Q3 2019 Earnings Call
Because the speakers presentation, there will be a question and answer session to ask a question. During this session you'll need to press star one on your telephone we ask that you limit yourself to one question you may recall you for additional questions. Please be advised that todays conference is being recorded if you require any further assistance. Please press star.
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I'd now like to turn the conference over to your Speaker today director of Investor Relations Shannon Burns. Thank you. Please go ahead Sir.
Good morning, everyone.
You can access the slide supporting this call at Investor Day, Harley Davidson Dot com click to earnings materials box in the center of the page. Our comments will include forward looking statements that are subject to risks that could cause actual results to be materially different. Those risks include among others matters. We have noted in our latest earnings release and filings with the FCC Harley Davidson disclaims any out.
Obligation to update information on this call joining me this morning, our president and CEO , Matt, Let me touch and CFO , Jonathan Matt, Let's get started.
Thanks, Shannon and good morning, everyone. We've closed out our third quarter with results that includes the P.S. an operating margin that were ahead of expectations and in addition, we made noteworthy progress, which I'll get into here today.
As we shared in September we've sharpened the focus of our objectives to build writers in the United States and made clear how we plan to invoke the power of our brand in new ways to deepen the commitment of writers now and into the future.
Our strategy and commitment to build writers is driving deeper understanding and broader capabilities that are and will continue to propel our company forward.
And our operating discipline, along with our dealers efforts continue to bring increasing business stability in this dynamic marketplace.
Guiding all our efforts is deeper analysis in insights on why people engage participate in disengage from writing.
Our advanced analytics capabilities and rider migration database have evolved into a powerful asset.
In a wealth of information and inspiration for US, we know more than ever about how to attract people to writing and keep them engaged to build committed riders and we know how this applies no matter what their experience level age or life stage, we have two primary focus areas attracting more people to rise.
Riding and keeping riders riding our execution might be different for young adult versus a returning rider, but the essence of our work has the same across the customer spectrum, we're bringing precise focus to how we influenced each customer at their decision points to build the total number of committed Harley Davidson riders.
Where we'd previously had an objective to build 2 million new riders in the U.S., We now know why where how and what we can do to work both sides of the equation, attracting and retaining to increase the total number of riders we've done the math considering demographics and used bikes.
And we've set targets for new riders, we need to attract and retention rates that we need to achieve 4 million total us Harley Davidson riders by 2027 re framing this objectives helps us sharpen our work on both increasing the pools of incoming riders and to better activating passions of new.
New and existing riders.
This is an important refinement that underscores what we've said for several years now our mission is about activating riding the power of this refinement is in the focus that our entire enterprise has on building new riders and keeping all riders in the saddle and enjoying the ride.
In September we also shared that we're directing investment building capabilities in structuring the organization to activate the Harley Davidson brand more powerfully.
We're intensifying our rider centric approach to spark a passion that deepens rider commitment.
In line with this focus we've added amplify brand as a growth catalyst in the more roads to Harley Davidson plan.
Our brand efforts will bolster the existing growth catalysts of new products broader access and stronger dealers.
We activated this additional growth catalyst during the quarter and started to embedded in all of our work, we're digging in and focusing investment to foster modal culture, and build and even bigger more passionate community of Harley Davidson riders across all aspects of the riding journey.
In Q3, our marketing spend was up over 30% and our efforts included live wire and low rider asks television spots running in major markets across the United States, which helped to generate over 700 million impressions.
We also continued rolling out a refreshed brand look at major events during the quarter, including Sturgis World Surf League and Spartan races, and we announced we will be the presenting sponsor at next summer's hotly anticipated how Omega music experience tour, featuring Green day, Weezer and fallout go away.
During the quarter, we also sharpened our objective to grow our international business to 50% of annual H. DMC revenue by 2027.
Previously the growth measure was motorcycle unit volume.
As we see opportunities we have for growth globally unit volume of traditional products will be less a proxy for revenue than it has been in the past revenue better captures all our efforts, including things like E bicycles and a refreshed apparel approach, we remain very focused and optimistic about our growth prospects out.
Side, the United States.
We have the research insights momentum and even sharper plans to create new pathways to Harley Davidson and expand access and appeal to more people around the world.
