibility lightly.

Without question, driving demand, growing the business and delivering strong returns are top priorities for all of us at Harley-Davidson. And we're focused every day on delivering for our riders, near-term and long-term in order to do so. With that, I'm going to turn it over to John. Thank you..

first, net interest income was up over prior year by $5.0 million, this increase was driven by higher receivables, partially offset by higher borrowing costs and lower yields due in part to the 2015 low interest rate promotional activity; second, the provision for retail motorcycle loan losses increased over prior year by $8.2 million driven by higher retail credit losses, and an associated increase in the allowance.

It is important to note that second quarter provision increase was significantly less than what we experienced in the first quarter of 2016. Finally you will see on the slide a gain on full securitization.

This represents a full securitization in which we sold retail finance receivables with a principal balance of approximately $302 million along with all the residual financial interest in those receivables.

Because we have no ownership interest in the receivables, the transaction was recorded as a sale which in this case resulted in a gain of $9.3 million. HDFS's operational results are summarized on slide 18. For the quarter, originations were down 3.9% compared to last year but HDFS's share of U.S. new retail motorcycle sales increased to 63.4%.

Year-to-date loan originations were comprised of approximately 80% prime loans and 20% subprime. As a predominant industry leader to subprime customers, these originations continue to represent a significant number of retail sales to the company, at very attractive returns.

At the end of the second quarter, we had $419 million of cash and cash equivalents at HDFS. In addition, HDFS had $1.02 billion of available liquidity through bank credit and conduit facilities. HDFS also paid a $43 million dividend to H-D Inc. during the quarter, which I will talk more about in a moment.

On slide 19, you'll see the 30-day delinquency rate for retail motorcycle loan receivables that remained on our balance sheet was 3.16% or 45 basis points higher than Q2 2015.14 basis points of the increase represents a change in the mix of the portfolio after the securitization of $302 million of prime receivables.

The delinquency rate on a managed basis, including those loans sold in the full securitization was still 31 basis points higher than the prior year due in part to deterioration in oil-dependent areas. Despite the increase, delinquencies remain near historically low levels.

Annualized retail credit losses for receivables that remain on our balance sheet was 1.50% or 42 basis points higher than Q2 2015. On a managed basis, the credit loss rate was 1.49%. The increase was a result of higher losses on loans in oil-dependent areas, normalizing loan performance and lower used bike values at auction.

During the quarter, HDFS continued to maintain a strong liquidity position and continued strong profitability to the company. Remaining Harley-Davidson Inc., financial results are summarized on slide 20. A few things to note, operating cash was down from last year, driven by net income, higher working capital and higher net wholesale lending.

And year-to-date tax rate was 32.7% which was lower than last year's tax rate behind the successful closure of various tax audits allowing us to reduce our tax reserves. 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.

Returning value to our shareholders is a top priority. We expect to return all excess cash to our shareholders in the form of increasing dividends and continued share repurchases. On slide 21, you will see we did both during the second quarter.

In addition, as I mentioned earlier, during the quarter, we completed a full securitization because we sold all ownership interest in the receivables, the receivables and any corresponding debt are not recorded on HDFS's balance sheet. Consequently, this allowed HDFS to pay a dividend to H-D Inc.

of $43 million without impacting HDFS's debt-to-equity ratio. We used the dividend to repurchase shares under the existing share repurchase authorizations.

While we believe the EPS impact was neutral, the shareholder repurchase associated with the full securitization increased our shareholder's ownership in the company at a time when our stock is trading at historically low PE. This was the first time HDFS or we believe any other manufacturer has utilized this market.

Actions such as this demonstrate our commitment to explore avenues to improve funding costs, diversified funding sources and return excess cash to our shareholders. We will continue to look for additional opportunities to return excess cash to our shareholders, without damaging the long-term value of the company or the brand.

On slide 22, you'll see our overall expectations for 2016. We now expect to ship 264,000 motorcycles to 269,000 motorcycles, which is approximately down 1% to up 1% over last year. We expect third quarter shipments to be approximately flat to down 9% versus last year's third quarter.

For the full year 2016, we now expect operating margin for the Motorcycles segment to be approximately 15% to 16%. We are lowering our expectations by approximately one percentage point due to the loss absorption on lower production, unfavorable mix, and higher manufacturing expense.

