HARLEY DAVIDSON INC – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Harley-Davidson, Inc. is the parent company for the groups of companies doing business asHarley-Davidson Motor Company (HDMC) andHarley-Davidson Financial Services (HDFS). HDMC produces heavyweight cruiser and touring motorcycles. HDMC manufactures five families of motorcycles: Touring, Dyna®, Softail®, Sportster® and V-Rod®. HDFS provides wholesale and retail financing and insurance programs primarily toHarley-Davidson dealers and customers. The Company operates in two business segments: Motorcycles & Related Products (Motorcycles) and Financial Services (Financial Services). The Company's reportable segments are strategic business units that offer different products and services. They are managed separately based on the fundamental differences in their operations. The "% Change" figures included in the "Results of Operations" section were calculated using unrounded dollar amounts and may differ from calculations using the rounded dollar amounts presented.
Overview
The Company's income from continuing operations for 2012 was$623.9 million , or$2.72 per diluted share compared to$548.1 million , or$2.33 per diluted share, in 2011. The increase in 2012 income from continuing operations was driven by strong financial performance in both the Motorcycles and the Financial Services segments. Operating income from the Motorcycles segment was up$154.3 million over 2011 on a 6.2% increase in wholesale shipments ofHarley-Davidson motorcycles, lower manufacturing costs and a decrease in restructuring expense. Operating income from the Financial Services segment was also up over the prior year, increasing$15.9 million , or 5.9%, driven primarily by a decrease in interest expense. In 2012, worldwide independent dealer retail sales of newHarley-Davidson motorcycles grew 6.2% compared to 2011, including a 6.6% increase in the U.S. and a 5.6% increase in international markets. The Company believes the improvement in retail sales of newHarley-Davidson motorcycles reflects the strength of the Harley-Davidson brand and the appeal of model- year 2012 and 2013 products, worldwide dealer efforts and continued investment in growth opportunities around the world. Please refer to the "Results of Operations 2012 Compared to 2011" for additional details concerning the results for 2012.
(1) Note Regarding Forward-Looking Statements
The Company intends that certain matters discussed in this report are "forward-looking statements" intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements can generally be identified as such by reference to this footnote or because the context of the statement will include words such as the Company "believes," "anticipates," "expects," "plans," or "estimates" or words of similar meaning. Similarly, statements that describe future plans, objectives, outlooks, targets, guidance or goals are also forward-looking statements. Such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those anticipated as of the date of this report. Certain of such risks and uncertainties are described in close proximity to such statements or elsewhere in this report, including under the caption "Risk Factors" in Item 1A and under "Cautionary Statements" in Item 7 of this report. Shareholders, potential investors, and other readers are urged to consider these factors in evaluating the forward-looking statements and cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements included in this report are made only as of the date of the filing of this report (February 22, 2013 ), and the Company disclaims any obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. 25 --------------------------------------------------------------------------------
Outlook(1)
OnJanuary 29, 2013 the Company announced the following expectations for 2013. The Company expects to ship 259,000 to 264,000Harley-Davidson motorcycles during 2013, with 71,000 to 76,000Harley-Davidson motorcycles expected to ship in the first quarter of 2013. The 2013 shipment estimates take several factors into consideration, including new model-year 2013 and 2014 products, the continued success of outreach efforts in the U.S., the improved product availability in the U.S., continued expansion of the international distribution network and the strong appeal of the Harley-Davidson brand. At the same time, the Company remains cautious on the world economies, in particular in the U.S. andEurope . Shipment expectations for the first quarter of 2013 reflect an increase of approximately 10% to 18% compared to the first quarter of 2012. This increase is expected to be supported by the new surge manufacturing capability launched at theYork ,Pennsylvania (York ) facility at the start of 2013. The surge manufacturing capabilities atYork will rely on a new seasonal workforce and will be supported by similar efforts at the Company'sWisconsin manufacturing facilities that supplyYork . The surge manufacturing capability is expected to enable the Company to increase manufacturing capacity in the first half of 2013 to more closely match retail demand. As a result, U.S. retail inventory is expected to increase by the end of the first quarter as dealers replenish inventory to prepare for the 2013 selling season. The Company expects to implement surge manufacturing capabilities at itsKansas City, Missouri (Kansas City ) facility in 2014. Consequently, the Company expects U.S. retail inventory to be slightly lower on a year over year basis at the end of 2013 as dealers more closely align inventory with the seasonal low point for retail sales in advance of the expected surge manufacturing capability at theKansas City facility. In addition, the Company expects full year 2013 gross margin to be between 35.25% and 36.25%. In 2013 gross margin is expected to be positively impacted by approximately$25 million in incremental restructuring savings, approximately$16 million less in temporary inefficiencies, a lower fixed cost per unit on higher production and higher pricing. To a lesser extent, gross margin is also expected to be favorably impacted by changes in product mix. However, these positive benefits are expected to be offset by unfavorable currency impacts due in part to less favorable hedge positions, higher pension expense and pressure on material costs. The Company believes operating income from financial services in 2013 will be modestly lower than 2012 as the business benefited from$17 million in credit loss allowance releases which may not repeat in 2013. In addition, the Company expects changing consumer behavior, HDFS' funding of additional prudently structured loans in the near-prime and sub-prime segments and lower recoveries resulting from lower charge-offs in prior periods to result in modestly higher credit losses in 2013. The Company's capital expenditure estimates for 2013 are between$200 million and $220 million . The Company anticipates it will have the ability to fund all capital expenditures in 2013 with cash flows generated by operations. The Company also announced onJanuary 29, 2013 that it expects the full year 2013 effective income tax rate to be approximately 34.8% for continuing operations which includes the impact of the reinstatement of theFederal Research and Development tax credit with the enactment of the American Taxpayer Relief Act of 2012. This guidance excludes the effect of any potential future adjustments such as changes in tax legislation or audit settlements which are recorded as discrete items in the period in which they are settled. Restructuring Activities(1) 2011 Restructuring Plans InDecember 2011 , the Company made a decision to cease operations at New Castalloy, its Australian subsidiary and producer of cast motorcycle wheels and wheel hubs, and source those components through other existing suppliers. The Company expects the transition of supply from New Castalloy to be complete in 2013. The decision to close New Castalloy comes as part of the Company's overall long term strategy to develop world-class manufacturing capability throughout the Company by restructuring and consolidating operations for greater competitiveness, efficiency and flexibility. In connection with the 2011 New Castalloy restructuring plan, the Company will reduce its workforce by approximately 200 employees by the end of 2013. InFebruary 2011 , the Company's unionized employees at its facility inKansas City, Missouri ratified a new seven-year labor agreement. The new agreement took effect onAugust 1, 2011 . The new contract is similar to the labor agreements ratified 26 -------------------------------------------------------------------------------- at the Company'sWisconsin facilities inSeptember 2010 and itsYork facility inDecember 2009 , and allows for similar flexibility, increased production efficiency and the addition of a flexible workforce component. The 2011 Kansas City restructuring plan results in approximately 145 fewer full-time hourly unionized employees in itsKansas City facility than would be required under the previous contract. 2010 Restructuring Plan InSeptember 2010 , the Company's unionized employees inWisconsin ratified three separate new seven-year labor agreements which took effect inApril 2012 when the prior contracts expired. The new contracts are similar to the labor agreement ratified atYork inDecember 2009 and allow for similar flexibility, increased production efficiency and the addition of a flexible workforce component. The 2010 restructuring plan results in approximately 250 fewer full-time hourly unionized employees in itsMilwaukee -area facilities than would be required under the previous contract and approximately 75 fewer full-time hourly unionized employees in its Tomahawk facility than would be required under the previous contract. 