Simply put we are working to make writing matter more to more people and we're building on a position of strength never have there been more Harley Davidson riders in 2018, there were over 1.3 million in international markets and 3 million in the United States.
Compared to 2010 in the US we saw growth across all ages, including young people in fact, contrary to some perceptions. The data shows a 1.5 times incident rate increase for 18 to 29 year olds in 2018 versus 2010.
We know more about these riders than we ever have a research helps us understand why and when people become riders and why and when along their riding journey. They leave which has informed our work to activate riders along the participation lifecycle.
Our insights in form not just our opportunity in the us, but the focus of our efforts around the globe, we see a significant opportunity to enact with tens of millions of people around the world, where curious about Harley Davidson or interested in becoming a Harley Davidson rider.
As we strengthen our focus to attract new riders and deepen rider commitment we've got more in our product pipeline than ever before we're also honing our research in international markets and we'll continue to use geographic and rider insights to drive targeted actions at the local and market level.
In the slide deck, you'll see a revised graphic that depicts the key structural elements of our strategy to build the next generation of Harley Davidson riders as shown the catalyst are interconnected and working in concert to meet our objectives, we must successfully leverage all catalysts.
A perfect example of this and initiative that touches every aspect of our more roads plan.
Is our leadership in the electrification of motorcycles.
Our work.
To further Harley Davidson and the industry is generating valuable learnings and cultivating capabilities that are both exercising the organization and propelling US forward, it's tough and rewarding work and we're hungry for the challenge.
As I've mentioned before our grit defines our culture as does our unrelenting drive to deliver for our riders.
During the quarter, we crossed to historic threshold when the first live wire motorcycles made their way down our new production line at our facility in New York, Pennsylvania, and today lie wire motorcycles are being produced and delivered to dealers and customers across the us in Canada.
Leading in this new space requires agility and a clear commitment to the first principles of quality and integrity and we're demonstrating bowls.
We are deploying rigorous protocols for product quality and integrity and facing first mover challenges head on.
Since day, one it's been essential that we set the bar for what a high performance no excuses electric motorcycle should be and the media have all but crowned that achievement, we take pride in the rigorous quality standards and controls we employ in our drive to lead the industry and deliver the world's best motorcycles.
We know our dealers and customers are eagerly awaiting live wire and we're ensuring it will exceed their expectations.
Live wire is an exceptional motorcycle our expectations for retail sales consider the premium nature of this product and the premium sets the bar for the industry and paves the way for the balance of our electric product portfolio will introduce over the next several years our portfolio designed to appeal to customers, who will enjoy the sthree.
Oil and ease of twist and go acceleration across a range of price points and design features suited to a variety of uses.
We have something in our plan for almost everyone starting with three year olds and on that note during the quarter, we delivered to our dealers. The first iron E electric powered to wheelers for kids are result of our stay sick acquisition earlier. This year. The thrill of writing is now being appreciated by kids and their families. It's.
Incredible to witness and our US dealers are powering up family fun Activations. This is a demonstration of our strategy a comprehensive approach to build the next generation of Harley Davidson rider.
As we attract new customers, we continue to reward existing riders and brand fans. In Q3, we also brought to market a terrific array of 2020 motorcycles and gear to ignite their passions, we're seeing strong demand for the low rider S and CVR triglyceride and great response to the significant technology.
We added to our class leading model year 2020 motorcycles. The team is laser focused on building riders today, and preparing us and our dealers to welcome a broader array of new riders moving forward.
Positive momentum in Q3 from our broader access and stronger dealers initiatives was driven by stronger mix of value driving equity marketing as we dial in and dial back sales incentives and further improved capabilities such as dealer digital programs and lead management tools deployed across our dealer network.
Stronger dealers retail marketing and dealer operations consulting teams continue their onsite dealer visits and operations evaluations in the us in international markets to assess and provide the tools and process support dealers need to take their business to the next level participating dealers are seeing improved results across.
Many areas of their business, including sales of new and used bikes PNM, a and apparel. In addition to product sales improvements dealers, who engage in operations consulting or seeing a 10% increase in service revenue compared to other dealers in their district.