Finally, we now expect our full year 2016 effective tax rate will be approximately 33%. Our 2016 directional expectations for gross margin, SG&A, HDFS and capital expenditures are unchanged and noted on the slide. While the weak U.S.

industry and continued intense competition drove less than expected retail sales during the quarter, we are encouraged by the positive market share results from our demand-driving investments and new models. We are also pleased to see international retail sales growth despite macroeconomic headwinds.

We continue to make the necessary decisions to support a prudent retail inventory position and to protect our strong brand and profitability into the future. We are maintaining our intense focus on maximizing shareholder value by returning cash to our shareholders through share repurchases and increased dividends.

We will continue to navigate through the challenging environment and are making investments to drive demand and deliver strong margins and strong returns over the long-term. Now let's take your questions..

Your first question comes from the line of Craig Kennison with Baird. Craig, your line is open..

Okay. Thanks for taking my question. Matt, with respect to industry demand, what do you think accounts for the significant weakness in new bike sales, specifically what role did either credit conditions or a surplus in the supply of used bikes account for some of that weakness in new demand? Thanks..

Thanks, Craig. I actually think that there's a lot going on, so it's really difficult to lay it off on any specific thing. Certainly, the uncertainty in the political environment, the credit conditions as you mentioned, the oil-dependent regions that we discussed, we have sort of numbers associated with that in particular.

Also the significant growth last year, as I mentioned and the corresponding comp for this year, we knew that that was going to create pressure. The forecast for the industry growth were kind of in that 2% range and clearly it's not materializing that way.

And so, we're looking at it very carefully, investing in new products and awareness and rider training and focusing on our efforts on what we can do to not only grow share, but grow our sales and primarily doing that through growing the sport. So, there is a lot of real positive things in that realm.

I mentioned some of them in my opening remarks, but clearly this is a disappointment and we're regrouping as a result of it, and doubling down on what we know is working and to drive the industry..

Thanks..

Your next question comes from line of Sharon Zackfia with William Blair. Sharon, your line is open..

Hi. Good morning. John, I had a question on the SG&A. I know you're still expecting it to be flattish year-over-year, but it was up nicely in the first half of the year.

So where are you going to see the opportunities to have those dollars decline in the back half? And then when you look out in future years, is there more room to kind of keep that SG&A flattish in future years or how are you guys thinking about that?.

Thanks, Sharon. So as you pointed out, when we look at SG&A over the first half, it is up about 6%, and I'm looking at our full year guidance to be flat to up slightly. Obviously the back half is going to be down.

We would expect the third quarter to still be up on a year-over-year basis as we continue to spend that incremental investment in driving demand, and then we would expect the fourth quarter to be down quite a bit in terms of SG&A.

And remember, Sharon, that in the fourth quarter of last year, there was a restructuring charge in that number of about $23 million in SG&A.

And so with that, as long as the other reductions that we've made in the core infrastructure of the company to fund the incremental demand-driving investments, we would expect the overall back half of the year to be down in SG&A..

In terms of going forward..

And then comment. Yeah. Thank you..

Sorry. In terms of going forward, we are focused on managing SG&A, but continuing to invest in the future, whether that be in new products or certainly the marketing of those..

Okay. Thank you..

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

Hi. Good morning. Thanks for taking my questions. I guess this question is for you both, Matt and John. Do you think that you're positioned appropriately for the declining industry that seemed to surprise you in the quarter? I'm just wondering if your plans for the second half and also for next year are appropriate for the current environment.

I mean understand the reasons behind the inventory build that you talked about, positioning for the new models, getting ahead of Kansas City ERP.

But, just given the environment, given the surprises that continue to come and given the competition, I'm just wondering how much you've stress tested your growth plans for the second half and for next year..

Okay. Thanks, Felicia. Let me break the question up into two answers. First, inventory as we exit the first half. Retail inventory was up 20, or I'm sorry 8,300 units, largely driven by five incremental models. On average, our dealers have about 2.5 of each of those models in their dealerships. And that adds up actually to over 8,000 units.

But, we also wanted to ship in ahead of the ERP implementation. So, when we look at second quarter, and you also, you look at the retail side, which is up 8,300 units, our company-owned inventory is down quite a bit. And, when you net those two, we're basically up in the second quarter one-third of July's production. And, that's what we expect to lose.

