Imagine a manufacturing and wholesale distribution company whose fortunes are dependent on higher-income customers with discretionary income, readily available access to credit and an optimistic view to the future. Now add a financial services component that extends credit to the company's dealers and customers.

Harley-Davidson (NYSE: HOG) is just such a company.

Harley is a classic case of a company that prospered immensely from the combination of an aging baby boomer population and a massive increase in the appearance of wealth resulting from unprecedented increases in home values and a stock market that exploded to new heights during the last 10 years.

Now that both of these bubbles have burst, HOG is feeling the impact of a recalcitrant consumer and mounting problems with the loan portfolio of its financial arm, Harley-Davidson Financial Services (HDFS).

As an American icon, Harley Davidson's line of heavyweight touring, custom and performance motorcycles is the most visible (and audible) symbol of American self-indulgence.

In keeping with its typical marketing flavor, Harley Davidson Inc., (NYSE: HOG) wants its newly opened Harley Davidson museum to be more about the rider's experience than just the ride. The company wants its museum to be a lifestyle exploration adventure, rather than a commercial presentation. While the new attraction indeeds feature hundreds of motorcycles, reams of vintage Harley Davidson advertising and other Harley memorabilia, in an article published by Business Week, museum director, Stacey Schiesl is quoted as stating: "It's not just about what's inside."

It's always been that way with Harley Davidson. In strong years and lean years, the company had always taken the experience of its enthusiasts very seriously. That is why the museum was designed and constructed to be enjoyed in a manner that stimulates what Harley owners like most about their bikes. It's a feeling of camaraderie. It's a sharing of an experience. It's good will and good times on a piece of open road. Architects designed the site to reflect and embody a feeling of Main Street Americana, with accommodations for up to 15,000 bikes at any given time.

The Harley Davidson Museum is a testimonial to 105 years of American made motorcycle greatness. Even in the face of tough times, with the company forecasting slowed earnings and reduced production, it's good to see that it has maintained its successful focus: to create both a visual and a tangible motorcycling lifestyle experience for all motorcycle enthusiasts to enjoy.

Harley-Davidson (NYSE: HOG) announced today that August sales sucked the tailpipe, and the rest of the year looks similarly grim. Third quarter shipments will fall several thousand units short of expectations, and it projects 2007 total shipments to finish at 328-332,000, down over 10,000 units over 2006. It's new projection for 2007 EPS is $3.69-$3.77, down from $3.93 in 2006.

The market reacted sharply to the news and the stock is down almost 9% in early trading. Since April, the stock has dropped from almost $66 a share to under $50.

The company points to dropping demand and a promotion-heavy July to explain the shortfall. I think Harley-Davidson is caught in a particularly awkward spot in this economy. As the number of Harleys on the road grew, the resale price has fallen, which creates more of a barrier for riders interested in trading up. About 35% of purchases financed by Harley-Davidson Financial Services were subprime, and the troubles in this market are bound to be reflected in sales declines, much as they have in the auto sector. Growing unemployment figures could also have an impact on sales.

The company entered 2007 with an overabundance of inventory in dealerships, and the July incentives used to clear out these models would have made 2008 models seem more expensive by comparison.

The company further cautioned that 2008 could be another slow year for bike sales, projecting moderate revenue growth and EPS up 4-7%.

I'd keep an eye on international growth, to see if the company can make enough inroads in foreign markets to absorb some of the excess capacity. Domestically, Harley-Davidson looks to be running into some rough road ahead.

[Photo SunFlowery]

Kudos to Harley-Davidson's (NYSE:HOG) management, which was rather forthright in expressing disappointment with the company's lackluster second quarter results. The biggest clunker of the day was the news that domestic sales fell 5.5% to 67,9512 units. The drop was offset in part by strong international sales, where 27,166 bikes sold, a 19.2% increase. Overall, the company reported a quarterly EPS of $1.14, which matched analyst expectations, on sales of $1.62 billion.

As expected, rising interest rates have had an impact on Harley-Davidson Financial Services. It reported that, of the loans securitized in this quarter, 35% were subprime, a percentage it expects to decrease with the tightening of the credit market. A drop in the recovery value of units, along with an increase of credit losses from 1.2% to 1.63%, and an increased use of promotional loans all diminished the quarterly results. On the brighter side, the percentage of unit sales financed through HDFS rose from 46% in 2006 to 53%.

MOST NOTEWORTHY: Home Depot (HD), Harley-Davidson, Inc (HOG), Walgreen Co (WAG), Teva Pharmaceutical (TEVA) were today's noteworthy upgrades:

• Goldman upgraded Home Depot (NYSE: HD) to Buy from Neutral to reflect management changes and an improved business mix and capital structure. They note this is a longer-term call given the ongoing impact from the sluggish housing market.

• Baird upgraded Harley-Davidson Inc (NYSE: HOG) to Outperform from Neutral on valuation.

• Matrix believes shares of Walgreen Co (NYSE: WAG) are undervalued as increasing sales of generic drugs continue to drive positive trends and upgraded shares to Strong Buy from Buy.

• Teva Pharmaceutical (NASDAQ: TEVA) was upgraded to Outperform from Peer Perform at Bear Stearns citing valuation and growth prospects.

OTHER UPGRADES:

• SAIA Inc (NASDAQ: SAIA) was upgraded to Equal Weight from Underweight at Stephens.

• France Telecom (NYSE: FTE) was upgraded to Neutral from Underperform at BNP Paribas.

• Raymond James raised Cognizant Technology Solutions Corp's (NASDAQ: CTSH) rating to Outperform from Sector Perform.

• Bernstein upgraded Satyam Computer (NYSE: SAY) to Outperform from Market Perform.

Analyst summaries provided by TheFlyOnTheWall.com (subscription required).

Harley-Davidson riders seldom choose their machine for its technical sophistication. The Harley's appeal is more intangible, comprised of words like freedom, strength, legacy, honesty; the essence of brand marketing. Or perhaps my point is better made in images:

Late last week a rumor began to circulate that Honda Motor Co. (NYSE: HMC) was pursuing a buyout of Harley-Davidson (NYSE: HOG). On the strength of the speculation, HOG stock jumped almost $3, closing the week at $62.55.

Honda has issued a strongly worded denial of such interest, and I believe it. Harley and Honda would be a bad fit for several reasons.

Culture: Harley's success is not mechanical, but cultural. The cachet surrounding the brand depends on its individuality, and the brand would not survive the subordination of it within a larger entity. Most Harley riders treasure the knowledge that the company is still American owned, at least in part, and among those in control are members of the original Davidson family such as Willie G.