MONACO COACH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The interim condensed consolidated financial statements have been prepared by Monaco Coach Corporation (the “Company”) without audit. In the opinion of management, the accompanying unaudited financial statements contain all adjustments necessary, consisting only of normal recurring adjustments, to present fairly the financial position of the Company as of December 30, 2006 and March 31, 2007, and the results of its operations and its cash flows for the quarters ended April 1, 2006 and March 31, 2007. The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, and all significant intercompany accounts and transactions have been eliminated in consolidation. The balance sheet data as of December 30, 2006 was derived from audited financial statements, but does not include all disclosures contained in the Company’s Annual Report to Stockholders on Form 10-K. These interim condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto appearing in the Company’s Annual Report to Stockholders on Form 10-K for the year ended December 30, 2006.
2. Inventories, Net
Inventories are stated at lower of cost (first-in, first-out) or market. The composition of inventory is as follows:
| | December 30, | | March 31, | |
| | 2006 | | 2007 | |
| | (in thousands) | |
| | | | | |
Raw materials | | $ | 84,069 | | $ | 87,377 | |
Work-in-process | | 55,473 | | 53,364 | |
Finished units | | 26,773 | | 23,859 | |
Raw material reserves | | (10,444 | ) | (10,655 | ) |
| | | | | |
| | $ | 155,871 | | $ | 153,945 | |
3. Joint Venture
On February 25, 2007, the Company closed a transaction with International Truck and Engine Corporation to form a joint venture to manufacture substantially all of the Company’s rear diesel chassis. The terms of the agreement grant the Company a 49% ownership in the joint venture, known as Custom Chassis Products, LLC (CCP). The investment is accounted for under the equity method. We contributed $4,060,000 of inventory, $246,000 of fixed assets, $140,000 of cash to CCP and incurred transaction costs of $226,000. Our portion of CCP’s net loss for the quarter ended March 31, 2007 was $278,000.
4. Line of Credit
The Company’s credit facilities consist of a revolving line of credit of up to $105.0 million. As of March 31, 2007, there is no balance outstanding on the revolving line of credit (the “Revolving Loan”). At the election of the Company, the Revolving Loan bears interest at varying rates that fluctuate based on the prime rate or LIBOR and are determined based on the Company’s leverage ratio. The Company also pays interest quarterly on the unused available portion of the Revolving Loan at varying rates, determined by the Company’s leverage ratio. The Revolving Loan is due and payable in full on November 17, 2009 and requires monthly interest payments. The agreement contains restrictive covenants as to the Company’s leverage ratio, current ratio, fixed charge coverage ratio, and tangible net worth. As of March 31, 2007, the Company was in compliance with these covenants. The Company also has two unused letters of credit totaling $3.0 million outstanding as of March 31, 2007.
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5. Long-Term Notes Payable
As of March 31, 2007, outstanding Term Debt under the credit facilities was $32.9 million. At the election of the Company, the Term Debt bears interest at varying rates that fluctuate based on the prime rate or LIBOR and are determined based on the Company’s leverage ratio. The Term Debt requires quarterly interest and principal payments of $1.4 million, with a final balloon payment of $12.9 million due on November 18, 2010. At March 31, 2007, the weighted-average interest rate on the Term Debt was 7.4%. The Term Debt is collateralized by all the assets of the Company. The agreement contains restrictive covenants as to the Company’s leverage ratio, current ratio, fixed charge coverage ratio, and tangible net worth. In January 2007, the Company amended its credit facility to modify certain restrictive covenants. As of March 31, 2007, the Company was in compliance with these covenants.
In November 2005, the Company obtained a term loan of $500,000 from the State of Oregon in connection with the relocation of jobs to the Coburg, Oregon production facilities from the Bend, Oregon facility. The principal and interest is due on April 30, 2009. The loan bears a 5% annual interest rate.
The following table displays the scheduled principal payments by fiscal year that will be due in thousands on the term loans.
| | Amount of | |
| | payment due | |
| | | |
2007 | | $ | 4,286 | |
2008 | | 5,714 | |
2009 | | 6,214 | |
2010 | | 17,143 | |
| | | |
| | $ | 33,357 | |
6. Income Taxes
The Company adopted FIN 48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FAS 109,” (the “Interpretation”) as of the beginning of fiscal year 2007. The Interpretation clarifies the accounting for uncertainty in income taxes recognized in accordance with FAS 109, “Accounting for Income Taxes,” by defining a criterion that an individual tax position must be met for any part of the benefit to be recognized in the financial statements.
As of the beginning of fiscal 2007, the Company’s total unrecognized tax benefits were $850,000 and all of these benefits, if recognized, would affect the Company’s effective tax rate. The Company also had accrued interest related to these unrecognized tax benefits of $55,000 as of the date of adoption. The interest expense associated with income tax contingencies is classified as income taxes in the Company’s financial statements. Penalties associated with income taxes are classified as selling, general, and administrative expenses. Within twelve months of the date of adoption, it is reasonably possible that the unrecognized tax benefits will decrease by $100,000 to $115,000 due to the expiration of federal and state statutes of limitations. The federal uncertainty relates to subjectivity in the measurement of certain deductions claimed for United States income tax purposes and the state uncertainty relates to state income tax apportionment matters.
As of the date of adoption, the Company’s income tax returns that remain subject to examination are tax years 2003 through 2006 for U.S. federal income tax and tax years 2002 through 2006 for major state income tax returns. There have been no material changes in the information above between the date of adoption and March 31, 2007.
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7. Earnings Per Common Share
Basic earnings per common share is based on the weighted-average number of shares outstanding during the period. Diluted earnings per common share is based on the weighted-average number of shares outstanding during the period, after consideration of the dilutive effect of outstanding stock-based awards. For the quarter ended March 31, 2007, there were 1,004,915 anti-dilutive stock-based awards excluded from the diluted earnings per share calculation (682,740 for the quarter ended April 1, 2006). The weighted-average number of common shares used in the computation of earnings per common share were as follows:
| | Quarter Ended | |
| | April 1, 2006 | | March 31, 2007 | |
| | | | | |
Basic | | | | | |
Issued and outstanding shares (weighted-average) | | 29,636,222 | | 29,829,697 | |
| | | | | |
Effect of Dilutive Securities | | | | | |
Stock-based awards | | 191,965 | | 575,974 | |
| | | | | |
Diluted | | 29,828,187 | | 30,405,671 | |
| | Quarter Ended | |
| | April 1, 2006 | | March 31, 2007 | |
| | | | | |
Cash dividends per common share | | $ | 0.06 | | $ | 0.06 | |
Cash dividends paid (in thousands) | | $ | 1,780 | | $ | 1,791 | |
8. Stock-Based Award Plans
The Company has an Employee Stock Purchase Plan (the “Purchase Plan”) - 1993, a non-employee 1993 Director Stock Plan (the “Director Plan”), and an amended and restated 1993 Stock Plan (the “Stock Plan”). The compensation expense recognized in the quarters ended April 1, 2006 and March 31, 2007 for the plans was $331,000 and $1.8 million, respectively. The amount of cash received in the quarters ended April 1, 2006 and March 31, 2007 from the exercise of stock options, stock issued under the Stock Purchase Plan, and stock issued in lieu of some directors’ cash retainer was $1.1 million and $927,000, respectively. The tax benefit realized from stock-based awards exercised or vested in the first quarter of 2006 and 2007 was zero and $136,000, respectively.