2009 Restructuring Plan During 2009, in response to the U.S. economic recession and worldwide slowdown in consumer demand, the Company committed to a volume reduction and a combination of restructuring actions that were expected to be completed at various dates between 2009 and 2012. The actions were designed to reduce administrative costs, eliminate excess capacity and exit non-core business operations. The Company's announced actions include the restructuring and transformation of itsYork production facility including the implementation of a new more flexible unionized labor agreement which allows for the addition of a flexible workforce component; consolidation of facilities related to engine and transmission production; outsourcing of certain distribution and transportation activities and exiting the Buell product line. In addition, the Company implemented projects under this plan involving the outsourcing of select information technology activities and the consolidation of an administrative office inMichigan into its corporate headquarters inMilwaukee, Wisconsin . The 2009 restructuring plan results in a reduction of approximately 2,700 to 2,900 hourly production positions and approximately 800 non-production, primarily salaried positions within the Motorcycles segment and approximately 100 salaried positions in the Financial Services segment. Restructuring Costs and Savings During 2012, the Company incurred$28.5 million in restructuring expense related to its combined restructuring plan activities. This is in addition to$455.8 million in restructuring and impairment expense incurred in prior years since its restructuring activities were initiated in 2009. OnJanuary 29, 2013 , the Company provided an estimate for restructuring expenses related to its combined restructuring plan activities that it expects to incur from 2009 to 2013 of approximately$495 million which is within the range of expected cost of$490 million to $510 million that the Company previously provided. The Company continues to expect approximately 35% of the amounts to be non-cash. The estimated restructuring expense includes an estimate of$13 million in 2013, which was revised up from the previous estimate of$5 million to $10 million reflecting a shift in expected expense from 2012 to 2013. The Company anticipates annual ongoing total savings from restructuring activities initiated since early 2009 of approximately$320 million upon completion of all announced restructuring activities. The Company has realized or estimates that it will realize cumulative savings from these restructuring activities, measured against 2008, as follows:
• 2009 -
• 2010 -
• 2011 -
• 2012 -
• 2013 -
60% cost of sales) (estimated); • Ongoing annually upon completion -$320 million (approximately 35% operating expense and approximately 65% cost of sales) (estimated). 27
-------------------------------------------------------------------------------- Results of Operations 2012 Compared to 2011
Consolidated Results
(in thousands, except earnings per Increase % share) 2012 2011 (Decrease) Change Operating income from motorcycles & related products $ 715,489 $ 561,176 $ 154,313 27.5 % Operating income from financial services 284,687 268,791 15,896 5.9 % Operating income 1,000,176 829,967 170,209 20.5 % Investment income 7,369 7,963 (594 ) (7.5 )% Interest expense 46,033 45,266 767 1.7 % Income before income taxes 961,512 792,664 168,848 21.3 % Provision for income taxes 337,587 244,586 93,001 38.0 % Income from continuing operations 623,925 548,078 75,847 13.8 % Income from discontinued operations, net of taxes - 51,036 (51,036 ) NM Net income $ 623,925 $ 599,114 $ 24,811 4.1 % Diluted earnings per share from continuing operations $ 2.72 $ 2.33 $ 0.39 16.7 % Diluted earnings per share from discontinued operations $ - $ 0.22 $ (0.22 ) NM Diluted earnings per share $ 2.72 $ 2.55 $ 0.17 6.7 % Operating income for the Motorcycles segment during 2012 improved by$154.3 million compared to 2011 driven by a 6.2% increase in motorcycle shipments, price increases, decreases in manufacturing costs and lower restructuring expenses compared to the prior year. Operating income for the Financial Services segment improved by$15.9 million during 2012 primarily due to lower interest expense. Please refer to the "Motorcycles and Related Products Segment" and "Financial Services Segment" discussions following for a more detailed discussion of the factors affecting operating income. The effective income tax rate for 2012 was 35.1% compared to 30.9% for 2011. The lower 2011 effective tax rate was mainly driven by a change in the 2011Wisconsin income tax law associated with certain net operating losses, the favorable settlement of anIRS audit and the impact of the federal Research and Development Tax Credit. In 2011, the Company recognized a$51.0 million benefit on income from discontinued operations, driven by the reversal of tax amounts reserved in prior years related to the divestiture of the Company's MV Agusta subsidiaries. The amounts had been reserved pending an agreement that the Company and theIRS reached on the tax treatment of the transaction inDecember 2011 . Diluted earnings per share from continuing operations was$2.72 in 2012, up 16.7% over 2011. The increase in diluted earnings per share was driven primarily by the 13.8% increase in income from continuing operations, but also benefited from lower diluted weighted average shares outstanding. Diluted weighted average share outstanding decreased from 234.9 million in 2011 to 229.2 million in 2012 driven by the Company's repurchase of common stock over the last two years. Please refer to "Liquidity and Capital Resources" for additional information concerning the Company's share repurchase activity. 28 -------------------------------------------------------------------------------- Motorcycles and Related Products Segment Harley-Davidson Motorcycle Retail Sales Worldwide independent dealer retail sales ofHarley-Davidson motorcycles increased 6.2% during 2012 compared to 2011. Retail sales ofHarley-Davidson motorcycles increased 6.6% inthe United States and 5.6% internationally in 2012. International retail sales as a percent of total retail sales were down slightly compared to 2011 reflecting the tough market conditions inEurope . International retail sales represented 35.3% and 35.5% of total retail sales in 2012 and 2011, respectively. Given the fact that the Company's European business was down in 2012 and the economic concerns that remain inEurope for the near term, the Company no longer believes it will meet its goal of international retail sales exceeding 40% of total retail sales by 2014. However, the Company continues to believe international retail sales will grow at a faster rate than domestic sales through 2014(1). The following table includes retail unit sales ofHarley-Davidson motorcycles: Harley-Davidson Motorcycle Retail Sales(a) Heavyweight (651+cc) Increase % 2012 2011 (Decrease) ChangeNorth America Region United States 161,678 151,683 9,995 6.6 % Canada 10,573 10,502 71 0.7 Total North America Region 172,251 162,185 10,066 6.2Europe ,Middle East andAfrica Region (EMEA) Europe(b) 37,027 39,334 (2,307 ) (5.9 ) Other 6,000 5,006 994 19.9 Total EMEA Region 43,027 44,340 (1,313 ) (3.0 ) Asia Pacific Region Japan 10,642 10,401 241 2.3 Other 13,839 11,015 2,824 25.6 Total Asia Pacific Region 24,481 21,416 3,065 14.3 Latin America Region 10,090 7,247 2,843 39.2 Total Worldwide Retail Sales 249,849 235,188 14,661 6.2 % (a) Data source for retail sales figures shown above is new sales warranty and
registration information provided by
the Company. The Company must rely on information that its dealers supply
concerning retail sales and this information is subject to revision.
(b) Data for
the
The following table includes industry retail motorcycle registration data:
Heavyweight Motorcycle Registration Data(a)
Increase % 2012 2011 (Decrease) Change United States(b) 281,974 271,029 10,945 4.0 % Europe(c) 268,299 292,533 (24,234 ) (8.3 )%
(a) Heavyweight data includes street legal 651+cc models. Street legal 651+cc
models include on-highway and dual purpose models and three-wheeled
vehicles.
(b)
revision and update. Prior periods have been adjusted to include all dual
purpose models that were previously excluded. 29
--------------------------------------------------------------------------------
(c)
and the
includes 651+cc models derived from information provided by Association des
Constructeurs Europeens de Motocycles (ACEM), an independent agency. This
third-party data is subject to revision and update.
Motorcycle Unit Shipments The following table includes wholesale motorcycle unit shipments for the Motorcycles segment: % 2012 2011 Increase Change United States 160,477 64.8 % 152,180 65.3 % 8,297 5.5 % International 87,148 35.2 % 80,937 34.7 % 6,211 7.7 Harley-Davidson motorcycle units 247,625 100.0 % 233,117 100.0 % 14,508 6.2 % Touring motorcycle units 99,496 40.2 % 92,002 39.5 % 7,494 8.1 % Custom motorcycle units* 96,425 38.9 % 91,459 39.2 % 4,966 5.4 Sportster motorcycle units 51,704 20.9 % 49,656 21.3 % 2,048 4.1 Harley-Davidson motorcycle units 247,625 100.0 % 233,117 100.0 % 14,508 6.2 % * Custom motorcycle units, as used in this table, include Dyna, Softail, V-Rod and CVO models. During 2012, wholesale shipments ofHarley-Davidson motorcycles were up 6.2% compared to the prior year and within the Company's most recent expected shipment range of 245,000 to 250,000 motorcycles. As expected, wholesale motorcycle shipments in the fourth quarter of 2012 were down compared to the fourth quarter of 2011 in advance of the launch of seasonal surge manufacturing at the Company'sYork facility in early 2013. Consequently, retail inventory in the U.S. was approximately 1,200 units lower than at the end of 2011. Segment Results The following table includes the condensed statement of operations for the Motorcycles segment (in thousands): (Decrease) % 2012 2011 Increase Change Revenue: Motorcycles $ 3,764,794 $ 3,554,547 $ 210,247 5.9 % Parts & Accessories 859,945 816,569 43,376 5.3 General Merchandise 299,403 274,124 25,279 9.2 Other 18,440 17,024 1,416 8.3 Total revenue 4,942,582 4,662,264 280,318 6.0 Cost of goods sold 3,222,394 3,106,288 116,106 3.7 Gross profit 1,720,188 1,555,976 164,212 10.6 Selling & administrative expense 846,894 788,565 58,329 7.4 Engineering expense 129,330 138,243 (8,913 ) (6.4 ) Restructuring expense 28,475 67,992 (39,517 ) (58.1 ) Operating expense 1,004,699 994,800
9,899 1.0 Operating income from motorcycles
30 -------------------------------------------------------------------------------- The following table includes the estimated impact of the significant factors affecting the comparability of net revenue, cost of goods sold and gross profit from 2011 to 2012 (in millions): Cost of Net Goods Gross Revenue Sold Profit 2011 $ 4,662 $ 3,106 $ 1,556 Volume 293 197 96 Price 30 - 30 Foreign currency exchange rates and hedging (76 ) (59 ) (17 ) Shipment mix 34 29 5 Raw material prices - (7 ) 7 Manufacturing costs - (43 ) 43 Total 281 117 164 2012 $ 4,943 $ 3,223 $ 1,720
The following factors affected the comparability of net revenue, cost of goods sold and gross profit from 2011 to 2012:
• Volume increases were driven by the increase in wholesale shipments of
motorcycle units as well as higher sales volumes for Parts & Accessories
and General Merchandise. • On average, wholesale prices on the Company's 2012 and 2013 model year motorcycles are higher than the preceding model years resulting in the favorable impact on revenue and gross profit during the period.
