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A Downshift for Harley-Davidson

The motorcycle maker will cut production and lay off workers as it deal with slowing U.S. sales

As it is gets ready to celebrate its 105th birthday, Harley-Davidson (HOG) is poised for a bumpy ride in the months ahead.

The Milwaukee-based outfit, which produces and sells the iconic Harley-Davidson motorcycles, said on Apr. 17 that it will reduce production for the year and cut its workforce, as the U.S. economy and business environment continue to be "challenging" , with "no signs when things will turn around", as CEO Jim Ziemer put it in an Apr. 17 conference call with analysts. The word "challenging" popped up frequently during the call.

Harley-Davidson now expects earnings to decline by 15% to 20% per share. Previously it was forecasting a modest growth of 4% to 7%.

Harley-Davidson reported first-quarter earnings of $187.6 million, or 79 cents per diluted share, compared with $192.3 million, or 74 cents, last year. Results for the prior-year quarter were pulled down by a strike at the company’s biggest plant that stopped production for a month.

Sales during the quarter rose 10.8% to $1.31 billion.

The slowing U.S. economy had a big impact. Company officials said the dismal performance was mainly driven by declining sales in the U.S. market and losses at its in-house consumer loan division.

"The majority of the retail slowdown is due to macroeconomic reasons" said Ziemer.

For Harley, the few bright spots remain in the international market.

While pinched U.S. consumers are not spending as much on Harley-Davidson's premium motorbikes, which can run $20,000 or more, customers in other countries revved up their spending. First-quarter international sales were up 18% from last year, as domestic sales plunged by 12.8%. Currently, about one quarter of Harley-Davidson's motorbikes are sold overseas, but the company official believe the proportion will grow.

The broader motorcycle market saw a decline of 14% in U.S. sales in the first three months of the year. The pain is expected to continue: Total motorcycle shipments this year will be cut by 23,000 to 27,000, the company said.

Losses from the company’s consumer financing subsidiary, have also hurt Harley-Davidson's bottom line. As credit-market turmoil continues and investor interest in securitized consumer loans shrinks, the company has to keep more loans on its books instead of selling them to investors. This has driven down the quarter's operating income at the finance unit by 40%.

Concerns surrounding the finance unit also point to the troubled division's ability to help consumers getting needed financing to purchase their coveted Harley-Davidson motorcycles, which could further hurt sales.

On the Apr. 17 conference call, Ziemer said "we will make a tough call for today based on what is good for the business in long term". The efforts include cutting short term production and shipment, maintaining inventory levels to keep the necessary supply and demand balance for a premium brand, and continued heavy investment in marketing and product development.

The company will cut unionized employees by 370 at its production units this year and lay off 360 non-production staffers, totaling about 10% of its workforce in North America.

The charges related to workforce reduction will be reported the second quarter this year, said company officials.

Standard & Poor’s Equity Research maintained its "sell" opinion on the shares. "We are cutting our '08 EPS estimates to $3.06 from $3.91, and reducing our 12-month target price to $32 from $37," wrote S&P analyst Erik Kolb in an Apr. 17 note. (S&P, like BusinessWeek, is a unit of the McGraw-Hill Cos.)

The willingness of Harley-Davidson's management to cut short-term production to preserve the brand’s integrity, growing international demand, and the company's "unlevered operating company balance sheet" and "strong cash generation" remain positive aspects, wrote Wachovia (WB) analyst Timothy Conder in an earlier note. (Wachovia Capital Markets provides investment banking services to Harley-Davidson.)

Harley-Davidson is reaching out to customer groups that traditionally are not its hardcore fans -- women, young people, and minorities. The heavier marketing indicates a "shift from a pull-driven to less-profitable push-driven customer acquisition model," said a research note by Credit Suisse (CS) analysts in February.

Consistent with the shift, Harley-Davidson's operating expense ratio has been on the rise and the trend is estimated to continue for the year despite lower sales expectation, the report by Credit Suisse noted. (Credit Suisse acts as a market maker or liquidity provider in Harley-Davidson's equity securities.)

Eva Woo is a reporter for .

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