Restricted Stock Unit Grant
A component of the Stock Plan permits the Company to grant shares of restricted stock units (RSU’s). These grants are compensation expense under the rules of FAS 123R, and are required to be recognized in the Company’s consolidated statements of income. The valuation of the RSU’s is based on the closing market price of the Common Stock on the date of grant. The RSU’s vest ratably over four years or cliff vest at four years for employees and cliff vest at three years for directors. RSU’s outstanding to participants who meet the retirement eligible provision vest upon actual retirement or the normal vesting period, whichever is earlier. Under Section 162(m) of the Internal Revenue Code of 1986, as amended, RSU’s granted to certain employees require performance criteria to be met in order for the units to cliff vest at three years. The performance criteria is based on the return on equity. As of March 31, 2007, there are 132,686 RSU’s outstanding that require the attainment of the performance criteria.
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The compensation expense recognized for RSU’s in the first quarter of 2006 and 2007 was $260,000 and $989,000, respectively. A forfeiture rate is applied to the majority of the RSU participants based on the historical forfeiture experience with stock options. The total remaining expense to be recognized in future periods for outstanding non-vested RSU’s is approximately $4.4 million. The expense is expected to be recognized over a weighted-average period of 3.2 years.
Restricted stock unit transactions under the Stock Plan are summarized with the weighted-average grant-date fair value as follows:
| | | | Weighted- | |
| | | | Average | |
| | Restricted | | Grant-Date | |
| | Stock Units | | Fair Value | |
| | | | | |
Non-vested at December 31, 2005 | | 53,250 | | $ | 14.73 | |
Granted | | 254,159 | | 12.71 | |
Forfeited | | (27,500 | ) | 14.67 | |
Non-vested at December 30, 2006 | | 279,909 | | 12.90 | |
Granted | | 198,049 | | 16.75 | |
Vested | | (38,219 | ) | 12.95 | |
Forfeited | | (2,500 | ) | 12.95 | |
| | | | | |
Non-vested at March 31, 2007 | | 437,239 | | $ | 14.64 | |
Performance Share Awards
A component of the Stock Plan also permits the Company to grant performance share awards (PSA’s). During the first quarter of 2007, the Company granted 138,714 shares under a three-year performance plan. The plan requires the achievement of performance based on Return on Net Assets-adjusted (RONA) and Total Shareholder Return (TSR) compared to a group of peer companies. Depending on the ranking of the Company’s performance against the peer group, the participants could earn from 0% up to 200% of the target payout of performance shares. A participant who retires during a performance period and meets the retirement eligible provision is entitled to receive 100% of the award that would have otherwise been earned had the participant remained employed through the end of the performance period. The award to such a participant will be settled at the end of the normal performance period. Grants are currently outstanding under a two-year performance period and two three-year performance periods.
The fair value of share awards requiring achievement of the goal based on TSR is estimated on the date of grant using a lattice-based valuation model. The assumptions used in the model to value the awards granted in the first quarter of 2007 are noted in the following table. Because lattice-based option valuation models incorporate ranges of assumptions for inputs, those ranges are disclosed. Expected volatilities were based on historical volatility of the Company’s stock and the average of the competitor companies’ stock, as well as other factors. The Company used historical data to estimate employee termination within the valuation model. The expected term of awards granted was derived from the output of the option valuation model and represents the period of time that awards granted are expected to be outstanding. The risk-free interest rate is based on interest rates on total constant maturity U.S. Treasury notes with lives consistent with the expected lives of the related award. The grant-date fair value of the TSR related awards granted in the first quarter of 2007 is $22.25 per award.
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| | Quarter Ended | |
| | March 31, 2007 | |
| | | |
Risk-free interest rate | | 4.50 | % |
Expected life (in years) | | 2 to 3 | |
Expected volatility of the Company | | 38.60 | % |
Expected dividend yield | | 1.40 | % |
Peer companies’ average volatility experience | | 33.10 | % |
The fair value of the share awards requiring achievement of the goal based on RONA is the Common Stock market price at grant date, which was $16.75 for the awards granted in the first quarter of 2007. The recognition of compensation expense is initially based on the probable outcome of the performance condition and adjusted for subsequent changes in the estimated or actual outcome. The Company reassesses at each reporting date whether achievement of the performance condition is probable. The assessment involves comparing the Company’s forecasted RONA for the performance period to the historical RONA achieved by a group of peer companies.
The TSR goal is based on the market price of the Company’s Common Stock as compared to the peer group. This is considered a market condition under FAS 123R, thus compensation expense recognized is not reversed if the goal is not achieved by the end of the performance period. The compensation expense related to share awards that are forfeited is reversed. If the performance goal related to RONA is not met, no compensation expense is recognized and any recognized compensation expense is reversed as of the end of the plan period. A total of $754,000 of compensation expense was recorded during the quarter ended March 31, 2007 relating to the performance share awards. As of March 31, 2007, it was not probable that the RONA goal would be met at the end of the performance periods for the awards granted in 2006 and thus no compensation expense has been recognized. As of March 31, 2007, the expected payout related to the 2007 RONA grants was 25% of the target payout, thus expense of $95,000 was recognized in the first quarter of 2007. The total remaining expense expected to be recognized in future periods for outstanding PSA’s is approximately $2.0 million. The expense is expected to be recognized over a weighted-average period of 2.2 years. The total number of PSA’s non-vested as of March 31, 2007 was 468,532 shares at target payout. The weighted-average grant-date fair value of these shares is $14.23.
9. Segment Reporting
The Company is a leading manufacturer of premium Class A, B and C motor coaches (Motorized Recreational Vehicle Segment) and towable recreational vehicles (Towable Recreational Vehicle Segment). Our product line currently consists of a broad line of motor coaches, fifth wheel trailers, travel trailers, and specialty trailers under the “Monaco,” “Holiday Rambler,” “Beaver,” “Safari,” “McKenzie,” “R-Vision,” “Bison,” and “Roadmaster” brand names.