• Foreign currency exchange rates during 2012 resulted in a negative impact
on net revenue, which was partially offset by the favorable impact of gains
associated with foreign currency hedging included in cost of goods sold.
• Shipment mix changes resulted primarily from favorable product mix changes
between motorcycle families.
• Raw material prices were lower in 2012 relative to 2011 primarily due to
lower metal costs. • Manufacturing costs were favorably impacted by savings related to restructuring initiatives. Temporary inefficiencies associated with the Company's restructuring and transformation at itsYork facility were$33 million in 2012 compared to$32 million in 2011.
The net increase in operating expense was primarily due to incremental investments to support the Company's growth initiatives and increases in employee costs including pension. These cost increases were partially offset by lower restructuring expense related to the Company's previously announced restructuring activities as well as lower engineering expense. For further information regarding the Company's previously announced restructuring activities, refer to Note 4 of Notes to Condensed Consolidated Financial Statements.
Financial Services Segment
Segment Results The following table includes the condensed statements of operations for the Financial Services segment (in thousands):
Increase % 2012 2011 (Decrease) Change Interest income $ 583,700 $ 598,675 $ (14,975 ) (2.5 )% Other income 54,224 50,774 3,450 6.8 Financial services revenue 637,924 649,449 (11,525 ) (1.8 ) Interest expense 195,990 229,492 (33,502 ) (14.6 ) Provision for credit losses 22,239 17,031 5,208 30.6 Operating expenses 135,008 134,135 873 0.7 Financial services expense 353,237 380,658
(27,421 ) (7.2 ) Operating income from financial services
31 -------------------------------------------------------------------------------- Interest income decreased during 2012 primarily due to lower average retail finance receivables outstanding. Interest expense benefited from lower debt levels related to lower average retail finance receivables outstanding, a more favorable cost of funds, and a$5.3 million lower loss on the extinguishment of medium-term notes as compared to 2011. The provision for credit losses was unfavorable by$5.2 million in 2012 as compared to 2011. The retail motorcycle provision increased by$6.6 million on smaller allowance releases during 2012 as compared to 2011, although both years experienced favorable credit performance. The provision for credit losses related to wholesale motorcycle finance receivables increased by$3.0 million in 2012 primarily due to larger dealer performance-related allowance releases in 2011 as compared to 2012. The wholesale and retail motorcycle provision increases were offset by decreases in the provision for credit losses related to other retail receivables. Annual losses on HDFS' retail motorcycle loans were 0.79% during 2012 compared to 1.20% in 2011. The decrease in credit losses from 2011 resulted from changes in underwriting and collections, as well as a lower frequency of loss. The 30-day delinquency rate for retail motorcycle loans atDecember 31, 2012 increased to 3.94% from 3.85% atDecember 31, 2011 . HDFS has not experienced a year-end 30-day delinquency rate below 4.50% in over ten years and believes the credit quality of its retail portfolio will remain strong in 2013(1). Changes in the allowance for credit losses on finance receivables were as follows (in thousands): 2012 2011
Balance, beginning of period
$ 107,667 $ 125,449 AtDecember 31, 2012 , the allowance for credit losses on finance receivables was$101.4 million for retail receivables and$6.2 million for wholesale receivables. AtDecember 31, 2011 , the allowance for credit losses on finance receivables was$116.1 million for retail receivables and$9.3 million for wholesale receivables. HDFS' periodic evaluation of the adequacy of the allowance for credit losses on finance receivables is generally based on HDFS' past loan loss experience, known and inherent risks in the portfolio, current economic conditions and the estimated value of any underlying collateral. Please refer to Note 6 of Notes to Consolidated Financial Statements for further discussion regarding the Company's allowance for credit losses on finance receivables. 32
-------------------------------------------------------------------------------- Results of Operations 2011 Compared to 2010
Consolidated Results
Increase % (in thousands, except earnings per share) 2011 2010 (Decrease) Change Operating income from motorcycles & related products $ 561,176 $ 378,758 $ 182,418 48.2 % Operating income from financial services 268,791 181,873 86,918 47.8 Operating income 829,967 560,631 269,336 48.0 Investment income 7,963 5,442 2,521 46.3 Interest expense 45,266 90,357 (45,091 ) (49.9 ) Loss on debt extinguishment - 85,247 (85,247 ) NM Income before income taxes 792,664 390,469 402,195 103.0 Provision for income taxes 244,586 130,800 113,786 87.0 Income from continuing operations 548,078 259,669 288,409 111.1 Income (loss) from discontinued operations, net of taxes 51,036 (113,124 ) 164,160 (145.1 ) Net income $ 599,114 $ 146,545 $ 452,569 308.8 % Diluted earnings per share from continuing operations $ 2.33 $ 1.11 $ 1.22 109.9 % Diluted earnings (loss) per share from discontinued operations $ 0.22 $ (0.48 ) $ 0.70 (145.8 )% Diluted earnings per share $ 2.55 $ 0.62 $ 1.93 311.3 % Operating income for the Motorcycles segment during 2011 improved by$182.4 million compared to 2010 primarily due to increased motorcycle shipments and lower spending on the Company's ongoing restructuring activities. Operating income for the Financial Services segment improved by$86.9 million during 2011 primarily due to improved credit performance in the retail motorcycle finance receivable portfolio. Please refer to the "Motorcycles and Related Products Segment" and "Financial Services Segment" discussions following for a more detailed discussion of the factors affecting operating income. Interest expense for 2011 related to the Company's senior unsecured notes, was approximately$45 million lower than in 2010. The decrease in interest expense on the senior unsecured notes is due to the Company's repurchase of$297.0 million of the$600.0 million senior unsecured notes during the fourth quarter of 2010. During the fourth quarter of 2010, the Company repurchased$297.0 million of the$600.0 million senior unsecured notes at a price of$380.8 million . As a result of the transaction, the Company incurred a loss on debt extinguishment of$85.2 million which also includes$1.4 million of capitalized debt issuance costs that were written-off. The Company used cash on hand for the repurchase and the repurchased notes were canceled. The effective income tax rate for 2011 was 30.9% compared to 33.5% for 2010. The lower 2011 effective tax rate was mainly driven by a change in the 2011Wisconsin income tax law associated with certain net operating losses and a one-time tax charge in 2010 associated with the federal healthcare legislation. In 2011, the Company recognized a$51.0 million benefit on income from discontinued operations, driven by the reversal of tax amounts reserved in prior years related to the divestiture of the Company's MV Agusta subsidiaries. The amounts had been reserved pending an agreement that was reached by the Company and theIRS on the tax treatment of the transaction inDecember 2011 . This compares to a$113.1 million loss from discontinued operations in 2010 due primarily to impairment charges related to a decrease in the fair value of MV Agusta. Motorcycles and Related Products Segment Harley-Davidson Motorcycle Retail Sales Worldwide independent dealer retail sales ofHarley-Davidson motorcycles increased 5.9% during 2011 compared to 2010. Retail sales ofHarley-Davidson motorcycles increased 5.8% inthe United States and 6.1% internationally in 2011. The following table includes retail unit sales ofHarley-Davidson motorcycles: 33 -------------------------------------------------------------------------------- Harley-Davidson Motorcycle Retail Sales(a) Heavyweight (651+cc) Increase % 2011 2010 (Decrease) ChangeNorth America Region United States 151,683 143,391 8,292 5.8 % Canada 10,502 10,376 126 1.2 Total North America Region 162,185 153,767 8,418 5.5Europe ,Middle East and Africa Region (EMEA) Europe(b) 39,334 37,378 1,956 5.2 Other 5,006 3,810 1,196 31.4 Total EMEA Region 44,340 41,188 3,152 7.7 Asia Pacific Region Japan 10,401 11,405 (1,004 ) (8.8 ) Other 11,015 9,582 1,433 15.0 Total Asia Pacific Region 21,416 20,987 429 2.0 Latin America Region 7,247 6,168 1,079 17.5 Total Worldwide Retail Sales 235,188 222,110 13,078 5.9 % (a) Data source for retail sales figures shown above is new sales warranty and
registration information provided by
the Company. The Company must rely on information that its dealers supply
concerning retail sales and this information is subject to revision.