In retail marketing consulting is driving a 20% average increase in unique website visits for participating dealers.
We and our dealers continue the groundwork to be nimbler and more responsive to market and customer demands. Our efforts in Q3 drove increased business stability with predictable performance in most areas of the business and we're encouraged by trends and retail sales results globally.
We are confident our strategy and sharpened focus will drive even more positive results going forward.
In the us and in all our markets, we continue to maximize value, while we invest in future strength and growth. We're walking. This line in all we do with keen awareness and focus we will do more with the Harley Davidson brand to drive relevance.
Inspire ridership and make riding matter more to more people.
So with that ill turn it over to John to discuss the financial results for the quarter. John Thanks, Matt in the third quarter. We were pleased to deliver EPS and motorcycle segment operating margin ahead of expectations. The worldwide retail sales rate improved during the quarter versus the first half of 2019. We also made good progress as.
We continued to execute on more roads, the Harley Davidson plan to drive future growth.
The summary of our Q3 results is on slide 13.
In the third quarter motorcycle segment operating income was impacted by lower shipments higher year over year tariffs and unfavorable mix, partially offset by lower year over year, SDMA and the benefit of our manufacturing optimization initiative.
Financial services operating income was down 13.0% consolidated net income was down versus prior year due to lower operating income.
EPS for the quarter was 55 cents when excluding restructuring plan costs and the impact of recent you in China tariffs adjusted EPS was 70 cents.
We remain focused and disciplined on tightening retail inventory aggressively managing costs generating cash from operations and delivering strong shareholder returns over the long term.
On slide 14 worldwide retail sales of new Harley Davidson motorcycles in the third quarter were down 1.2% versus prior year.
International retail sales were up 2.7% driven by growth in both our developed and emerging markets.
In the US Q3 retail sales were down 3.6% versus prior year, which represents an improvement in the sales rate over recent quarters, our retail sales benefited from our actions and that the tempering of the industry's retail sales declines.
We expect our business remain under pressure as the US and developed international markets continue to face substantial headwinds the global competitive environment remains intense with aggressive promotional activity in the us and worldwide new product introductions, we expect to overcome these market challenges by focusing on our intensified efforts to exit.
Acute are more roads plan and to build committed riders. We believe that we have a strong plan for the future and we are executing with great urgency.
Now, let's take a closer look at the us on slide 15.
In the US Q3 retail sales were down behind lower but improved industry retail sales performance and softer market share.
Third quarter industry retail sales were down 1.7% the industries third quarter performance represents the lowest year over year rate of decline in the last 14 consecutive quarters.
On a year to date basis, the industry was down 3.9% versus a decline of 8.7% during the same period last year.
Similarly, Harley davidson's year over year retail sales rate of decline tempered in the third quarter as compared to recent quarters and was in line with our expectations.
On a year to date basis, Harley Davidson's retail sales decline of 5.6% compares favourably to last year's decline of 10.2%.
We believe this improved rate of decline was driven by improved industry performance, our focus on stronger dealer growth catalysts and increased marketing investment.
During the quarter, our market share of new bike registrations in the US was 49.8% down 1.1 percentage points on stronger performance in segments, which we do not currently compete but plan to compete and by the end of next year as we execute our more roads plan.
Harley Davidson gained 2.2 percentage points of market share during the quarter within our touring and cruiser segments, which represents approximately 70% of the total six so one plus cc industry.
In the second and third quarters, we increased the execution of our stronger dealer growth catalyst and increased brand marketing while dialing back on our short term focused sales incentives during the third quarter, we reduced our year over year sales incentives, but did offer a two week finance incentive on carryover motorcycles aimed at driving dealership.
Traffic in conjunction with the arrival of our new model year motorcycles and to further reduce our dealers carryover inventory.
We tightly managed shipments of new motorcycles into the dealer network in the quarter.
This resulted in the quarter end us retail inventory decreasing approximately 550 motorcycles versus prior year.
We were pleased with the dealer inventory levels and the mix of our new product, our new model year bikes at the end of the quarter.
We believe this market disciplined is important and maintaining consumer and dealer value and will ultimately result in stronger retail sales of new motorcycles.
