With Harley-Davidson's (NYSE: HOG) first-quarter results now public, and the initial wave of knee-jerk, mainstream-press observations over, let's revisit what we were looking for in our Foolish Forecast on Tuesday:

  • Inventories: Did CEO Jim Ziemer deliver on his promise to work down Harley's bloated inventories of unsold bikes?
  • Gross margins: And if so, did Harley have to sacrifice profit margins in order to roll these bikes out the store front door?
  • Operating margins: And if Ziemer cut production at Harley's factories to allow the old inventory to drain through the system, what did this do to operating efficiency -- and operating margins?

Let's find out.

Brake lines cut
Uh-oh. Initial indications are not good. Looking at Harley's balance sheet, we can see that inventories grew more than 19% year over year in the first quarter. Sequential results were even more troubling -- inventories grew 26%. As production slowdowns go, this one can only be termed a miserable failure.

But not for lack of trying. You see, Ziemer did take some steps to work down inventory, and promised more to come. Combined, these suggest a concerted effort to reverse course on Harley's exploding inventories. Sales for the quarter grew 11% in comparison to Q1 2007 (slower than the inventory rise, so you see the problem).

But those sales included parts, accessories, and apparel with motorcycles. Focusing on the bikes per se, we find that Harley shipped 6% more of them this year than last, while revenues from motorcycle sales grew 14%. Translation: Harley sold a bunch more bikes than it built. That's a good first step.

Moreover, Ziemer expanded on his promise to ship "fewer Harley-Davidson motorcycles to our worldwide dealer network than we expect they will sell this year." Year over year, Harley plans to ship out 23,000 to 27,000 fewer bikes. Looks like Harley is finally getting serious about this, and not a quarter too soon.

Rollbacks? We don't need no stinkin' rollbacks
No two ways about it -- I got this call wrong. In Tuesday's Foolish Forecast, I mentioned that numerous Hog-Heads had written me to argue that Harley's bikes were immortal, did not go out of style, and would not require price cuts to sell. Early indications support their argument. Far from seeing gross margins crash as Harley took a hacksaw to prices, the company's gross margin increased 50 basis points, to 36.4%.

Riding lower
In contrast, I appear to have called the risk to operating margins more accurately. Given the increase in gross margin discussed above, you'd expect operating margins earned on production (i.e., not counting revenue and profits from financing sales) to rise in tandem if all were well at Harley.

Instead, they just held firm at 20%. Operating margins on production's failure to increase tells us that the gross margin gains were eaten up by higher operating costs.

What's more, it seems that GE and CarMax (NYSE: KMX) aren't the only unexpected casualties of the financial crisis; it bit Harley this quarter, too. The company suffered its most serious operating margin erosion not in its factories, but in its "banks." Operating profit at Harley's financial-services division fell 40% year over year; as a result, the whole of Harley (production and finance divisions combined) saw its operating margin decline 220 basis points, to 22.3%.

But still riding high
For those keeping score, Q1 therefore leaves Harley still riding higher in the profitability seat than nearly any rival for consumer "fun transportation" dollars: Honda (NYSE: HMC), Polaris (NYSE: PII), or Arctic Cat (Nasdaq: ACAT). And it goes without saying that, as long as Harley's margins stay in the double digits, it will remain a much more profitable operation than four-wheeled cousins Ford (NYSE: F) or General Motors (NYSE: GM).

Foolish takeaway
That's not to say that the road ahead will be smooth. Harley's already seeing potholes and putting its earnings guidance in reverse. Management predicts a 15% to 20% decline in profits this year, profits of about three bucks-and-change as it cuts shipments, works down inventory, shuts down production (temporarily), and lays off 370 union workers. But while the road ahead is rough, I think Harley's finally moving in the right direction.

What did we expect out of Harley last quarter, and what did we get? Find out:

Fool contributor Rich Smith does not own shares of any company named above. The Motley Fool has a disclosure policy. CarMax is an Inside Value selection.