(b) Data for
the
The following table includes industry retail motorcycle registration data:
Heavyweight Motorcycle Registration Data(a)
% 2011 2010 Increase (Decrease) Change United States(b) 271,029 259,733 11,296 4.3 % Europe(c) 292,533 301,321 (8,788 ) (2.9 )%
(a) Heavyweight data includes street legal 651+cc models. Street legal 651+cc
models include on-highway and dual purpose models and three-wheeled
vehicles.
(b)
revision and update. Prior periods have been adjusted to include all dual
purpose models that were previously excluded.
(c) Europe data includes
and the
includes 651+cc models derived from information provided by Association des
Constructeurs Europeens de Motocycles (ACEM), an independent agency.
market data is reported on a one-month lag. This third-party data is subject to revision and update. 34
-------------------------------------------------------------------------------- Motorcycle Unit Shipments The following table includes wholesale motorcycle unit shipments for the Motorcycles segment: % 2011 2010 Increase(Decrease) Change United States 152,180 65.3 % 131,636 62.5 % 20,544 15.6 % International 80,937 34.7 % 78,858 37.5 % 2,079 2.6Harley-Davidson motorcycle units 233,117 100.0 % 210,494 100.0 % 22,623 10.7 % Touring motorcycle units 92,002 39.5 % 81,927 38.9 % 10,075 12.3 % Custom motorcycle units* 91,459 39.2 % 87,158 41.4 % 4,301 4.9 Sportster motorcycle units 49,656 21.3 % 41,409 19.7 % 8,247 19.9 Harley-Davidson motorcycle units 233,117 100.0 % 210,494 100.0 % 22,623 10.7 % Buell motorcycle units 274 2,614 (2,340 ) (89.5 )% * Custom motorcycle units, as used in this table, include Dyna, Softail, V-Rod and CVO models. During 2011, wholesale shipments ofHarley-Davidson motorcycles were up 10.7% compared to the prior year. Temporary production constraints resulting from restructuring efforts at the Company'sYork facility that impacted its production for 2011 eased during the fourth quarter of 2011, allowing a slightly higher mix of Touring motorcycles compared to the prior year. Sportster shipment mix was also higher than in 2010 and near the high end of the historical range of 18% to 22% due to strong retail demand for Sportster models. Segment Results The following table includes the condensed statement of operations for the Motorcycles segment (in thousands): Increase % 2011 2010 (Decrease) Change Revenue: Harley-Davidson motorcycles $ 3,553,291 $ 3,136,987 $ 416,304 13.3 % Buell motorcycles 1,256 16,280 (15,024 ) (92.3 ) Parts & Accessories 816,569 749,240 67,329 9.0 General Merchandise 274,124 259,125 14,999 5.8 Other 17,024 14,995 2,029 13.5 Total revenue 4,662,264 4,176,627 485,637 11.6 Cost of goods sold 3,106,288 2,749,224 357,064 13.0 Gross profit 1,555,976 1,427,403 128,573 9.0 Selling & administrative expense 788,565 756,177 32,388 4.3 Engineering expense 138,243 128,960 9,283 7.2 Restructuring expense 67,992 163,508 (95,516 ) (58.4 ) Operating expense 994,800 1,048,645
(53,845 ) (5.1 ) Operating income from motorcycles
35 -------------------------------------------------------------------------------- The following table includes the estimated impact of the significant factors affecting the comparability of net revenue, cost of goods sold and gross profit from 2010 to 2011 (in millions): Cost of Net Goods Gross Revenue Sold Profit 2010 $ 4,177 $ 2,749 $ 1,428 Volume 365 250 115 Price 15 - 15 Foreign currency exchange rates and hedging 89 84 5 Shipment mix 16 15 1 Raw material prices - 32 (32 ) Manufacturing costs - (24 ) 24 Total 485 357 128 2011 $ 4,662 $ 3,106 $ 1,556
The following factors affected the comparability of net revenue, cost of goods sold and gross profit from 2010 to 2011:
• Volume increases were driven by the 10.7% increase in wholesale shipments
ofHarley-Davidson motorcycle units as well as higher sales volumes for Parts & Accessories and General Merchandise.
• On average, wholesale prices on the Company's 2012 model year motorcycles
are higher than the prior model year resulting in the favorable impact on
revenue and gross profit during the period.
• Foreign currency exchange rates during 2011 relative to 2010 resulted in a
positive impact on net revenue. Gains and losses associated with the revaluation of foreign-denominated assets and liabilities and foreign currency hedging (included in cost of goods sold) were unfavorable when compared to 2010 which offset the majority of the positive impact of currency included in net revenue.
• Shipment mix changes positively impacted net revenue and resulted primarily
from product mix changes both between and within the Company's motorcycle
families. However, the impact of these mix changes on cost of goods sold mostly offset the benefits included in revenue.
• Raw material prices were higher in 2011 relative to 2010 due to increased
metals and fuel costs. • Manufacturing costs were favorably impacted by savings related to
restructuring and continuous improvement initiatives, partially offset by
temporary inefficiencies associated with the Company's restructuring and
transformation at its
The increase in selling, administrative and engineering expense was primarily due to increased spending on growth initiatives and higher recall expenses offset by savings realized from the Company's restructuring efforts and continuous improvement initiatives. In addition, during 2010 the Company incurred approximately$15 million of non-recurring costs in connection with the Company's efforts to expand its presence inBrazil . Restructuring expense was lower in 2011 than in 2010. For further information regarding the Company's previously announced restructuring activities, refer to Note 4 of Notes to Condensed Consolidated Financial Statements. Financial Services Segment
Segment Results The following table includes the condensed statements of operations for the Financial Services segment (in thousands):
36 --------------------------------------------------------------------------------
Increase % 2011 2010 (Decrease) Change Interest income $ 598,675 $ 635,207 $ (36,532 ) (5.8 )% Other income 50,774 47,502 3,272 6.9 Financial services revenue 649,449 682,709 (33,260 ) (4.9 ) Interest expense 229,492 272,484 (42,992 ) (15.8 ) Provision for credit losses 17,031 93,118 (76,087 ) (81.7 ) Operating expenses 134,135 135,234 (1,099 ) (0.8 ) Financial services expense 380,658 500,836
(120,178 ) (24.0 ) Operating income from financial services
Interest income decreased during 2011 due to lower average retail and wholesale finance receivables outstanding. Interest expense benefited from lower debt levels related to lower average retail and wholesale finance receivables outstanding and a more favorable cost of funds, partially offset by a$9.6 million loss on the extinguishment of debt. The provision for credit losses related to retail motorcycle and wholesale receivables decreased by$70.1 million and$7.1 million , respectively, in 2011 compared to 2010. The decrease in the provision for retail motorcycle credit losses was primarily driven by favorable finance receivable credit loss performance. The decrease in provision for wholesale credit losses was primarily due to favorable finance receivable performance. Annual losses on HDFS' retail motorcycle loans were 1.20% during 2011 compared to 2.11% in 2010. The decrease in credit losses from 2010 was due to a lower frequency of loss and a modest improvement in the recovery values of repossessed motorcycles. The 30-day delinquency rate for retail motorcycle loans atDecember 31, 2011 decreased to 3.85% from 5.07 % atDecember 31, 2010 . Changes in the allowance for credit losses on finance receivables were as follows (in thousands): 2011 2010 Balance, beginning of period $ 173,589 $ 150,082 Allowance related to newly consolidated finance receivables -
49,424
Provision for credit losses 17,031
93,118
Charge-offs, net of recoveries (65,171 ) (119,035 ) Balance, end of period $ 125,449 $ 173,589 AtDecember 31, 2011 , the allowance for credit losses on finance receivables was$116.1 million for retail receivables and$9.3 million for wholesale receivables. AtDecember 31, 2010 , the allowance for credit losses on finance receivables was$157.8 million for retail receivables and$15.8 million for wholesale receivables. As part of theJanuary 1, 2010 adoption of the new accounting guidance within Accounting Standards Codification (ASC) Topic 810 "Consolidations" and ASC Topic 860 "Transfers and Servicing", the Company consolidated an initial allowance for credit losses of$49.4 million related to the previously unconsolidated securitized finance receivables through an adjustment to retained earnings. Subsequent changes in the provision for credit losses are included in the statement of operations. HDFS' periodic evaluation of the adequacy of the allowance for credit losses on finance receivables is generally based on HDFS' past loan loss experience, known and inherent risks in the portfolio, current economic conditions and the estimated value of any underlying collateral. Please refer to Note 6 of Notes to Consolidated Financial Statements for further discussion regarding the Company's allowance for credit losses on finance receivables. Other Matters 37