On slide 16 third quarter International retail sales were up 2.7% versus prior year Q3 retail sales were up in both our developed and in our emerging markets.
Emerging markets retail sales were up 4.7% during the quarter led by growth in ASEAN markets.
Mark has benefited from reduced pricing, which was enabled by the elimination of terrorists due to supplying these markets from our plant in Thailand strong growth in these markets was partially offset by softness in India and Mexico.
Retail sales in developed markets were up 1.8% during the quarter are developed markets Q3 retail sales rebounded from the second quarter, which was down 13.6%.
During the quarter, we delivered solid retail sales growth in Australia, Canada, and Japan, which all have been down over the past several quarters.
We believe that strength in Japan was partially aided by an increase in the countries consumption tax which went into effect on October onest.
Western Europe retail sales were down slightly but significantly improved from the decline in the second quarter.
Our year to date market share in Europe was 8.9% down 1.5 percentage points versus prior year, our market share was adversely impacted by lapping last year's strong softail results and by lower sales of street motorcycles due to the impact of implementing the street recall.
We remain confident in and committed to the great potential that exists in our international markets. We believe our more roads planned supports the strength of our brand products and distribution to drive growth sustainable growth internationally.
On slide 17.
Wholesale motorcycle shipments in Q3 were down 5.8% and roughly at the midpoint of our guidance.
Overall family mix shifted from Turing to cruiser motorcycles versus last year's third quarter.
On slide 18 revenue for the motorcycle segment was down 4.9% behind a 5.8% decrease in motorcycle shipments.
Average motorcycle revenue per byte was essentially flat a less rich product mix and unfavorable foreign currency exchange were offset by higher year over year pricing and reduced sales incentives.
Wholesale and MSRP weighted average pricing of our new model year 2020 motorcycles increased approximately 0.5% adjusting for the costs of the new content pricing increased approximately 0.2 percentage points expressed as a percent of revenue.
On slide 19 gross margin in Q3 was down as a result of lower shipments product mix and unfavorable currency, partially offset by favorable manufacturing expense and slightly higher pricing.
Product mix was unfavorable by 18, and a half million dollars in the quarter driven by family model PNM and general merchandise mix.
Q3, gross margin was adversely impacted by 3.8 million of unfavorable currency.
Three revenue was down nearly one percentage point due to stronger us dollar, which was largely offset by hedge gains.
In Q3 manufacturing expense was favorable versus prior year, driven largely by savings, resulting from the implementation of our manufacturing optimization initiative.
Partially offset by lower absorption on lower production and shipments.
In addition, Q3 tariff impacts of 21.6 million were up 11.3 million versus prior year.
On slide 20 operating margin as a percent of revenue for Q3 was lower compared to last year, driven by lower gross margin, partially offset by lower SGN, a and restructuring expenses.
So DNA was lower than prior year as we continue to aggressively manage costs and reinvest savings in our more roads plan and in in increased marketing investments.
Restructuring charges for the manufacturing optimization totaled $7.6 million in the third quarter down 7.2 million from prior year.
Profitability with strong profitability and cash flow remain a key focus.
And as our objective to further leverage and build our capabilities to continue to drive profit cash flow and top Cortile Motor company ROI IC.
Financial services segment third quarter operating income shown on slide 21 was $72.9 million down 13.0% compared to the prior year.
Net interest income was up 1.1 million due to higher year over year receivables and favorable interest rate yields largely offset by higher interest expense.
The provision for retail motorcycle loan losses was $11.4 million unfavorable in the quarter driven by higher credit losses, and an increase in Q3 2019 reserve rate compared to a decrease in the reserve rate in Q3 2018.
Operating expenses were up versus prior year as a result of a Q4 2018 reporting change in which Harley Davidson dealer systems business moved in the motorcycle segment to the financial services segment and due to a higher depreciation as a result of our investment in a new loan management system, which was implemented in January 2019.
I mean.
H. DFS is operational results are on slide 22.
Q3, retail originations were up 0.8% versus prior year, driven by an increase in used bike loan originations.
Hi, CFS as market share was 67.6%.
At the end of the quarter, there was $380.3 million of cash and cash equivalents at each DFS and $1.33 billion of liquidity available through bank credit and conduit facilities.