In addition to the manufacturing of premium recreational vehicles, the Company owns and operates two motorhome resort properties (Motorhome Resort Segment) located in Las Vegas, Nevada, and Indio, California. The Company has also acquired property in southern California, and subsequent to the end of quarter we closed on property in Naples, Florida. These properties are planned to be developed and sold over the next three to five years. The resorts offer sales of individual lots to motor coach owners and also offer a common interest in the amenities at the resort. The resorts provide destination locations for premium Class A motor coach owners and help to promote the recreational vehicle lifestyle.
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The following table provides the results of operations of the three segments of the Company for the quarters ended April 1, 2006 and March 31, 2007, respectively. All dollars represented are in thousands.
| | Quarter Ended | |
| | April 1, 2006 | | March 31, 2007 | |
| | | | | |
Motorized Recreational Vehicle Segment | | | | | |
| | | | | |
Net sales | | $ | 254,954 | | $ | 245,548 | |
Cost of sales | | 230,001 | | 219,061 | |
Gross profit | | 24,953 | | 26,487 | |
| | | | | |
Selling, general, and administrative expenses and corporate overhead | | 20,133 | | 23,155 | |
| | | | | |
Operating income | | $ | 4,820 | | $ | 3,332 | |
| | | | | |
Towable Recreational Vehicle Segment | | | | | |
| | | | | |
Net sales | | $ | 114,413 | | $ | 69,480 | |
Cost of sales | | 100,133 | | 64,753 | |
Gross profit | | 14,280 | | 4,727 | |
| | | | | |
Selling, general, and administrative expenses and corporate overhead | | 9,408 | | 6,372 | |
| | | | | |
Operating income (loss) | | $ | 4,872 | | $ | (1,645 | ) |
| | | | | |
Motorhome Resorts Segment | | | | | |
| | | | | |
Net sales | | $ | 15,701 | | $ | 7,216 | |
Cost of sales | | 6,485 | | 2,434 | |
Gross profit | | 9,216 | | 4,782 | |
| | | | | |
Selling, general, and administrative expenses and corporate overhead | | 4,438 | | 2,831 | |
| | | | | |
Operating income | | $ | 4,778 | | $ | 1,951 | |
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| | Quarter Ended | |
| | April 1, 2006 | | March 31, 2007 | |
| | (in thousands) | |
| | | | | |
Reconciliation to Net Income | | | | | |
| | | | | |
Operating income (loss): | | | | | |
Motorized recreational vehicle segment | | $ | 4,820 | | $ | 3,332 | |
Towable recreational vehicle segment | | 4,872 | | (1,645 | ) |
Motorhome resorts segment | | 4,778 | | 1,951 | |
Total operating income | | 14,470 | | 3,638 | |
| | | | | |
Other income, net | | 132 | | 113 | |
Interest expense | | (1,252 | ) | (967 | ) |
Loss from investment in joint venture | | 0 | | (278 | ) |
Income before income taxes | | 13,350 | | 2,506 | |
| | | | | |
Provision for income taxes | | 5,057 | | 1,007 | |
| | | | | |
Net income | | $ | 8,293 | | $ | 1,499 | |
10. Commitments and Contingencies
Repurchase Agreements
Many of the Company’s sales to independent dealers are made on a “floor plan” basis by a bank or finance company which lends the dealer all or substantially all of the wholesale purchase price and retains a security interest in the vehicles. Upon request of a lending institution financing a dealer’s purchases of the Company’s product, the Company will execute a repurchase agreement. These agreements provide that, for up to 18 months after a unit is shipped, the Company will repurchase a dealer’s inventory in the event of a default by a dealer to its lender.
The Company’s liability under repurchase agreements is limited to the unpaid balance owed to the lending institution by reason of its extending credit to the dealer to purchase its vehicles, reduced by the resale value of vehicles which may be repurchased. The risk of loss is spread over numerous dealers and financial institutions.
The approximate amount subject to contingent repurchase obligations arising from these agreements at March 31, 2007 is $576.8 million, with approximately 5.5% concentrated with one dealer. If the Company were obligated to repurchase a significant number of units under any repurchase agreement, its business, operating results, and financial condition could be adversely affected. The Company has included the disclosure requirements of FASB Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” in its financial statements, and has determined that the recognition provisions of FIN 45 apply to certain guarantees routinely made by the Company, including contingent repurchase obligations to third party lenders for inventory financing of dealer inventories. The Company has recorded a liability of approximately $362,000 for potential losses resulting from guarantees on repurchase obligations for products shipped to dealers. This estimated liability is based on the Company’s experience of losses associated with the repurchase and resale of units in prior years.
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Product Liability
The Company is subject to regulations which may require the Company to recall products with design or safety defects, and such recall could have a material adverse effect on the Company’s business, results of operations, and financial condition.
The Company has from time to time been subject to product liability claims. To date, the Company has been successful in obtaining product liability insurance on terms the Company considers acceptable. The terms of the policy contain a self-insured retention amount of $500,000 per occurrence, with a maximum annual aggregate self-insured retention of $3.0 million. Overall product liability insurance, including umbrella coverage, is available to a maximum amount of $100.0 million for each occurrence, as well as in the aggregate. There can be no assurance that the Company will be able to obtain insurance coverage in the future at acceptable levels or that the cost of insurance will be reasonable. Furthermore, successful assertion against the Company of one or a series of large uninsured claims, or of one or a series of claims exceeding any insurance coverage, could have a material adverse effect on the Company’s business, results of operations, and financial condition. The following table discloses significant changes in the product liability:
| | Quarter Ended | |
| | April 1, 2006 | | March 31, 2007 | |
| | (in thousands) | |
| | | | | |
Beginning balance | | $ | 19,275 | | $ | 15,764 | |
Expense | | 2,318 | | 3,911 | |
Payments | | (2,953 | ) | (3,166 | ) |
Adjustments | | 73 | | 0 | |
| | | | | |
Ending balance | | $ | 18,713 | | $ | 16,509 | |
Product Warranty
Estimated warranty costs are provided for at the time of sale of products with warranties covering the products for up to one year from the date of retail sale (five years for the front and sidewall frame structure, and three years on the Roadmaster chassis). These estimates are based on historical average repair costs, as well as other reasonable assumptions deemed appropriate by management. The following table discloses significant changes in the product warranty reserve:
| | Quarter Ended | |
| | April 1, 2006 | | March 31, 2007 | |
| | (in thousands) | |
| | | | | |
Beginning balance | | $ | 32,902 | | $ | 33,804 | |
Expense | | 10,721 | | 9,883 | |
Payments | | (9,758 | ) | (9,140 | ) |
| | | | | |
Ending balance | | $ | 33,865 | | $ | 34,547 | |
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Litigation
The Company is involved in various legal proceedings which are incidental to the industry and for which certain matters are covered in whole or in part by insurance or, for those matters not covered by insurance, the Company has recorded accruals for estimated settlements. Management believes that any liability which may result from these proceedings will not have a material adverse effect on the Company’s consolidated financial statements.