-------------------------------------------------------------------------------- Critical Accounting Estimates The Company's financial statements are based on the selection and application of significant accounting policies, which require management to make significant estimates and assumptions. Management believes that the following are some of the more critical judgment areas in the application of accounting policies that currently affect the Company's financial condition and results of operations. Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of the Board of Directors. Allowance for Credit Losses on Finance Receivables - The allowance for uncollectible accounts is maintained at a level management believes is adequate to cover the losses of principal in the existing finance receivables portfolio. HDFS performs a periodic and systematic collective evaluation of the adequacy of the retail allowance. HDFS utilizes loss forecast models which consider a variety of factors including, but not limited to, historical loss trends, origination or vintage analysis, known and inherent risks in the portfolio, the value of the underlying collateral, recovery rates and current economic conditions including items such as unemployment rates. The wholesale portfolio is primarily composed of large balance, non-homogeneous finance receivables. HDFS' wholesale allowance evaluation is first based on a loan-by-loan review. A specific allowance is established for wholesale finance receivables determined to be individually impaired when management concludes that the borrower will not be able to make full payment of contractual amounts due based on the original terms of the loan agreement. The impairment is determined based on the cash that the Company expects to receive discounted at the loan's original interest rate or the fair value of the collateral, if the loan is collateral-dependent. In establishing the allowance, management considers a number of factors including the specific borrower's financial performance as well as ability to repay. Finance receivables in the wholesale portfolio that are not individually evaluated for impairment are segregated, based on similar risk characteristics, according to the Company's internal risk rating system and collectively evaluated for impairment. The related allowance is based on factors such as the Company's past loan loss experience, current economic conditions as well as the value of the underlying collateral. Product Warranty - Estimated warranty costs are reserved for motorcycles, motorcycle parts and motorcycle accessories at the time of sale. The warranty reserve is based upon historical Company claim data used in combination with other known factors that may affect future warranty claims. The Company updates its warranty estimates quarterly to ensure that the warranty reserves are based on the most current information available. The Company believes that past claim experience is indicative of future claims; however, the factors affecting actual claims can be volatile. As a result, actual claims experience may differ from estimated which could lead to material changes in the Company's warranty provision and related reserves. The Company's warranty liability is discussed further in Note 1 of Notes to Consolidated Financial Statements. Pensions and Other Postretirement Healthcare Benefits - The Company has a defined benefit pension plan and several postretirement healthcare benefit plans, which cover employees of the Motorcycles segment. The Company also has unfunded supplemental employee retirement plan agreements (SERPA) with certain employees which were instituted to replace benefits lost under the Tax Revenue Reconciliation Act of 1993. U.S. GAAP requires that companies recognize in their statement of financial position a liability for defined benefit pension and postretirement plans that are underfunded or an asset for defined benefit pension and postretirement benefit plans that are overfunded. Pension, SERPA and postretirement healthcare obligations and costs are calculated through actuarial valuations. The valuation of benefit obligations and net periodic benefit costs relies on key assumptions including discount rates, long-term expected return on plan assets, future compensation and healthcare cost trend rates. The Company determines its discount rate assumptions by referencing high-quality long-term bond rates that are matched to the duration of its own benefit obligations. Based on this analysis, the Company decreased the discount rate for pension and SERPA obligations from 5.30% as ofDecember 31, 2011 to 4.23% as ofDecember 31, 2012 . The Company decreased the discount rate for postretirement healthcare obligations from 4.90% to 3.93%. The Company determines its healthcare trend assumption for the postretirement healthcare obligation by considering factors such as estimated healthcare inflation, the utilization of healthcare benefits and changes in the health of plan participants. Based on the Company's assessment of this data as ofDecember 31, 2012 , the Company set its healthcare cost trend rate at 7.5% as ofDecember 31, 2012 . The Company expects the healthcare cost trend rate to reach its ultimate rate of 5.0% by 2019.(1) These assumption changes were reflected immediately in the benefit obligation and will be amortized into net periodic benefit costs over future periods. 38 -------------------------------------------------------------------------------- Plan assets are measured at fair value and are subject to market volatility. In estimating the expected return on plan assets, the Company considers the historical returns on plan assets, adjusted to reflect the current view of the long-term investment market. Changes in the funded status of defined benefit pension and postretirement benefit plans resulting from the difference between assumptions and actual results are initially recognized in other comprehensive income and amortized to expense over future periods. The following information is provided to illustrate the sensitivity of pension and postretirement healthcare obligations and costs to changes in these major assumptions (in thousands): Impact of a 1% Impact of a 1% Amounts based Impact of a 1% decrease in the increase in the on current decrease in the expected healthcare assumptions discount rate return on assets cost trend rate 2012 Net periodic benefit costs Pension and SERPA $ 52,910 $ 21,946 $ 15,016 n/a Postretirement healthcare $ 19,868 $ 1,086 $ 1,179 $ 1,854 2012 Benefit obligations Pension and SERPA $ 1,871,575 $ 314,517 n/a n/a Postretirement healthcare $ 403,227 $ 42,841 n/a $ 14,879 This information should not be viewed as predictive of future amounts. The calculation of pension, SERPA and postretirement healthcare obligations and costs is based on many factors in addition to those discussed here. This information should be considered in combination with the information provided in Note 14 of Notes to Consolidated Financial Statements. Stock Compensation Costs - The total cost of the Company's share-based equity awards is equal to the grant date fair value per award multiplied by the number of awards granted (adjusted for forfeitures). This cost is recognized as expense on a straight-line basis over the service periods of the awards. Forfeitures are initially estimated based on historical Company information and subsequently updated over the life of the awards to ultimately reflect actual forfeitures. As a result, changes in forfeiture activity can influence the amount of stock compensation cost recognized from period to period. The Company estimates the fair value of option awards as of the grant date using a lattice-based option valuation model which utilizes ranges of assumptions over the expected term of the options, including stock price volatility, dividend yield and risk free interest rate. The valuation model uses historical data to estimate option exercise behavior and employee terminations. The expected term of options granted is derived from the output of the option valuation model and represents the average period of time that options granted are expected to be outstanding. The Company uses a weighted-average of historical and implied volatility to determine the expected volatility of its stock. The implied volatility is derived from options that are actively traded and the market prices of both the traded options and underlying shares are measured at a similar point in time to each other and on a date reasonably close to the grant date of the employee stock options. In addition, the traded options have exercise prices that are both (a) near-the-money and (b) close to the exercise price of the employee stock options. Finally, the remaining maturities of the traded options on which the estimate is based are at least one year. Dividend yield was based on the Company's expected dividend payments and the risk-free rate was based on the U.S. Treasury yield curve in effect at the time of grant. Changes in the valuation assumptions could result in a significant change to the cost of an individual option. However, the total cost of an award is also a function of the number of awards granted, and as result, the Company has the ability to control the cost of its equity awards by adjusting the number of awards granted. Income Taxes - The Company accounts for income taxes in accordance with ASC Topic 740, "Income Taxes." Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and other loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Company is subject to income taxes inthe United States and numerous foreign jurisdictions. Significant judgment is required in determining the Company's worldwide provision for income taxes and recording the related deferred tax assets and 39 -------------------------------------------------------------------------------- liabilities. In the ordinary course of the Company's business, there are transactions and calculations where the ultimate tax determination is uncertain. Accruals for unrecognized tax benefits are provided for in accordance with the requirements of ASC Topic 740. An unrecognized tax benefit represents the difference between the recognition of benefits related to exposure items for income tax reporting purposes and financial reporting purposes. The unrecognized tax benefit is included within other long-term liabilities in the Consolidated Balance Sheets. The Company has a reserve for interest and penalties on exposure items, if applicable, which is recorded as a component of the overall income tax provision. The Company is regularly under audit by tax authorities. Although the outcome of tax audits is always uncertain, management believes that it has appropriate support for the positions taken on its tax returns and that its annual tax provision includes amounts sufficient to pay any assessments. Nonetheless, the amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ materially from the amounts accrued for each year.