During Q3, H. DFS pay dividends of $50 million to Harley Davidson, Inc.
On slide 23, both our 30 day, plus delinquencies and credit losses were adversely impacted as expected by startup inefficiencies, resulting from the implementation of our new loan management system in the first quarter.
In the fourth quarter, we expect the system implementations impact on key metrics to be largely behind us.
The 30 day delinquency rate for retail motorcycle loan receivables on balance sheet in Q3 was 3.75% or 15 basis points higher than last year's Q3 rate, but seeds sequentially improved from Q2, 2019, which was up 24 basis points.
The annualized retail credit loss rate for receivables on balance sheet was 1.83%.
Q3's loss rate increase of 28 basis points was slightly above Q2, 2019, which was up 26 basis points as it takes times for the increased delinquent loans, resulting from the LMS system implementation to roll through to credit losses.
To a lesser extent third quarter credit losses were also adversely impacted by soffer motorcycle prices at auction.
The remaining Harley Davidson Inc. financial results are summarized on slide 24.
Our quarter end cash and marketable securities balance was $862.4 million.
Year to date operating cash flow of $848.6 million was down versus last year, driven by higher working capital and lower net income.
Regarding liquidity the company has and intends to continue to maintain a minimum of 12 months of projected liquidity needs in cash and or committed credit facilities.
We believe the charts on slide 25 demonstrate that we are leader in ROI see at the motor company and our OE at H. DFS and we are a clear leader in our ability to generate and return cash to our shareholders.
One of the five objectives guiding our business strategies and execution through 2027 is to deliver superior return on invested capital as measured by Motor Company ROI see in the cop top quartile of the S&P 500, and by best in class return on equity at age DFS.
Slide 26 illustrates the recent history of returning cash to our shareholders in the third quarter of 2019, we paid a quarterly dividend of 37, and a half cents per share and repurchased $112.5 million of our stock.
Having superior value for our shareholders as a top priority, we have a robust and disciplined process for our investment decisions, we look for opportunities to grow value through investments that maximize the performance and long term percent potential of the company and the brand.
After investing in our business, we intend to return excess cash to our shareholders in the form of increasing dividends and share repurchases.
Slide 27 in the summary of our multiyear manufacturing optimization.
Annual ongoing cash savings are expected to be $65 million to $75 million after 2020.
We continue to expect $25 million to $30 million and savings for 2019, and we realized 16.7 million of these savings in the third quarter.
For the full year, we continue to expect to incur $40 million to $50 million of operating expense.
Manufacturing optimization costs were $10.0 million in Q3.
We believe these investments at very attractive returns they simplify our manufacturing footprint provide focus in our operational investments and expect to improve gross margin by roughly one on a quarter percentage points.
Moving on our 2019 full year guidance on slide 28 remains unchanged from Q2.
With the exception of the 2019 capital spending we now expect capital spending to be $205 million to $225 million, which is $20 million lower than our previous guidance.
On the heels of last quarter's approval by the EU to allow favorable tariff treatment of our Softail Sportster motorcycles produced in our Thailand facilities, we remain on track to begin producing motorcycles in Thailand by the end of October for sale in the EU.
Allowing time for transportation and flow through of high tariff inventory, we continue to expect to begin mitigating EU tariffs in early Q2 of 2020.
For the full year 2019, we now expect impacts of recent you in China tariffs to be approximately $105 million.
This is a $5 million increase from prior expectations and is driven by an increase in section 301, tariffs, which remained very fluid as they continue to shift with global trade negotiations.
For 2020, we now expect annualized Threeo, one tariff impacts to be approximately $20 million. We're currently evaluating alternatives to help mitigate the impacts of these new tariffs.
In the fourth quarter, we expect to ship approximately 38, and a half to 43 and a half thousand motorcycles.
Also in the fourth quarter, we expect motorcycle operating margin as a percent of revenue to be a loss of approximately 5.5%.
Representing an improvement over last year's fourth quarter margin.
Fourth quarter results are expected to be adversely impacted by lower shipments unfavorable mix approximately $14 million of higher year over year tariff costs and unfavorable currency, partially offset by favorable SGN a behind lapping Q4 2018 recalls.