11. Subsequent Events
Purchase of Land for Development
On April 20, 2007, the Company acquired land near Naples, Florida for $8.0 million. The 80 acre parcel will be developed into a motorhome resort with approximately 198 lots available for sale beginning in 2008.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements include, but are not limited to, those in this report that have been marked with an asterisk (*). In addition, statements containing words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “seeks,” and variations of such words and similar expressions are intended to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to differ materially from those expressed or implied by such forward-looking statements, including those set forth below in Part II, Item 1A under the caption “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. The reader should carefully consider, together with the other matters referred to herein, the factors set forth in Part II, Item 1A under the caption “Risk Factors,” as well as in other documents we file with the Securities and Exchange Commission. We caution the reader, however, that these factors may not be exhaustive.
GENERAL
OVERVIEW
Background
Monaco Coach Corporation (the “Company”) is a leading manufacturer of premium recreational vehicles including Class A, B, and C motor coaches, as well as towable recreational vehicles. The Company also develops and sells luxury motorcoach resort facilities. These three operations, while closely tied into the recreational lifestyle, are segmented for reporting purposes as the Motorized Recreational Vehicle (MRV) segment, the Towable Recreational Vehicle (TRV) segment, and the Motorhome Resort (MR) segment.
Motorized and Towable Recreational Vehicle Segment Products
Our products range in suggested retail price from $45,000 to $700,000 for motor coaches and from $11,000 to $80,000 for towables. Based upon retail registrations in 2006, we believe we had a 23.8% share of the market for diesel Class A motor coaches, a 7.7% share of the market for gas Class A motor coaches, a 16.0% share of the market for all Class A motor coaches, a 2.6% share of the market for all Class B and C motor coaches, a 4.2% share of the market for fifth wheel towables and a 4.6% share of the market for travel trailers.
Motorhome Resort Segment
In addition to the manufacturing of premium recreational vehicles, the Company also owns and operates two motorhome resort properties (the “Resorts”), located in Las Vegas, Nevada, and Indio, California. In addition, the Company has acquired land to develop properties in La Quinta, California, and in Naples, Florida. The Resorts offer sales of individual lots to owners, and also offer common interests in the amenities at the resort. Lot prices at the two resorts range from $79,900 to $339,900. Amenities at the Resorts include: club house facilities, tennis, swimming, and golf. The Resorts provide destination locations for premium Class A motor coach owners, and help to promote the recreational lifestyle.
Business Changes
We have conducted a series of acquisitions during our history. Beginning in March 1993, we commenced operations by acquiring substantially all of the assets and liabilities of a predecessor company that had been formed in 1968. In March 1996, we acquired the Holiday Rambler Division of Harley-Davidson, Inc., a manufacturer of a full line of Class A motor coaches and towables. In August 2001, we acquired SMC Corporation, manufacturer of the Beaver and Safari brand Class A motorhomes. In November 2002, we acquired from Outdoor Resorts of America (“ORA”) three luxury motorcoach resort properties being developed by ORA in Las Vegas, Nevada, Indio, California, and Naples, Florida. In September 2003, we sold the property in Naples, Florida. In November of 2005, we acquired R-Vision, Inc., R-Vision Motorized, LLC, Bison Manufacturing, LLC, and Roadmaster LLC, (collectively referred to as “R-Vision”), manufacturers of R-Vision, Bison, and Roadmaster motorized and towable products. The R-Vision acquisition was accounted for using the purchase method of accounting, through a cash offer on November 18, 2005. All operations of R-Vision have been incorporated for the quarters ended April 1, 2006 and March 31, 2007 in the consolidated quarterly financial statements of the Company included with this Quarterly Report on Form 10-Q.
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During the third quarter of 2005, the Company announced the closure of its Royale Coach operations in Elkhart, Indiana. Royale Coach produced Prevost bus conversion motor coaches with price points in excess of $1.4 million. Royale Coach sold approximately 20 coaches per year and was not a significant portion of the Company’s overall business. As of the end of 2006, the Company had sold all remaining assets of Royale Coach.
During the first quarter of 2007 we completed the formation of a joint venture with International Truck and Engine Corporation (ITEC) for the purpose of manufacturing rear diesel chassis. This joint venture, known as Custom Chassis Products LLC (CCP), will enable us to take advantage of purchasing synergies, access engineering and design expertise from ITEC, and improve the utilization of our Roadmaster chassis manufacturing facility in Elkhart, Indiana. Our ownership interest is 49%, and we are accounting for the activity of this operation using the equity method of accounting.
RESULTS OF CONSOLIDATED OPERATIONS
Quarter ended March 31, 2007 Compared to Quarter ended April 1, 2006
The following table illustrates the results of consolidated operations for the quarters ended April 1, 2006 and March 31, 2007. All dollar amounts are in thousands.
| | Quarter Ended | | % | | Quarter Ended | | % | | $ | | % | |
| | April 1, 2006 | | of Sales | | March 31, 2007 | | of Sales | | Change | | Change | |
Net sales | | $ | 385,068 | | 100.0 | % | $ | 322,244 | | 100.0 | % | $ | (62,824 | ) | (16.3 | )% |
Cost of sales | | 336,619 | | 87.4 | % | 286,248 | | 88.8 | % | 50,371 | | 15.0 | % |
Gross profit | | 48,449 | | 12.6 | % | 35,996 | | 11.2 | % | (12,453 | ) | (25.7 | )% |
Selling, general, and administrative expenses | | 33,979 | | 8.8 | % | 32,358 | | 10.0 | % | 1,621 | | 4.8 | % |
| | | | | | | | | | | | | |
Operating income | | $ | 14,470 | | 3.8 | % | $ | 3,638 | | 1.2 | % | $ | (10,832 | ) | (74.9 | )% |
Motorized and Towable Recreational Vehicle Segments
The recreational vehicle (“RV”) market in the first quarter of 2007 is continuing to show little signs of returning to more historical levels. Higher fuel prices, rising interest rates, and uncertainty related to international events have impacted consumer confidence and continue to create challenges for the RV market. Even though retail sales by our independent dealers on a year over year basis have shown some improvement, the overall contraction in the RV market continues to put pressure on our business. We believe that this trend will likely continue through most of 2007.* However, we believe the long-term potential of the RV market is still rooted in solid demographics. This is most readily evidenced by the so-called “ baby boomer” generation, which as it ages will continue to expand our target market well into 2015 and should provide a consumer base that is enthusiastic to embrace the RV lifestyle.