Contractual Obligations A summary of the Company's expected payments for significant contractual obligations as of
2013 2014 - 2015 2016 - 2017 Thereafter Total Principal payments on debt $ 732,105 $ 2,113,867 $ 1,324,137 $ 932,540 $ 5,102,649 Interest payments on debt 193,255 252,679 151,263 29,094 626,291 Operating lease payments 12,556 15,913 10,206 14,269 52,944 $ 937,916 $ 2,382,459 $ 1,485,606 $ 975,903 $ 5,781,884 Interest obligations include the impact of interest rate hedges outstanding as ofDecember 31, 2012 . Interest for floating rate instruments assumesDecember 31, 2012 rates remain constant. As ofDecember 31, 2012 , the Company had no material purchase obligations other than those created in the ordinary course of business related to inventory and property, plant and equipment which generally have terms of less than 90 days. The Company has long-term obligations related to its pension, SERPA and postretirement healthcare plans atDecember 31, 2012 . During 2012, the Company contributed$244.4 million to its pension, SERPA and postretirement healthcare plans, which included a$200.0 million voluntary contribution to its pension plan. No additional contributions were required during 2012 beyond current benefit payments for SERPA and postretirement healthcare plans. InJanuary 2013 , the Company voluntarily contributed another$175 million to its qualified pension plan to further fund its pension plan and the Company expects that no additional qualified pension plan contributions will be required in 2013. The Company expects it will continue to make on-going contributions related to current benefit payments for SERPA and postretirement healthcare plans. The Company's expected future contributions to these plans are provided in Note 14 of Notes to Consolidated Financial Statements. As described in Note 13 of Notes to Consolidated Financial Statements, the Company has unrecognized tax benefits of$48.8 million and accrued interest and penalties of$20.6 million as ofDecember 31, 2012 . However, the Company cannot make a reasonably reliable estimate for the period of cash settlement for either the liability for unrecognized tax benefits or accrued interest and penalties. Commitments and Contingencies The Company is subject to lawsuits and other claims related to environmental, product and other matters. In determining required reserves related to these items, the Company carefully analyzes cases and considers the likelihood of adverse judgments or outcomes, as well as the potential range of possible loss. The required reserves are monitored on an ongoing basis and are updated based on new developments or new information in each matter. Environmental Protection Agency Notice InDecember 2009 , the Company received formal, written requests for information from theUnited States Environmental Protection Agency (EPA) regarding: (i) certificates of conformity for motorcycle emissions and related designations and labels, (ii) aftermarket parts, and (iii) warranty claims on emissions related components. The Company promptly submitted written responses to theEPA's inquiry and engaged in discussions with theEPA . It is possible that a result of theEPA's investigation will be some form of enforcement action by theEPA that will seek a fine or other relief. However, at this time the Company does not know and cannot reasonably estimate the impact of any remedies theEPA might seek. 40 -------------------------------------------------------------------------------- York Environmental Matters: The Company is involved with government agencies and groups of potentially responsible parties in various environmental matters, including a matter involving the cleanup of soil and groundwater contamination at itsYork ,Pennsylvania facility. TheYork facility was formerly used by theU.S. Navy and AMF prior to the purchase of theYork facility by the Company from AMF in 1981. Although the Company is not certain as to the full extent of the environmental contamination at theYork facility, it has been working with thePennsylvania Department of Environmental Protection (PADEP) since 1986 in undertaking environmental investigation and remediation activities, including an ongoing site-wide remedial investigation/feasibility study (RI/FS). InJanuary 1995 , the Company entered into a settlement agreement (the Agreement) with theNavy . The Agreement calls for theNavy and the Company to contribute amounts into a trust equal to 53% and 47%, respectively, of future costs associated with environmental investigation and remediation activities at theYork facility (Response Costs). The trust administers the payment of the Response Costs incurred at theYork facility as covered by the Agreement. InFebruary 2002 , the Company was advised by theEPA that it considers some of the Company's remediation activities at theYork facility to be subject to theEPA's corrective action program under the Resource Conservation and Recovery Act (RCRA) and offered the Company the option of addressing corrective action under a RCRA facility lead agreement. InJuly 2005 , theYork facility was designated as the first site inPennsylvania to be addressed under the "One Cleanup Program." The program provides a more streamlined and efficient oversight of voluntary remediation by both PADEP andEPA and will be carried out consistent with the Agreement with theNavy . As a result, the RCRA facility lead agreement has been superseded. The Company estimates that its share of the future Response Costs at theYork facility will be approximately$3.2 million and has established a reserve for this amount which is included in accrued liabilities in the Condensed Consolidated Balance Sheets(1). As noted above, the RI/FS is still underway and given the uncertainty that exists concerning the nature and scope of additional environmental investigation and remediation that may ultimately be required under the RI/FS or otherwise at theYork facility, we are unable to make a reasonable estimate of those additional costs, if any, that may result. The estimate of the Company's future Response Costs that will be incurred at theYork facility is based on reports of independent environmental consultants retained by the Company, the actual costs incurred to date and the estimated costs to complete the necessary investigation and remediation activities. Response Costs related to the remediation of soil are expected to be incurred primarily over a period of several years ending in 2015. Response Costs related to ground water remediation may continue for some time beyond 2015. Product Liability Matters: Additionally, the Company is involved in product liability suits related to the operation of its business. The Company accrues for claim exposures that are probable of occurrence and can be reasonably estimated. The Company also maintains insurance coverage for product liability exposures. The Company believes that its accruals and insurance coverage are adequate and that product liability will not have a material adverse effect on the Company's consolidated financial statements. Liquidity and Capital Resources as of December 31, 2012 Over the long-term, the Company expects that its business model will continue to generate cash that will allow it to invest in the business, fund future growth opportunities and return value to shareholders.(1) The Company believes the Motorcycles operations will continue to be primarily funded through cash flows generated by operations. The Company's Financial Services operations have been funded with unsecured debt, unsecured commercial paper, asset-backed commercial paper conduit facilities, committed unsecured bank facilities, term asset-backed securitizations and intercompany borrowings. The Company's strategy is to maintain a minimum of twelve months of its projected liquidity needs through a combination of cash and marketable securities and availability under credit facilities. The following table summarizes the Company's cash and marketable securities and availability under credit facilities (in thousands): 41 --------------------------------------------------------------------------------
December 31, 2012 Cash and cash equivalents $ 1,068,138 Marketable securities 135,634
Total cash and cash equivalents and marketable securities 1,203,772
Global credit facilities
1,055,057
Asset-backed U.S commercial paper conduit facility (a)
600,000
Asset-backed Canadian commercial paper conduit facility (b) 25,782 Total availability under credit facilities
1,680,839 Total $ 2,884,611 (a) The U.S. commercial paper conduit facility expires onSeptember 13, 2013 . The Company anticipates that it will renew this facility prior to expiration(1). (b) The Canadian commercial paper conduit facility expires onAugust 30, 2013 and is limited to Canadian denominated borrowings. The Company anticipates that it will renew this facility prior to expiration(1). Although the Company believes it has obtained the funding necessary to support HDFS' operations for 2013(1), the Company recognizes that it must continue to adjust its business to changes in the lending environment. The Company intends to continue with a diversified funding profile through a combination of short-term and long-term funding vehicles and to pursue a variety of sources to obtain cost-effective funding. The Financial Services operations could be negatively affected by higher costs of funding and the increased difficulty of raising, or potential unsuccessful efforts to raise, funding in the short-term and long-term capital markets.(1) These negative consequences could in turn adversely affect the Company's business and results of operations in various ways, including through higher costs of capital, reduced funds available through its Financial Services operations to provide loans to independent dealers and their retail customers, and dilution to existing shareholders through the use of alternative sources of capital. The Company has long-term obligations related to its qualified pension, SERPA and postretirement healthcare plans atDecember 31, 2012 . During 2012, the Company contributed$244.4 million to its qualified pension, SERPA and postretirement healthcare plans, which includes a$200.0 million voluntary contribution to its pension plans. InJanuary 2013 , the Company made a voluntary contribution of$175.0 million to its qualified pension plans to further fund its pension plans and expects that no qualified pension plan contributions will be required in 2013.(1) The Company expects it will continue to make on-going contributions related to current benefit payments for SERPA and postretirement healthcare plans. The Company's expected future contributions to these plans are provided in Note 14 of Notes to Consolidated Financial Statements. Cash Flow Activity The following table summarizes the cash flow activity of continuing operations for the years endedDecember 31, 2012 , 2011 and 2010 (in thousands): 2012 2011