To wrap up during the quarter, we progress against our more roads to Harley Davidson plan that addresses today's marketplace challenges and the tremendous opportunities that exist in our international markets.
As we look to the remainder of 2019, we are encouraged by the momentum of retail sales trends through the first nine months of this year, but also recognize a substantial headwinds that we continue to face.
Looking longer term, we are prepared for an extremely dynamic and highly competitive global marketplace. We are committed to driving long term growth for our company and strong returns for our shareholders.
Thank you and now let's take your questions.
Thank you and at this time I'd like to remind everyone in order to ask a question. Please press star followed by the number one on your Touchtone keypad I'd also like to remind everyone to please limit yourself to one question. If you have a follow up question. We ask you to please re queue.
And your first question comes from line of Joe Altobello from Raymond James.
Please your line is open.
Hey, guys good morning.
So first question wanted to delve into the international retail improvement obviously.
Pretty significant quarter over quarter.
After about some of the drivers of that it to pad.
That's the tax for example, but want to get better effect or what drove the improvement.
Europe , Canada beyond that.
Okay. Joe This is John with regards to on the improvement that we saw a quarter over quarter one very.
Very pleased with it.
Second quarter, we had the developed markets down 13.6% and they were up 1.8%.
All developed markets improved on a quarter over quarter basis, Canada, Australia, and Japan all posted.
I am pretty strong gains on a year over year basis, and that's a first time in several quarters that they've been up year over year and Western Europe , while it was down slightly.
Still had some significant improvement as we look across all of them.
And we've talked about stronger dealer efforts, which started about five or six quarters.
Go in the United States, we've been looking to fast adapt those efforts into our international markets and you're seeing some of that come through in the third quarter. So Joe for example.
And on dealer sales incentives, we changed our dealer sales incentives in United States about four quarters ago, just changed them in the third quarter internationally.
Much more simplified the dealers on certainly.
Got a lot more clarity as what theyre doing on retail sales and we believe that benefited.
The second aspect is really fell off of the dealer network fell off a little bit on.
On the demo rides and test rides that they were doing.
Got that was back on track in the four in the third quarter and then finally similar to the United States as we look to amplify the brand we increased our brand equity marketing in international markets in the third quarter as well.
That's very helpful caught that Gary just one quick follow up in terms of the operating margin outlook, you mentioned fourth quarter minus 5.5%, but that the GAAP number I think on an adjusted basis, you're probably looking at something if you're if you're looking at a full year temper that market fourth quarter, adjusted operating margins will likely going to be up modestly as that.
Okay.
They will be improved I don't have that number in front of us basically peel out.
The tariffs, which are going to be up incrementally 14 million.
As well as the year over year.
Manufacturing optimization spending I don't have that number in front of me Joe Okay. Perfect. Thank you guys.
Your next question comes from line of Jamie Katz from Morningstar Go ahead. Please your line is open.
Hi, Good morning, I'm curious you guys had factored into promotional environment into your outlook for the full year I'm going if you havent what impact that might have.
On the ability to capture the housing prices and Robin is annual quarter heading into next year. Thanks.
Hi, Jamie if I'm understanding the question first of all we are in a higher promotional environment today, as we look quarter over quarter.
We believe that about half of our competitors have increase or mono promotional activity.
From last year to this year and at the same time that Theyre doing that we are starting to back off of some of what we would call sales incentives.
And thats bottom promotional offers and.
Finance offers and so again when we look at the results that we posted in the United States in Q3, while they were down they certainly tempered, but that was in the face of pulling back on some of the.
Sales incentives that we had been offering on they are actually down about 50% in the on third quarter as we look across the full year on were continued to look to shift.
Money from sales incentive into more brand.
Equity based on and more sustainable.
Marketing.
Okay, and then I think in the prepared remark there with some comments that there's an expectation of retail sales for alive wire, which you care to share that with us.
The.
I don't think there was Jamie.
We do not provide model level shipment or retail sales data on what we did on live wire as we began shipping in the last week of September . So we had some shipments but on the 40000 units are so that we shipped a very minor.
And we're just very excited to have live wire in the market and starting delivered to our customers.
Thank you.