The motorized market has been significantly impacted by the current market conditions. Higher interest rates are placing pressures on our dealers. Floorplan interest charges are a significant cost of carrying inventory, and as interest rates rise, our dealers, whom we share with our competitors, are more cautious in the amount of inventory that they are willing to carry. Consequently, we have been very diligent in monitoring the wholesale versus retail shipments of our products. This has enabled us to manage our finished goods inventories levels without the use of extensive wholesale discounting. While our gross margins have improved due to the reduced levels of discounting and improvements in our plant efficiencies, they are still not at optimal levels due to the lower run rates within our production facilities. Despite the current cyclical downturn in the motorized market, we continue to remain optimistic on the prospects for long-term growth in this sector, as the demographics for our customer base show a continuing increase in the number of new entrants into our target age and economic group.*
The towable market has slowed considerably. The first quarter 2007 retail sales for the industry finished down by 12.6% of the volume of the same period in 2006. FEMA shipments weren’t retail registered. However, certain price points in the low to mid-priced products are performing better than the higher-end products. We have been working on developing new floorplans, and new lightweight and inexpensive models to compete in this market sector. We believe that these new offerings, which will be available in the second quarter of 2007, will enable us to compete very well in these more challenging market conditions. * Even though the towable market is currently soft, we remain confident that indicators such as the demographics for our customer base remain positive and that the market will remain viable well into the future.*
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The recreational vehicle industry is extremely competitive, and retail customers have many choices available to them. To distinguish ourselves within the industry, we introduced our Franchise For The Future (FFTF) program in June of 2005. This program is designed to introduce the concept to our dealer partners that our specific brands have intrinsic values as a selling tool. To support this, and to encourage our dealers to participate in FFTF, we have worked with outside marketing consultants to develop brand signage, informational computer kiosks, and brand specific displays that are placed within our various independent dealer locations. In 2006, we followed this up with Monaco Financial Services (MFS). MFS is a branded financing program from General Electric Commercial Distribution Finance (GECDF) and General Electric Consumer Finance (GECF). Through MFS, our dealer partners earn rebates from GECDF and GECF for wholesale floorplanning, and retail financing for customers. We believe that these concepts, along with other features designed to encourage our dealers to focus selling efforts on our various product offerings, will assist them in their sales efforts through the strength of improved brand identity. *
Motorhome Resort Segment
In the first quarter, our motorhome resort properties experienced challenges in Las Vegas and Indio related to weather conditions, as well as construction access restrictions in Las Vegas. Even though this caused a reduction in the number of potential new owners visiting our resort, we were successful in maintaining a profitable quarter. Normal access to the Las Vegas resort was restored near the end of the first quarter and we have seen improved sales since then. We remain confident that these resort properties will continue to sell through their respective remaining available inventories of lots by the end of 2007.* To ensure the continued growth of this segment, we have acquired property in southern California, and subsequent to the end of the quarter we closed on property in Naples, Florida. We will begin construction on these two resorts in the second and third quarters of 2007, and expect to have lots available for sale in the first quarter of 2008.*
Overall Company Performance in the First Quarter of 2007
First quarter net sales decreased 16.3% to $322.2 million compared to $385.1 million for the same period last year. Sales decreases were the results of continued weakness in the RV segments, and slower seasonal results from our recreational resort properties. Gross diesel motorized sales were down 0.5%, gas motorized sales were down 35.7%, and towables were down 35.1%. Diesel products accounted for 68.9% of our first quarter revenues while gas products were 7.4%, and towables were 23.7%. Our overall unit sales were down 34.9% in the first quarter of 2007 to 5,749 units, with diesel motorized unit sales down 2.7% to 1,112 units, gas motorized unit sales down 26.3% to 348 units, and towable unit sales down 40.6% to 4,289 units. Towable unit sales decreases were due primarily to the inclusion in the first quarter of 2006 of FEMA related travel trailers that were ordered for hurricane Katrina victims. In 2007 there was no hurricane related FEMA order placement. Excluding FEMA related activity, unit sales for towable products declined from 5,198 units in the first quarter of 2006 to 4,289 units in the first quarter of 2007. Our total average unit selling price increased to $55,800 from $42,600 in the same period last year, reflecting a shift in the mix of products sold.
Gross profit for the first quarter of 2007 decreased to $36.0 million, down from $48.4 million in the first quarter of 2006, and gross margin decreased from 12.6% in the first quarter of 2006 to 11.2% in the first quarter of 2007. Changes in the components of cost of sales are set forth in the following table (dollars in thousands):
| | Quarter Ended | | % | | Quarter Ended | | % | | Change in | |
| | April 1, 2006 | | of Sales | | March 31, 2007 | | of Sales | | % of Sales | |
Direct materials | | $ | 232,095 | | 60.3 | % | $ | 196,944 | | 61.1 | % | 0.8 | % |
Direct labor | | 38,386 | | 10.0 | % | 32,041 | | 9.9 | % | (0.1 | )% |
Warranty | | 10,722 | | 2.8 | % | 9,883 | | 3.1 | % | 0.3 | % |
Other direct | | 23,295 | | 6.0 | % | 16,900 | | 5.2 | % | (0.8 | )% |
Indirect | | 32,121 | | 8.3 | % | 30,480 | | 9.5 | % | 1.2 | % |
| | | | | | | | | | | |
Total cost of sales | | $ | 336,619 | | 87.4 | % | $ | 286,248 | | 88.8 | % | 1.4 | % |
· Direct material increases in 2007, as a percent of sales, were 0.8% or $2.6 million. This increase was a result of the changes in the mix of products sold. In 2006 versus 2007 there was a substantial amount of sales to FEMA for travel trailers. These units had a lower direct material cost. The remaining portion of the overall total dollar decrease in direct materials of $35.1 million was related to sales volume decreases.
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· Direct labor decreases in 2007, as a percent of sales, were $322,000. This decrease was the result of improvements in our plants as we realigned production facilities and consolidated component facilities to meet demand. The remaining portion of the overall total dollar decrease of $6.3 million in direct labor was the result of sales volume decreases.
· Increases in warranty expense in 2007, as a percent of sales, were $967,000. These increases were the result of higher warranty costs associated with some of our current model year motorized products. The remaining portion of the overall total dollar decrease in warranty costs of $839,000 was the result of sales volume decreases.
· Decreases in other direct costs in 2007, as a percent of sales, were $2.6 million. This decrease was primarily the result of improvements in costs associated with workers’ compensation expense . The remaining portion of the overall total dollar decrease in other direct costs of $6.4 million was the result of sales volume decreases.
· Increases in indirect costs in 2007, as a percent of sales, were $3.9 million. These increases were the result of running at our plants at lower efficiency due to the reduced volume of sales in 2007 versus 2006. The overall total dollar decrease of $1.6 million was the result of sales volume decreases.