2010
Net cash provided by operating activities (a) $ 801,458 $ 885,291 $ 1,163,418 Net cash (used) provided by investing activities (261,311 ) (63,542 )
145,437
Net cash (used) provided by financing activities (a) (990,073 ) (308,944 ) (1,856,090 ) Effect of exchange rate changes on cash and cash equivalents (8,886 ) (7,788 )
4,940
Net increase (decrease) in cash and cash equivalents $ (458,812 ) $ 505,017 $ (542,295 )
(a) The 2012 cash flow from operating activities and the 2012 cash flow from
financing activities amounts presented above reflect revisions from the
unaudited amounts presented in the Company's earnings press release published
on
operating activities and an offsetting decrease to cash flow from financing
activities of$8.4 million ; there was no change to the net decrease in cash and cash equivalents. Operating Activities 42
-------------------------------------------------------------------------------- The decrease in operating cash flow in 2012 compared to 2011 was due primarily to working capital changes which resulted in lower operating cash inflows in 2012 as compared to 2011. This was due in part to the recognition of a prepaid income tax balance at the end of 2012 driven by accelerated depreciation deductions as well as the timing of quarterly earnings and related estimated tax payments during 2012. Additionally, the Company made voluntary contributions to its qualified pension plans totaling$200 million in both 2012 and 2011, impacting operating cash flow in both years. The decrease in operating cash flow for 2011 compared to 2010 was due primarily to the$200.0 million voluntary contribution to the Company's qualified pension plan in 2011 and higher cash outflows related to an increase in wholesale finance receivables originations in 2011. In addition, working capital changes resulted in lower operating cash inflows in 2011 as compared to 2010. The working capital changes were driven by increases in inventory that were the result of a management decision to increase finished goods motorcycle inventories at the end of 2011 in preparation for the 2012 ERP implementation that was completed at theYork facility. Investing Activities The Company's investing activities consist primarily of capital expenditures, net changes in retail finance receivables and short-term investment activity. Capital expenditures were$189.0 million ,$189.0 million and$170.8 million during 2012, 2011 and 2010, respectively. Net cash flows from finance receivables, which consisted primarily of retail finance receivables, for 2012 were$228.7 million lower than 2011 as a result of an increase in retail motorcycle loan originations during 2012. Net cash flows from finance receivables, which consisted primarily of retail finance receivables, for 2011 were$278.4 million lower than in 2010 as a result of an increase in retail motorcycle loan originations during 2011. Changes in the Company's investment in marketable securities resulted in cash inflows of$18.3 million in 2012 and cash outflows of$12.5 million and$100.1 million in 2011 and 2010, respectively. Financing Activities The Company's financing activities consist primarily of dividend payments, share repurchases and debt activity. The Company paid dividends of$0.62 per share totaling$141.7 million during 2012,$0.475 per share totaling$111.0 million during 2011 and$0.40 per share totaling$94.1 million in 2010. Cash outflows from share repurchases were$311.6 million ,$224.5 million and$1.7 million for 2012, 2011 and 2010, respectively. Share repurchases during 2012 and 2011 included 6.7 million and 6.2 million shares of common stock, respectively, related to discretionary share repurchases and shares of common stock that employees surrendered to satisfy withholding taxes in connection with the vesting of restricted stock awards. Share repurchases in 2010 were limited to shares of common stock that employees surrendered to satisfy withholding taxes in connection with the vesting of restricted stock awards. As ofDecember 31, 2012 , 14.5 million shares remained on a board-approved share repurchase authorization. As ofDecember 31, 2012 , there were no shares available on a separate board-approved share repurchase authorization that is in place to offset option exercises and restricted stock grants. The Company's total outstanding debt consisted of the following as ofDecember 31, 2012 , 2011 and 2010 (in thousands): 2012 2011 2010 Global credit facilities $ - $ 159,794 $ 213,772 Unsecured commercial paper 294,943 874,286 582,572 Asset-backed Canadian commercial paper conduit facility 175,658 - - Medium-term notes 2,881,272 2,298,193 1,897,778 Senior unsecured notes 303,000 303,000 303,000
Term asset-backed securitization debt 1,447,776 2,087,346
2,755,234 Total debt $ 5,102,649 $ 5,722,619 $ 5,752,356 In order to access the debt capital markets, the Company relies on credit rating agencies to assign short-term and long-term credit ratings. Generally, lower credit ratings result in higher borrowing costs and reduced access to debt capital markets. 43 -------------------------------------------------------------------------------- A credit rating agency may change or withdraw the Company's ratings based on its assessment of the Company's current and future ability to meet interest and principal repayment obligations. The Company's short-term debt ratings affect its ability to issue unsecured commercial paper. The Company's short- and long-term debt ratings as ofDecember 31, 2012 were as follows: Short-Term Long-Term Outlook Moody's P2 Baa1 Positive Standard & Poor's A2 BBB+ Positive Fitch F2 A- Stable Global Credit Facilities - OnApril 13, 2012 , the Company and HDFS entered into a new$675.0 million five-year credit facility to refinance and replace a$675.0 million three-year credit facility that was due to mature inApril 2013 . The new five-year credit facility matures inApril 2017 . The Company and HDFS also have a$675.0 million four-year credit facility which matures inApril 2015 . The new five-year credit facility and the four-year credit facility (together, the Global Credit Facilities) bear interest at various variable interest rates, which may be adjusted upward or downward depending on certain criteria, such as credit ratings. The Global Credit Facilities also require the Company to pay a fee based upon the average daily unused portion of the aggregate commitments under the Global Credit Facilities. The Global Credit Facilities are committed facilities and primarily used to support HDFS' unsecured commercial paper program. Unsecured Commercial Paper - Subject to limitations, HDFS could issue unsecured commercial paper of up to$1.35 billion as ofDecember 31, 2012 supported by the Global Credit Facilities. Outstanding unsecured commercial paper may not exceed the unused portion of the Global Credit Facilities. Maturities may range up to 365 days from the issuance date. HDFS intends to repay unsecured commercial paper as it matures with additional unsecured commercial paper or through other means, such as borrowing under the Global Credit Facilities, borrowing under its asset-backed U.S. commercial paper conduit facility or through the use of operating cash flow.(1) Medium-Term Notes - The Company has the following medium-term notes (collectively, the Notes) issued and outstanding atDecember 31, 2012 (in thousands): Principal Amount Rate Issue Date Maturity Date $500,000 5.75% November 2009 December 2014 $600,000 1.15% September 2012 September 2015 $450,000 3.875% March 2011 March 2016 $400,000 2.70% January 2012 March 2017 $933,511 6.80% May 2008 June 2018 InJanuary 2012 , HDFS issued$400.0 million of medium-term notes which mature inMarch 2017 and have an annual interest rate of 2.70%. InSeptember 2012 , HDFS issued$600.0 million of medium-term notes which mature inSeptember 2015 and have an annual interest rate of 1.15%. During 2011, HDFS issued$450.0 million of medium-term notes which mature inMarch 2016 and have an annual interest rate of 3.875%. All of the Notes provide for semi-annual interest payments and principal due at maturity. During 2012 and 2011, HDFS repurchased an aggregate$16.6 million , and$49.9 million , respectively, of its$1.0 billion , 6.80% medium-term notes which mature inJune 2018 . As a result, HDFS recognized in financial services interest expense$4.3 million and$9.6 million , respectively, in loss on the extinguishment of debt, which included unamortized discounts and fees. DuringDecember 2012 ,$400.0 million of 5.25% medium-term notes matured, and the principal and accrued interest were paid in full. Unamortized discounts on the Notes reduced the balance by$2.2 million ,$1.9 million , and$2.2 million atDecember 31, 2012 , 2011 and 2010, respectively. Senior Unsecured Notes - InFebruary 2009 , the Company issued$600.0 million of senior unsecured notes in an underwritten offering. The senior unsecured notes provide for semi-annual interest payments and principal due at maturity. The senior unsecured notes mature inFebruary 2014 and have an annual interest rate of 15%. During the fourth quarter of 2010, the Company repurchased$297.0 million of the$600.0 million senior unsecured notes at a price of$380.8 million . As a result of the transaction, the Company incurred a loss on debt extinguishment in 2010 of$85.2 million which included unamortized fees.