And once again as a reminder, we do asset you limit yourself to one question for any additional questions. We ask that you reenter the queue in a Q. Your next question comes from the line of David Macgregor from Longbow Research Go ahead. Please your line is open.
Yes, good morning, everyone.
John a question was on the HD Fs and just your.
Looking at an increasing your provisioning I think was $11 million increase in provisioning and.
You talked about financing promotions that sounds like maybe year dialing goes back a little bit now, but can you talk about the extent to which the provision increases were a function of the financing promotions versus maybe other factors and to what extent you expect that provisioning to pullback now that may be reaching back on the promotions.
Thanks, David.
We don't ahead.
There is we don't believe that Theres anything with regards to the finance offers driving there was promotion are those on higher provisions. So what you're referring to is in the quarter. We had eight increased provision of $11.4 million.
And that was driven by about half of that is driven by higher credit losses, and we've talked about that the last several quarters on the majority of that is being driven by.
The LMS system implementation in the startup that we had and as Weve.
Got things going we expect those would be largely behind us, but in the third quarter. The majority of that was driven by the LMS. The other half of its simply is the provisioning on in the reserves on a year over year basis, and we look at those reserves are made up of two things. One is the reserves that we have.
Book This year and those are slightly higher in the third quarter, but the biggest piece of the.
Reserves is what happened in the 2018 third quarter is we actually reduced on reserves.
By a fair amount and so we're just lapping that so that provision is made up of two pieces credit losses, as well as the reserves about half and half.
There is not a significant impact due to the promotions that we've had or the finance offers that we have made.
Thank you.
Your next question comes from the line of Sharon Zackfia from William Blair Go ahead. Please your line is open.
Hi, good morning.
John I wanted ask a question about the motorcycle operating margin in the quarter I think originally guided for to be down about 300 basis points and it was kind of down half of that so could you give us some color on what surprised with a positive on the motorcycle margin.
Great. Thanks, and thanks for the question churn I love the share. This one with yes, you're absolutely right. It came in about 1.1 about one and a half.
Points favorable and that's largely driven by lower SGN a.
And into that reason why I say I'm glad you asked it is our employees have done an absolutely fantastic job of becoming more efficient on evaluating every dollar that they spend and as we've talked about for quite some time is we're looking to fund our more roads investment.
Internally and so while we've got those costs rising on more roads as well as our amplifying the brand and we've increased marketing is Matt had mentioned over 30% in the quarter all of that was paid for by.
Our employees doing their jobs and doing a more efficiently everyday on so we couldn't be more pleased with that and so that came in higher than what we expected and on the quarter basis SGN a was lower by.
By about a million and a half dollars again on the absorbing all the cost with our more roads and a 30% increase in marketing expanding we couldn't be more thrilled with them that performance.
Okay. Thank you.
Your next question comes from the line of James Hardiman from Wedbush Securities Go ahead. Please your line is open.
Hi, good morning.
Thanks for taking my question so.
Some of my questions are answered, but I wanted to maybe circle back on.
One of the somewhat but one of the questions I've gotten a lot coming out of the analyst day and Thats, how to think about gross margins and in 2020.
Just as a point of clarification I think you guys mentioned that with some of the new middleweight bikes gross margins would be down, but but am I wrong, and saying that's on a pro forma basis, excluding tariffs, but that when we factor in the tariffs gross margin should still be up next year and maybe just late.
Okay.
You mentioned some stuff in the prepared remarks about pairs for this year next maybe just give us the best estimate right now based on the timetable of of when Youre going to be up and running in Thailand and shipping into that you just how much of a tariff.
Benefit should should we expect in 2020.
Okay James.
First of all we've not provided any guidance on gross margin in 2020.
And the middle weights will not have.
Significant impact in 2020, because they will.
Come out later in the year.
We will provide more guidance on operating margin next quarter.
But in general we've said over the next three year period of time or through 2022 is that we would face some gross margin headwinds on because of the new on products that were coming out with that are coming out at very strong margins, but just not at the same level as the products that we've been delivering for 116 years and our touring and cruiser bikes.
And with that headwind some of that will be offset by the absorption in the higher growth that we expect coming out of those investments.
But then overall operating margin would increase through the period of AMR through 2022, as we further leverage SGN a.