So, to answer your question, as we exit the first half, we're right in line with what we expected in terms of inventory on a year-on-year basis, again, to compensate for the lost production in July. When we extend that forward, we were expecting inventories in the U.S. to grow behind additional models.

And, given that environment that you've mentioned and certainly that we experienced in the second quarter, we are more cautious and want to be more prudent from an inventory perspective and with that we do not expect inventories to grow in the United States at year-end.

And yes, we absolutely feel that is the appropriate level of inventory given soft retail sales that we're seeing in the first half of this year..

That's a great answer, John. I'll just add my perspective on it. My short answer is yes. I think we've looked very clear eyed at the condition in the industry year-to-date, projected that forward and what you see in behind John's comments, finishing flat with additional models is actually leaning out our inventory.

And you can read from that, that we expect and we believe is embedded in our numbers the industry to continue to be soft for the balance of the year, and probably into next year as well.

And so we feel we're adequately provisioning and preparing for that, but, and I guess, also with a healthy dose of realism given what we saw that was quite surprising here in the second quarter. So, we feel like we're in very good shape on both sales and inventory for the balance of the year as well as heading into next year in the level..

Your next question comes from the line of Tim Conder with Wells Fargo Securities. Tim, your line is open..

Thank you.

John, on HDFS with the prime sale, how do you see any of those potential transactions going forward? And then does this leave you with more loans that you still have on the balance sheet or exposure to a higher mix of prime? And then one other thing related to Brexit, what are you seeing in the UK and Europe retail trends post the Brexit vote.

Any impact whatsoever? Thank you..

Thanks, Jim. When we look at the securitization that we recently did about a month ago, there were two changes in that securitization from normal securitizations that we execute.

(35:40) pointed out is that they were made up of a 100% of prime receivables and the second one is we sold the residual interest that allowed us to classify it off balance sheet. Your question centers around the prime aspect of it, so historically we've sold securitizations that resemble our originations about 80% prime and 20% subprime.

I've heard all kinds of speculation as to why we did a 100% prime, so let me clear that up, some of that speculation has been is we can't sell subprime into the market, and that is absolute untruth nonsense.

So for over a decade, we've been selling a mix of prime and subprime into a very robust demand in the marketplace and that have not changed at all. What has changed over the last couple securitization is that our spreads have widened on the securitization to our benchmark.

Our benchmark is prime auto, and there is no one else that does a mixture of securitizations like we do, so we benchmark the prime auto. What we have noticed over the last couple securitizations is the spreads widening out a little bit. And so the best way to tether them back was to get a comparable securitization to our benchmark.

And with that we saw extreme tightening of those margins or of those spreads to prime auto. So, as we look forward, whether we decide to do all prime or subprime and prime, the kind of the tethering of the investment community to that spread against prime has been very important to us, and will pay dividends as we move into the future.

So that's why we move forward with the prime securitization. Your second question is with regards to Brexit. And you know at this point, there is not enough information or not enough time has gone by to understand the impact of Brexit.

I think, what we are very certain of is that Brexit does not provide any benefit to retail sales or consumer confidence in Europe. And I think, this is what Matt talked about a little is, I'd put it into a broader bucket instead of just Brexit as overall consumer confidence driven by geopolitical concerns or macroeconomic concerns.

But we're very excited about the momentum that we have in our European business, as you can see for the quarter, it was up quite significantly. We'll keep a close eye on Brexit, but we're going to focus on what we can control and continue to drive a great customer experience for our customers around the world..

Okay..

Your next question comes from the line of Greg Badishkanian from Citigroup. Greg, your line is open..

Thanks. Great. Thank you.

Two questions, first on follow-up to kind of Tim's question, just Europe, I mean, the 8% growth this quarter, what was the key driver for that? And how sustainable can it be, because it's been – it was strong last quarter as well pretty similar? And then second, there was some speculation that I think you were in discussions or maybe you received an offer from private equity firm few weeks back.

Just wondering was that, is that the case or are you in a – were you in any serious conversations or are you at this point?.

All right. First question Greg is with regards to Europe, we – again, we couldn't be more pleased – I think, Matt mentioned it in his upfront remarks is the focus of our European team on getting people on our motorcycles, the demos that they're doing has driven a tremendous amount of volume in that market.