Asset-Backed U.S. Commercial Paper Conduit Facility VIE - In
44 -------------------------------------------------------------------------------- revolving asset-backed U.S. commercial paper conduit facility (U.S. Conduit) which provides for a total aggregate commitment of$600.0 million . The agreement has terms that are similar to those of the prior agreement and is for the same amount. AtDecember 31, 2012 and 2011, HDFS had no outstanding borrowings under the U.S. Conduit. This debt provides for interest on outstanding principal based on prevailing commercial paper rates, or LIBOR plus a specified margin to the extent the advance is not funded by a conduit lender through the issuance of commercial paper. The U.S Conduit also provides for an unused commitment fee based on the unused portion of the total aggregate commitment of$600.0 million . There is no amortization schedule; however, the debt is reduced monthly as available collections on the related finance receivable collateral are applied to outstanding principal. Upon expiration of the U.S. Conduit, any outstanding principal will continue to be reduced monthly through available collections. Unless earlier terminated or extended by mutual agreement of HDFS and the lenders, as ofDecember 31, 2012 , the U.S. Conduit expiresSeptember 13, 2013 . HDFS is considered to have the power over the significant activities of the U.S. Conduit VIE due to its role as servicer. Servicing fees are typically not considered potentially significant variable interests in a VIE. However, HDFS retains a residual interest in the VIE in the form of a debt security, which gives HDFS the right to receive benefits that could be potentially significant to the VIE. Therefore, the Company is the primary beneficiary and consolidates this VIE within its consolidated financial statements. Asset-Backed Canadian Commercial Paper Conduit Facility - InAugust 2012 , HDFS entered into an agreement with a Canadian bank-sponsored asset-backed commercial paper conduit facility (Canadian Conduit). Under the agreement, the Canadian Conduit is contractually committed, at HDFS' option, to purchase from HDFS eligible Canadian retail motorcycle finance receivables for proceeds up toC$200 million . The terms for this facility provide for interest on the outstanding principal based on prevailing market interest rates plus a specified margin. The Canadian Conduit also provides for a program fee and an unused commitment fee based on the unused portion of the total aggregate commitment ofC$200 million . There is no amortization schedule; however, the debt is reduced monthly as available collections on the related finance receivables are applied to outstanding principal. Upon expiration of the Canadian Conduit, any outstanding principal will continue to be reduced monthly through available collections. Unless earlier terminated or extended by mutual agreement of HDFS and the lenders, as ofDecember 31, 2012 , the Canadian Conduit has an expiration date ofAugust 30, 2013 . The contractual maturity of the debt is approximately 5 years. During 2012, HDFS transferred$230.0 million of Canadian retail motorcycle finance receivables to the Canadian Conduit for proceeds of$201.3 million . HDFS maintains effective control over the transferred assets and therefore the transaction does not meet accounting sale requirements under ASC Topic 860, "Transfers and Servicing". As such, this transaction is treated as a secured borrowing. The transferred assets are restricted as collateral for the payment of the debt. AtDecember 31, 2012 ,$194.3 million of finance receivables and$11.7 million of cash were restricted as collateral for the payment of$175.7 million of debt. Approximately$37.7 million of the debt was classified as current atDecember 31, 2012 . Term Asset-Backed Securitization VIEs - For all of its term asset-backed securitization transactions, HDFS transferred U.S. retail motorcycle finance receivables to separate VIEs, which in turn issued secured notes, with various maturities and interest rates to investors. All of the notes held by the VIEs are secured by future collections of the purchased U.S. retail motorcycle finance receivables. The U.S. retail motorcycle finance receivables included in the term asset-backed securitization transactions are not available to pay other obligations or claims of HDFS' creditors until the associated debt and other obligations are satisfied. Cash and cash equivalent balances held by the VIEs are used only to support the securitizations. There is no amortization schedule for the secured notes; however, the debt is reduced monthly as available collections on the related retail motorcycle finance receivables are applied to outstanding principal. The secured notes' contractual lives have various maturities ranging from 2013 to 2019. HDFS is considered to have the power over the significant activities of its term asset-backed securitization VIEs due to its role as servicer. Servicing fees are typically not considered potentially significant variable interests in a VIE. However, HDFS retains a residual interest in the VIEs in the form of a debt security, which gives HDFS the right to receive benefits that could be potentially significant to the VIE. Therefore, the Company is the primary beneficiary and consolidates all of these VIEs within its consolidated financial statements. During the third quarter of 2012, the Company issued$675.3 million of secured notes through one term asset-backed securitization transaction. Additionally, during the second quarter of 2012, the Company issued$89.5 million of secured notes through the sale of notes that had been previously retained as part of theDecember 2009 ,August 2011 , andNovember 2011 term asset-backed securitization transactions. These notes were sold at a premium, and atDecember 31, 2012 , the unaccreted 45 -------------------------------------------------------------------------------- premium associated with these notes was$1.2 million . During 2011, the Company issued$1.09 billion of secured notes through two term asset-backed securitization transactions. As ofDecember 31, 2012 , the assets of the VIEs totaled$2.28 billion , of which$2.10 billion of finance receivables and$176.3 million of cash were restricted as collateral for the payment of$1.45 billion secured notes. Approximately$399.5 million of the obligations under the secured notes were classified as current atDecember 31, 2012 , based on the contractual maturities of the restricted finance receivables. Intercompany Borrowings - HDFS has a revolving credit line with the Company whereby HDFS may borrow up to$210.0 million from the Company at a market interest rate. As ofDecember 31, 2012 , 2011 and 2010, HDFS had no outstanding borrowings owed to the Company under this agreement. During the fourth quarter of 2012, HDFS and the Company entered into a$400.0 million Term Loan Agreement which provides for monthly interest payments based on the prevailing commercial paper rates and principal due at maturity inJanuary 2013 or upon earlier demand by the Company. Intercompany loan balances and related interest are eliminated in the Company's consolidated financial statements. Support Agreeement - The Company has a support agreement with HDFS whereby, if required, the Company agrees to provide HDFS with financial support in order to maintain HDFS' fixed-charge coverage at 1.25 and minimum net worth of$40.0 million . Support may be provided at the Company's option as capital contributions or loans. Accordingly, certain debt covenants may restrict the Company's ability to withdraw funds from HDFS outside the normal course of business. No amount has ever been provided to HDFS under the support agreement. Operating and Financial Covenants - HDFS and the Company are subject to various operating and financial covenants related to the Global Credit Facilities and various operating covenants under the Notes and the U.S. and Canadian asset-backed commercial paper conduit facilities. The more significant covenants are described below. The covenants limit the Company's and HDFS' ability to: • incur certain additional indebtedness;
• assume or incur certain liens;
• participate in certain mergers, consolidations, liquidations or dissolutions; and
• purchase or hold margin stock.
Under the financial covenants of the Global Credit Facilities, the consolidated debt to equity ratio of HDFS cannot exceed 10.0 to 1.0. In addition, the Company must maintain a minimum interest coverage ratio of 2.25 to 1.0 for each fiscal quarter throughJune 2013 and 2.5 to 1.0 for each fiscal quarter thereafter. No financial covenants are required under the Notes or the U.S. or Canadian asset-backed commercial paper conduit facilities. AtDecember 31, 2012 , 2011 and 2010, HDFS and the Company remained in compliance with all of the existing covenants. Cash Flows from Discontinued Operations There were no cash flows from discontinued operations during 2012 and 2011. During the year endedDecember 31, 2010 , cash flows from discontinued operations were a net cash outflow of$72.3 million . Cautionary Statements The Company's ability to meet the targets and expectations noted depends upon, among other factors, the Company's ability to: (i) execute its business strategy, (ii) adjust to fluctuations in foreign currency exchange rates, interest rates and commodity prices, (iii) manage through inconsistent economic conditions, including changing capital, credit and retail markets, 46
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(iv) implement and manage enterprise-wide information technology
solutions, including solutions at its manufacturing
facilities, and
secure data contained in those systems,
(v) anticipate the level of consumer confidence in the economy,
(vi) continue to realize production efficiencies at its production facilities and manage operating costs including materials, labor and overhead,
(vii) manage production capacity and production changes,
(viii) manage changes and prepare for requirements in legislative and
regulatory environments for its products, services and
operations,
(ix) provide products, services and experiences that are successful in the marketplace,
(x) manage risks that arise through expanding international operations
and sales, (xi) manage the credit quality, the loan servicing and collection activities, and the recovery rates of HDFS' loan portfolio, (xii) successfully implement with our labor unions the agreements that we have executed with them that we believe will provide
flexibility and
cost-effectiveness to accomplish restructuring goals and long-term competitiveness, (xiii) effectively execute the Company's restructuring plans within expected costs and timing,
(xiv) manage supply chain issues, including any unexpected interruptions
or price increases caused by raw material shortages or natural disasters, (xv) develop and implement sales and marketing plans that retain existing retail customers and attract new retail customers in an
increasingly
competitive marketplace,,
(xvi) adjust to healthcare inflation and reform, pension reform and tax changes,
(xvii) retain and attract talented employees,
(xviii) manage the risks that our independent dealers may have difficulty obtaining capital and managing through changing economic conditions and consumer demand, (xix) continue to have access to reliable sources of capital funding and adjust to fluctuations in the cost of capital, (xx) continue to develop the capabilities of its distributor and dealer network, and
(xxi) detect any issues with our motorcycles or manufacturing processes to
avoid delays in new model launches, recall campaigns, increased warranty costs or litigation. In addition, the Company could experience delays or disruptions in its operations as a result of work stoppages, strikes, natural causes, terrorism or other factors. Other factors are described in "Risk Factors" under Item 1A which includes a discussion of additional risk factors and a more complete discussion of some of the cautionary statements noted above. The Company's ability to sell its motorcycles and related products and services and to meet its financial expectations also depends on the ability of the Company's independent dealers to sell its motorcycles and related products and services to retail customers. The Company depends on the capability and financial capacity of its independent dealers and distributors to develop and implement effective retail sales plans to create demand for the motorcycles and related products and services they purchase from the Company. In addition, the Company's independent dealers and distributors may experience difficulties in operating their businesses and sellingHarley-Davidson motorcycles and related products and services as a result of weather, economic conditions or other factors.
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