So that's what's been set about on gross margin when we talk about tariffs and I had mentioned.
In the prepared remarks is that tariffs are expected to be $105 million.
This year and has made up of up three component pieces.
Approximately $90 million of that James is is you tariffs rate and with that we expect to mitigate the vast majority of them. There's a couple of models that will continue to ship from the United States, but that will come in.
Early in the second quarter.
So the timing is is that will start producing in late October in Thailand.
It has time on the water it will arrive in the EU market at the end of 2019 in the beginning of 2020.
We need time to burn off the existing inventory, we're taking down production right now and are limiting as much inventory of the high tariff bikes as we can into the market the low tier of bikes will enter into the market in early on January's late this year and Don will flow through the system and we believe bye.
Early second quarter.
We will begin mitigating the tariffs in Europe , so on a year over year basis.
It will be.
The 90 million less what we're able to.
Okay.
We will still have tariffs in the first quarter.
The second component of it is tariffs of of shipments that we've had from the United States in the China that represents this year about $7 million. Those bikes are currently being produced in on Thailand, today and being shipped into China today.
In were little bit earlier in the in the cycle than we are in IPU and right now we're burning off the high on tour of inventory in the.
The bikes in China and by the beginning of the year, we would expect to be able to mitigate the vast majority of that $7 million of tariffs.
By the of the very beginning in 2020.
And then the third component is about $8 million of 301 tariffs and this is the component that's increased from last quarter to this quarter and that's the advent of list for that went into effect on September onest and the expectation of let list for a.
And another lists for set of products, becoming implemented in the middle of December again. This is very volatile and it's what we know today and it seemed to change quite often.
But given the timing of when these are we would expect lists for products to be approximately 20 million in 2020.
And so that would be an incremental increase in non those tariffs by about $12 million James and we're looking to mitigate those through largely through resourcing the products.
That's really helpful. Thanks, guys.
Your next question comes on line of Craig Kennison with Baird Go ahead. Please Sir your line is open.
Thanks, just a quick two part question first on James' question.
As it relates to the EU tariff and then 90 million. This year should we just take.
One quarter of that and apply it into next year and then Matt as it relates to the US economy today, what's your view on things and unemployment is low but recession peers are rising.
Curious what your take as overall.
I'll answer the first part Craig with regards to.
The first quarter.
We're going to be in the neighborhood of that we will provide more granularity.
At the end of the ended January when we do our call and we'll see the inventories on what ended up in market and so on and so forth.
But by and large no early into the second quarter is when those tariffs would be mitigated.
Okay, Craig it's Matt. Thanks for the question I am if I had that crystal ball I would be utilizing it on a daily basis I think that the market continues whether you're talking at the.
Corporate level or the consumer level to face quite a bit of uncertainties regarding.
All manner of new sort of economic stability related to the tariffs and obviously the political.
Presidential campaign.
And so for us, but having said that a sitting here right now I don't think that Dan that uncertainty is higher than it was six months ago.
And in fact seeing the industry pickup that we saw in this third quarter is obviously, an encouraging sign I would just say that from a company perspective, we're looking at our business with the abundance of caution necessary in an environment like this in that.
Underscores how pleased we are with increased predictability.
And performance to plan that we see in our business, we've done a nice job really dialing in our measures in our our dashboard of how things are moving keeping inventory very tightening very nimble in.
Production and shipments recognizing that were in probably the most uncertain forward environment that we've been in a long time and we'll continue to do that and that's that's the focus because we can't predict the future anymore than anyone else can all we can do is be as nimble and responsive.
As possible I think we're well positioned to do that so things. Thank you.
Your next question comes from line of Adam Jonas from Morgan Stanley Go ahead. Please your line is open.
Hi, This is bill like fondest of off Adam Jonas quick question on ice TFS and the quarter. It looked like the beta motorcycle operating margins was offset by a CFS validation FES margins down year on year, despite pretty supportive credit conditions.
Blood management changes aside and an accounting change as a side could you. Please comment on our H. DFS, maybe they have been impacted by efforts to build new right is is it reasonable to assume misled sacrificing credit quality and I'd say first notice to drive some revenue growth. Thanks.