Selling, general, and administrative expenses (S,G,&A) decreased by $1.6 million in the first quarter of 2007 to $32.4 million compared to the first quarter of 2006 and increased as a percentage of sales from 8.8% in the first quarter of 2006 to 10.0% in the first quarter of 2007. Changes in S,G,&A expenses are set forth in the following table (dollars in thousands):
| | Quarter Ended | | % | | Quarter Ended | | % | | Change in | |
| | April 1, 2006 | | of Sales | | March 31, 2007 | | of Sales | | % of Sales | |
Salaries, bonus, and benefit expenses | | $ | 9,581 | | 2.5 | % | $ | 7,897 | | 2.4 | % | (0.1 | )% |
Selling expenses | | 10,987 | | 2.8 | % | 9,846 | | 3.1 | % | 0.3 | % |
Settlement expense | | 2,318 | | 0.6 | % | 3,911 | | 1.2 | % | 0.6 | % |
Marketing expenses | | 1,876 | | 0.5 | % | 1,667 | | 0.5 | % | 0.0 | % |
Other | | 9,217 | | 2.4 | % | 9,037 | | 2.8 | % | 0.4 | % |
| | | | | | | | | | | |
Total S,G,&A expenses | | $ | 33,979 | | 8.8 | % | $ | 32,358 | | 10.0 | % | 1.2 | % |
· Decreases in salaries, bonus and benefit expenses in 2007 were $1.7 million. This decrease was due to a reduction in management bonus expense of $3.2 million that was offset by an increase in the expenses associated with long-term incentive stock-based programs.
· Decreases in selling expenses in 2007 were $1.1 million. This decrease was due to lower costs for selling programs at our resort properties of $500,000, lower sales commissions of $237,000, and lower costs of $207,000 related to employee benefits. The remaining difference was comprised of various other related selling expenses.
· Settlement expense (litigation settlement expense) in 2007 increased by $1.6 million. The total dollar increase was the result of increases in the number of litigation cases in 2007 versus 2006 as well as for the increases in the amounts reserved for certain pending litigation.
· Decreases in marketing expenses in 2007 were $209,000. These reductions were the result of savings due to lower expenses associated with shows and rallies.
· Decreases in other expenses in 2007 were $180,000.
Operating income was $3.6 million, or 1.2% of sales, in the first quarter of 2007 compared to $14.5 million, or 3.8% of sales, in the similar 2006 period. The decrease in operating income was due predominantly to decreased sales.
Net interest expense was $967,000 in the first quarter of 2007 versus $1.3 million in the comparable 2006 period, reflecting lower corporate borrowing during the first quarter of 2007.
We reported a provision for income taxes of $1.0 million in the first quarter of 2007, compared to $5.1 million in the first quarter of 2006, or an effective tax rate of 40.2% in the first quarter of 2007, compared to 37.9% for the comparable 2006 period. The income tax provision in the first quarter of 2006 included a one-time benefit of $336,000 attributable to the enactment of certain state laws that reduced the Company’s deferred tax liabilities. The absence of this benefit in the first quarter of 2007 is the primary reason for the increase in the effective tax rate.
Net income for the first quarter of 2007 was $1.5 million compared to $8.3 million for the first quarter of 2006 due primarily to lower sales and gross margin.
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First Quarter 2007 versus First Quarter 2006 for the Motorized Recreational Vehicle Segment
The following table illustrates the results of the MRV segment for the quarters ended April 1, 2006, and March 31, 2007 (dollars in thousands):
| | Quarter Ended | | % | | Quarter Ended | | % | | $ | | % | |
| | April 1, 2006 | | of Sales | | March 31, 2007 | | of Sales | | Change | | Change | |
Net sales | | $ | 254,954 | | 100.0 | % | $ | 245,548 | | 100.0 | % | $ | (9,406 | ) | (3.7 | )% |
Cost of sales | | 230,001 | | 90.2 | % | 219,061 | | 89.2 | % | 10,940 | | 4.8 | % |
Gross profit | | 24,953 | | 9.8 | % | 26,487 | | 10.8 | % | 1,534 | | 6.1 | % |
Selling, general, and administrative expenses & corporate overhead | | 20,133 | | 7.9 | % | 23,155 | | 9.4 | % | (3,022 | ) | (15.0 | )% |
| | | | | | | | | | | | | |
Operating income | | $ | 4,820 | | 1.9 | % | $ | 3,332 | | 1.4 | % | $ | (1,488 | ) | (30.9 | )% |
Total net sales for the MRV segment were down from $255.0 million in the first quarter of 2006 to $245.5 million in the first quarter of 2007. Gross diesel motorized revenues were down 0.5% and gas motorized revenues were down 35.7%. Diesel products accounted for 90.4% of the MRV segment’s first quarter of 2007 gross revenues while gas products were 9.6%. The overall decrease in revenues reflected continuing challenges in the marketplace as dealers sought to lower their current inventories because of softened retail demand and higher interest costs associated with their floorplan borrowings. Our MRV segment unit sales were down 9.6% year over year from 1,615 units in the first quarter of 2006 to 1,460 units in the first quarter of 2007. Diesel motorized unit sales were down 2.7% to 1,112 units and gas motorized unit sales were down 26.3% to 348 units.
Gross profit for the MRV segment for the first quarter of 2007 increased to $26.5 million, up from $25.0 million in the first quarter of 2006, and gross margin increased from 9.8% in the first quarter of 2006 to 10.8% in the first quarter of 2007. Changes in the components of cost of sales are set forth in the following table (dollars in thousands):
| | Quarter Ended | | % | | Quarter Ended | | % | | Change in | |
| | April 1, 2006 | | of Sales | | March 31, 2007 | | of Sales | | % of Sales | |
Direct materials | | $ | 157,272 | | 61.7 | % | $ | 150,726 | | 61.4 | % | (0.3 | )% |
Direct labor | | 25,536 | | 10.0 | % | 24,138 | | 9.8 | % | (0.2 | )% |
Warranty | | 7,568 | | 3.0 | % | 7,573 | | 3.1 | % | 0.1 | % |
Other direct | | 13,454 | | 5.3 | % | 10,998 | | 4.5 | % | (0.8 | )% |
Indirect | | 26,171 | | 10.2 | % | 25,626 | | 10.4 | % | 0.2 | % |
| | | | | | | | | | | |
Total cost of sales | | $ | 230,001 | | 90.2 | % | $ | 219,061 | | 89.2 | % | (1.0 | )% |
· Direct material decreases in 2007, as a percent of sales, were 0.3% or $737,000. This decrease was due to changes in the mix of products produced in 2007 versus 2006. The remaining portion of the overall decrease in total dollars associated with direct materials of $6.5 million was due to lower sales volumes in 2007 as compared to 2006.
· Direct labor decreases in 2007, as a percent of sales, were 0.2% or $491,000. This decrease was the result of improvements in our plants as we realigned production facilities and consolidated component facilities to meet demand. The remaining portion of the overall decrease in total dollars associated with direct labor of $1.4 million was due to lower sales volumes in 2007 as compared to 2006.