Also, our product offering, you got to remember that Europe has got a bigger mix of Cruisers, to Touring than we have in the United States.

The product is just as well received in Europe, as it is here in the United States, that's certainly helping to drive some of the performance, and we expect the team there to continue to focus on getting people exposed to our motorcycles and we couldn't again be more pleased with where we're at in growing market share.

Again, and just as a competitive market as the United States, not driven by price (39:58) Europe by tremendous addition of the lower displacement motorcycles. And again, we're doing well and gaining share in a robustly growing market in Europe.

The second comment is with regards to market rumors, surrounding our stock and a potential private equity investor, we don't comment on any rumors – any stock market rumors. That would consume our entire life if we did that..

Thanks..

Your next question comes from the line of James Hardiman with Wedbush. James, your line is open..

Hi, good morning. Thanks for taking my call. A clarification and then a question from me. I guess, first, obviously retail was materially worse than what you anticipated and yet the shipments were actually a little bit higher than the high-end of your guidance.

I guess what was different there than how you anticipated heading into the quarter? And then maybe a little bit of a follow-up to Robin's question. We're trending towards the lower-end of that down 1% to up 1% in terms of retail year-to-date.

I guess, what gives you confidence that the industry and/or your numbers will get any better, and I guess what happens if the industry gets worse given that the most recent data point is a step down from what we saw in the first quarter? Thanks..

Okay. Thanks, James. When you look at the second quarter, we did ship a little bit over the high end of guidance and at the same time during the quarter, we were cutting production quite dramatically and our retail sales were down. So, you're saying is, can you help me out – help me understand this.

So, basically as we got toward the end of the quarter, we had all the product made, and that was either in retail or in our company-owned inventory, and typically we have a bit of company-owned inventory in the United States, that facilitates the flow and the orderly shipment of motorcycles.

We made the decision to ship it all out prior to the period. The reason we did that is in the very outside chance that we had any issues with ERP system. If they're in our system, we may have trouble getting them shipped. So it was just a simple act of de-risking of the overall ERP implementation.

I couldn't be more pleased to say that the team did a fantastic job, everything came up as expected, the ramp plans are on plan, and everything is moving forward. But James, it was simply that is, we could take a little bit more risk out of it.

Now having said that, overall inventories as I mentioned, I think, to Felicia, overall inventories didn't change. But we had company-owned inventories lower on a year-over-year basis and we put a little bit more into the field.

So, overall inventories are where we would've expected them despite the lower than expected sales based on our production reductions and lower company-owned inventory. The second question that you asked is with regards to our revised guidance, which is down 1% to up 1%.

We go through a robust process, looking at all factors and everything that we know in the marketplace, which is centered around new dealerships coming up in the international markets. We'll have more dealers in the back half – new dealers in the back half than front half.

We look at the performance of outreach in the United States, that's performing extremely well.

We look at the investments that we made and the demand driving activities, what we expect to come out of those, and certainly and most importantly, we look at the new models that we're going to be launching here in three weeks to four weeks, and we couldn't be more excited about that. You take all those together, James.

We're very confident that we are going to ship from 264,000 motorcycles to 269,000 motorcycles for 2016..

Great. Thanks. I'll hop back in the queue..

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

Good morning. Thanks for taking my questions. First, I am curious with regards to inventory and what's in the channel now in light of the slower growth environment. Can you guys talk about your thoughts on the ability to take prices in the next model year coming online, and then if you would comment on where you might be seeing the most share gains.

I know – I think the share losses last year were from international competitors, but it sounds like there's still a decent amount of discounting going on, so if you have any color on that, that would be really helpful. Thanks..

Yes. With regards to inventory, retail sales, we've talked a little bit about that. We feel that we're at the right spot given our forward look at retail sales, given where we expect inventories to be.

And if we haven't shown our resolve to manage this company for the long-term value of our shareholders and the actions that we've taken to keep the marketplace, aggressively managed supply in line with demand or to hold to – we're not going to discount our way out of this soft spot that we're expecting that people aren't looking.

We've got tremendous resolve and we will manage the inventory at appropriate levels. And now with regards to pricing, I'm not going to speak a lot about that because in three weeks you'll see the new models, and you'll see the pricing and you can answer that question for yourself, Jamie.