· Increases in warranty costs in 2007, as a percent of sales, were 0.1% or $246,000. These increases were the result of some fit and finish issues. The remaining impact to warranty expense is a result of lower sales volumes in 2007 as compared to 2006.
· Decreases in other direct costs in 2007, as a percent of sales, were 0.8% or $2.0 million. This decrease was due to improvements in workers’ compensation expense, and a reduction in the amount of out-of-warranty policy rework performed. The remaining portion of the overall decrease in total dollars associated with other direct costs of $2.5 million was due to lower sales volumes in 2007 as compared to 2006.
· Increases in indirect costs in 2007, as a percent of sales, were 0.2% or $491,000. The increase in indirect costs is related to lower absorption of these costs in our plants as we ran lower production rates in 2007 versus 2006. The overall decrease in total dollars associated with indirect costs of $545,000 was due to lower sales volumes in 2007 as compared to 2006.
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S,G,&A expenses for the MRV segment increased as a percent of sales due to lower sales levels and increases in selling expenses. In addition, in the fourth quarter of 2006 we completed a study on the allocation of corporate overhead, and allocated certain costs on an activity basis. These costs are now classified in a single line item for S,G,&A expense and corporate overhead allocation. Corporate overhead allocation is comprised of certain shared services such as executive, financial, information systems, legal, and investor relations expenses.
Operating income decreased as both a percent of sales and in total dollars due to sales and higher gross margins that were offset by increases in S,G,&A expenses as a percent of sales.
First Quarter 2007 versus First Quarter 2006 for the Towable Recreational Vehicle Segment
The following table illustrates the results of the TRV Segment for the quarters ended April 1, 2006, and March 31, 2007 (dollars in thousands):
| | Quarter Ended | | % | | Quarter Ended | | % | | $ | | % | |
| | April 1, 2006 | | of Sales | | March 31, 2007 | | of Sales | | Change | | Change | |
Net sales | | $ | 114,413 | | 100.0 | % | $ | 69,480 | | 100.0 | % | $ | (44,933 | ) | (39.3 | )% |
Cost of sales | | 100,133 | | 87.5 | % | 64,753 | | 93.2 | % | 35,380 | | 35.3 | % |
Gross profit | | 14,280 | | 12.5 | % | 4,727 | | 6.8 | % | (9,553 | ) | (66.9 | )% |
Selling, general, and administrative expenses & corporate overhead | | 9,408 | | 8.2 | % | 6,372 | | 9.2 | % | 3,036 | | 32.3 | % |
| | | | | | | | | | | | | |
Operating income (loss) | | $ | 4,872 | | 4.3 | % | $ | (1,645 | ) | (2.4 | )% | $ | (6,517 | ) | (133.8 | )% |
Total net sales for the TRV segment were down from $114.4 million in the first quarter of 2006 to $69.5 million in the first quarter of 2007. The decrease in revenues was due primarily to the inclusion in the first quarter of 2006 of FEMA related travel trailers that were ordered for hurricane Katrina victims. In 2007 there was no hurricane related FEMA order placement. Excluding FEMA related activity, unit sales for towable products declined from 5,198 units in the first quarter of 2006 to 4,289 units in the first quarter of 2007. The Company’s unit sales were down 40.6% to 4,289 units. Average unit selling price increased to $17,800 in the first quarter of 2007 from $16,300 in the same period last year.
Gross profit for the first quarter of 2007 decreased to $4.7 million, down from $14.3 million in the first quarter of 2006, and gross margin decreased from 12.5% in the first quarter of 2006 to 6.8% in the first quarter of 2007. Changes in the components of cost of sales are set forth in the following table (dollars in thousands):
| | Quarter Ended | | % | | Quarter Ended | | % | | Change in | |
| | April 1, 2006 | | of Sales | | March 31, 2007 | | of Sales | | % of Sales | |
Direct materials | | $ | 68,829 | | 60.2 | % | $ | 44,070 | | 63.4 | % | 3.2 | % |
Direct labor | | 12,626 | | 11.0 | % | 7,693 | | 11.1 | % | 0.1 | % |
Warranty | | 3,154 | | 2.7 | % | 2,310 | | 3.3 | % | 0.6 | % |
Other direct | | 9,812 | | 8.6 | % | 5,875 | | 8.5 | % | (0.1 | )% |
Indirect | | 5,712 | | 5.0 | % | 4,805 | | 6.9 | % | 1.9 | % |
| | | | | | | | | | | |
Total cost of sales | | $ | 100,133 | | 87.5 | % | $ | 64,753 | | 93.2 | % | 5.7 | % |
· Direct material increases in 2007, as a percent of sales, were 3.2% or $2.2 million. This increase was due to changes in the mix of products produced in the first quarter of 2007 versus 2006. The most significant change in the mix relates to the production of FEMA units in 2006, which had a low material cost as a percent of sales. The remaining portion of the overall decrease in total dollars associated with direct materials of $24.8 million is the result of the decrease of sales volumes in 2007 compared to 2006.
· Direct labor decreases in 2007 are the result of the decrease of sales volumes in 2007 compared to 2006.
· Increases in warranty expense in 2007, as a percent of sales, were 0.6% or $417,000. This increase was due to a shift in the mix of towables produced that have a higher cost as a percent of sales. The remaining portion of the overall decrease in total dollars associated with warranty costs of $844,000 is the result of the decrease of sales volumes in 2007 compared to 2006.
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· Decreases in other direct costs in 2007 of $3.9 million are the result of the decrease of sales volumes in 2007 compared to 2006.
· Increases in indirect costs in 2007, as a percent of sales, were 1.9% or $1.3 million. These increases relate to lower absorption of indirect costs in some of our plants as we reduced output in the first quarter of 2007. The remaining portion of the overall decrease in total dollars associated with indirect costs of $907,000 is the result of the decrease of sales volumes in 2007 compared to 2006.
S,G,&A expenses for the TRV segment increased as both a percent of sales and in total dollars due to increases in selling expenses. In addition, in the fourth quarter of 2006 we completed a study on the allocation of corporate overhead, and allocated certain costs on an activity basis. These costs are now classified in a single line item for S,G,&A expense and corporate overhead allocation. Corporate overhead allocation is comprised of certain shared services such as executive, financial, information systems, legal, and investor relations expenses.
Operating income decreased as a percent of sales due to lower gross margins and higher S,G,&A expenses as a percent of sales.