But again, we feel very comfortable where we're at with regards to the market, and we'll continue to manage it very tightly. I'm glad you asked about share gains in the United States. I couldn't be more thrilled to answer this question.

A year ago, we sat here, Matt and I, Matt's first conference call, and we said that we had an issue, given the shift in world currencies and the incredible competitiveness that came out of it, in particular in discounting, and we said that we were not going to discount our way out it, we weren't going to drain the industry of profits and chase this thing.

And it was going to take us some time, but we were going to spend more time understanding what we need to do, and how we can compete world of expanded price gaps without cheapening our brand, and now dial forward a couple quarters, we are there, and we delivered 2 two points of market share gains.

So, let me talk a second about those, the gains were very strong and wide. Number one, they came in all of our segments, our Touring segment, our Cruisers and our Street/Sportster segment size of motorcycle. They came in the seven sales regions that we have in the United States, we gained share in each and every one of them.

Our gains were over double the nearest competitor. And when you look broadly at those share gains, what we saw is the biggest loser were in aggregate Japanese competitors.

We also saw while we had mentioned in the preamble that overall discounting was higher on a year-over-year basis, we did see the Japanese discounting be down a little bit versus year ago, and that seems to be reflecting in their market share.

With that we saw a rotation in the brand discounting from the Japanese to the American brands in the second quarter, and we're seeing some of the share gains in there. Overall, Europeans' market share was down a little bit, but we had some big winners and big losers in that segment. Hopefully that helps, Jaime..

Thank you..

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

Yes. Good morning, everyone. I realize there's a limit on what you want to say about model year 2017 just given we're so close to the rollout.

But I guess what I wanted to ask you was, what did you learn from the model year 2016 product and the way it was received in a more competitive environment that's guided you on your plans for 2017?.

Yeah. Thanks, David, I appreciate the question. Actually, we're incredibly pleased with the model year 2016 products and how they drove the market globally. This is a lot of the S models that we launched a year ago basically, as well as the products we introduced during the model year.

And clearly, there are a lot of constraints in this competitive environment that we're in, but our product drives customer passion, customer loyalty and sales and market share. We saw that with the shift in sales to large cruisers, which helped us gain share. Those large cruisers are a little lower margin than our touring motorcycles.

So that's part of the gross margin deterioration that we just spoke about on the call today. But product is a very key lever for us. It's one of our four focus areas to increase both the cadence and the impact of the product and 2016 is a good example of both, high-impact product at an increased cadence. And 2017 is going to be no different.

It's a formula that's working for us and we've invested more heavily, both capital and expense as part of the demand driving shift to make sure that the product that we deliver makes a difference in the marketplace and that we do it well and we do it more rapidly.

And so, that's a new pattern for us that we can expect rolling forward in 2017, 2018 and beyond..

Thanks very much..

Your next question comes from the line of James Hardiman with Wedbush. James, your line is open..

Hey, thanks for taking a couple follow-ups here. So, the gain on sale with HDFS, I guess help us understand. I'm assuming that that gain comes out of future potential income that we would have otherwise seen in a normal securitization transaction.

How should we think about that?.

Thanks, James. It's a good question. In the 8-K that we put out, we talked about this overall transaction is neutral when you look at the present value of earnings per share. So, it's a great question. Basically, here's what happened.

What happens is, in a securitization we sell off a bunch of bonds to investors and it goes into a trust and all the residual earnings that we get off of that we keep, because we keep the risk and we keep that reward.

What we did (50:43) a slightly different market and we found an investor to buy that and what they did is they paid us a bunch of upfront cash to buy that residual interest in the trust or those trailing earnings.

We believe that the opportunity cost of the transaction that we did is about $7 million of those trailing earnings, so to do broad math, we took a $9 million gain, gave up about $7 million of opportunity cost, so they would have earned about $16 million. We took $9 million today, right.

So if you take and you discount over the next seven years, that $7 million that would have come in, bring it to the present value, a net impact on EPS, along with the fact that because it's off balance sheet, we have freed up equity at HDFS to maintain the same debt-to-equity, we've now got more equity, so HDFS wrote a check that works out to be $43 million and we bought shares back with that.

And if you take that impact on EPS, they're about neutral. So the question is, well, why did we do it if it's neutral? Number one is that once you get into a market, you don't know how the market is going to exactly respond, but there's two reasons that we did this.

Number one is it's an additional source of liquidity, so we're always looking for opportunities on more investors, more liquidity, and this is a great opportunity. The other thing with the additional liquidity opportunity, we also learned that we can monetize the assets on our balance sheet to some extent. And that is very important to know.

So that's number one reason.

Number two and the more important reason is, is one of our – we talk about it every conference call, a top priority of ours is to return value to our shareholders in the form of rising dividends and share repurchases, and we will look at every opportunity to do that with the caveat that we're not going to do anything to damage the long-term value of the brand or the company.

This transaction fits squarely in there. There is absolutely no extra risk to the company or anything like that. What it did is it liberated $43 million of excess cash. That excess cash was used to buy share repurchases.

And even though again, from a present value basis, we're neutral on EPS, we believe that our long-term shareholders would prefer to have at this moment in time more equity in our company given the historically low PEs that we're trading at.

And so they get the ownership today versus waiting over that period of time for the opportunity cost of that money..

That's really helpful. And then maybe just two real quick hitters here.

Inventories are going to be down domestically, are they also going to be – or I'm sorry, flat domestically, are they also going to be flat internationally or will we see some growth there? And you also mentioned I think earlier in the Q&A that you maybe had some stats on oil areas versus non-oil areas, I was wondering if you'd care to share those? Thanks..

Sure. Sure, James. Internationally, we do expect to grow modestly as well. We'll be adding a lot of dealerships this year and they're growing markets, and we would expect to add a little bit of inventory internationally. The second quarter – sorry, so your second question is on oil dependent areas. We talked about this last quarter.

It is certainly a headwind to the industry. And what we saw about a year ago, first quarter – well, first quarter 2015, we first noticed that those areas were declining more than other areas in the United States, obviously driven by the depression in oil prices.

We saw that increase from a modest amount in the first quarter, increased through the second quarter and third quarter, and it hit about a 10% rate in the fourth quarter. Now, we've seen that hold at 10% in the fourth quarter of last year, the first quarter of this year, and the second quarter was also a 10%.

As we look forward, we're going to start to lap more significant rises on a year-over-year basis, hopefully we'll start to see it temper a little bit, but at this point, it's not getting worse, but it is not getting better either..

Very helpful. Thank you..

Your last question comes from the line of Scott Hamann with KeyBanc Capital Markets. Scott, your line is open..

Thanks, good morning. Can you talk a little bit about the demand creation money that you're spending, is $70 million still a good number for this year? When did you kind of start to deploy that? Where are you seeing some of the best traction? And then would you consider spending more or even less as you kind of look forward? Thanks..

Thanks, Scott. Great question. So, again, going back to a year-ago, we tried some things in the second quarter and third quarter, some worked, some didn't. We kind of regrouped, looked at what was working, what wasn't, and we sized the overall opportunity.

We came back as a company and said we needed $70 million to really address the widened price gaps which is a headwind to us, and compete without lowering price or discounting.

And we got into the marketplace early in the first quarter, $70 million and again we're very pleased with what we're seeing in terms of new people coming in, being trained on through our Rider Academy, the motorcycles that they're buying with that, the demos that are going on, Live Your Legend campaign, again Heroes Ride Free that promotion that we're getting, people that identify very closely with our brand, getting them free training to get on motorcycles, all of that is working well and you're seeing that manifests itself in our competitiveness with expanded price gaps in the second quarter.

In terms of where we go with the $70 million? That's something that we evaluate on an ongoing basis. And not only the overall dollar amount of the buck – of the $70 million, we will look at, and change when need be whether that'd be more or less.

We're also looking at what's working and what's not, and trying to become very nimble on how we redirect the money in the right spots whether that be within a market or between markets, or within a promotion or between promotions. There is nothing but a single-minded focus here on driving demand..

Hi. Thank you everyone for your time this morning. Thanks for your time this morning, everyone. The audio and slides will be available at harleydavidson.com. The audio can also be accessed until August 11 by calling 404-537-3406 or 855-859-2056 in the U.S. The pin number is 424-153-21#. We appreciate your investment in Harley-Davidson.

If you have any questions, please contact Investor Relations at 414-343-8002. Thanks..

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