First Quarter 2007 versus First Quarter 2006 for the Motorhome Resort Segment
The following table illustrates the results of the Motorhome Resort Segment (MR segment) for the quarters ended April 1, 2006, and March 31, 2007 (dollars in thousands):
| | Quarter Ended | | % | | Quarter Ended | | % | | $ | | % | |
| | April 1, 2006 | | of Sales | | March 31, 2007 | | of Sales | | Change | | Change | |
Net sales | | $ | 15,701 | | 100.0 | % | $ | 7,216 | | 100.0 | % | $ | (8,485 | ) | (54.0 | )% |
Cost of sales | | 6,485 | | 41.3 | % | 2,434 | | 33.7 | % | 4,051 | | 62.5 | % |
Gross profit | | 9,216 | | 58.7 | % | 4,782 | | 66.3 | % | (4,434 | ) | (48.1 | )% |
Selling, general, and administrative expenses & corporate overhead | | 4,438 | | 28.3 | % | 2,831 | | 39.3 | % | 1,607 | | 36.2 | % |
| | | | | | | | | | | | | |
Operating income | | $ | 4,778 | | 30.4 | % | $ | 1,951 | | 27.0 | % | $ | (2,827 | ) | (59.2 | )% |
Net sales decreased 54.0% to $7.2 million compared to $15.7 million for the same period last year. This decrease was due in part to challenges in Las Vegas and Indio related to weather conditions, as well as construction access restrictions in Las Vegas.
Gross profit for the MR segment increased to 66.3% of sales in the first quarter of 2007 compared to 58.7% of sales in the same period last year. This was due to the mix of lot sales. In the first quarter 2007 most sales were from the Indio resort which has a higher gross margin.
S,G,&A expenses decreased in total dollars due to the reduction in sales, as well as to the reduction in participation expense accrued for which was a result of lower profits. In addition, in the fourth quarter of 2006 we completed a study on the allocation of corporate overhead, and allocated certain costs on an activity basis. These costs are now located in a single line item for S,G,&A expense and corporate overhead allocation. Corporate overhead allocation is comprised of certain shared services such as executive, financial, information systems, legal and investor relations expenses.
Operating income decreased due to lower sales and to higher S,G,&A costs and corporate overhead allocation as a percent of sales.
LIQUIDITY AND CAPITAL RESOURCES
The Company’s primary sources of liquidity are internally generated cash from operations and available borrowings under its credit facilities. For the first quarter of 2007, the Company generated cash of $46.4 million from operating activities and had a cash balance of $29.0 million at March 31, 2007. The Company generated $6.7 million from net income and non-cash expenses such as depreciation and amortization, gains on sales of assets, and expenses associated with stock-based compensation. Other sources of cash included a $35.3 million increase in accounts payable, a decrease of $1.2 million in resort inventory, a $361,000 decrease in prepaid expenses, a $743,000 increase in accruals for product warranty, a $3.0 million increase in accrued liabilities, a $9.5 million increase in income tax payable, and a $745,000 increase in accruals for
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product liability reserve. The uses of cash in the first quarter of 2007 included a $6.8 million increase in trade receivables, a $2.1 million increase in inventory levels, a decrease of $50,000 in deferred revenue, and a decrease in assets from discontinued operations of $10,000. Increases in accounts payable are mostly the result of a purchase of a large number of engines from Cummins, and the changes in the amounts of other raw materials at the end of the first quarter of 2007 versus the fourth quarter of 2006. Decreases in resort lot inventories are the result of the continued sell through of the Company’s resort properties. Decreases in prepaid expenses reflect the amortization of prepaid expenses for insurance costs. Increases in warranty reserves were the result of increases in experience for warranty costs on some of our current model year products. Increases in accrued expenses and other liabilities are associated with increases for accruals for promotions and advertising, employee benefit costs, and participation income. Increases in income taxes payable reflect the provision for expected income taxes due. Increases in accrued product liability reflect the increase in activity on pending litigation claims. Increases in trade accounts receivable reflect the effects of the shipments of products near the end of the quarter. Increases in inventory levels were due to the receipt of a large number of Cummins engines that were partially offset by the $4.1 million of inventory contributed to the joint venture. Decreases in deferred revenues are related to revenue associated with Monaco Financial Services that the Company received in 2006 and is amortizing over the length of the contract with GECDF and GECF. Decreases in assets related to discontinued operations are for the sales of all remaining Royale Coach discontinued products.
On November 18, 2005, the Company amended its credit facilities to borrow $40.0 million of term debt (the “Term Debt”) to complete the acquisition of R-Vision. The revolving line of credit remains at $105.0 million. At the quarter ended March 31, 2007, borrowings outstanding on the revolving line of credit (the “Revolving Loan”) were zero, and Term Debt borrowings were $32.9 million. At the election of the Company, the Revolving Loan and the Term Debt bear interest at varying rates that fluctuate based on the Prime rate or LIBOR, and are determined based on the Company’s leverage ratio. The Company also pays interest quarterly on the unused available portion of the Revolving Loan at varying rates, determined by the Company’s leverage ratio. The Revolving Loan is due and payable in full on November 17, 2009 and requires interest payments quarterly. The Term Debt requires quarterly interest payments and quarterly principal payments of $1.4 million, with a final balloon payment of $12.9 million due on November 18, 2010. Both the Revolving Loan and Term Debt are collateralized by all the assets of the Company and the credit facilities include various restrictions and financial covenants. The Company was in compliance with these covenants at March 31, 2007. The Company utilizes “zero balance” bank disbursement accounts in which an advance on the line of credit is automatically made for checks clearing each day. Since the balance of the disbursement account at the bank returns to zero at the end of each day, the outstanding checks of the Company are reflected as a liability. The outstanding check liability is combined with the Company’s positive cash balance accounts to reflect a net book overdraft or a net cash balance for financial reporting. At March 31, 2007, cash is a positive net balance and thus no book overdraft is reported.
In November 2005, the Company obtained a term loan of $500,000 from the State of Oregon in connection with the relocation of jobs to the Coburg, Oregon production facilities from the Bend, Oregon facility. The principal and interest is due on April 30, 2009. The loan bears a 5% annual interest rate.
The Company’s principal working capital requirements are for purchases of inventory and financing of trade receivables. Many of the Company’s dealers finance product purchases under wholesale floor plan arrangements with third parties as described below. At March 31, 2007, the Company had working capital of approximately $108.3 million, a decrease of $1.5 million from working capital of $109.8 million at December 30, 2006. The Company has been using short-term credit facilities and operating cash flow to finance its capital expenditures.
The Company believes that cash flow from operations and funds available under its anticipated credit facilities will be sufficient to meet the Company’s liquidity requirements for the next 12 months.* The Company’s capital expenditures were $1.8 million in the first quarter of 2007, which included costs related to additions of automated machinery in many of its production facilities, upgrades to its information systems infrastructure, and other various capitalized upgrades to existing facilities. The Company anticipates that capital expenditures for all of 2007 will be approximately $10 to $12 million, which includes expenditures to purchase additional machinery and equipment in both the Company’s Coburg, Oregon and Wakarusa, Indiana facilities, as well as upgrades to existing information systems infrastructures.* The Company may require additional equity or debt financing to address working capital and facilities expansion needs, particularly if the Company significantly increases the level of working capital assets such as inventory and accounts receivable. The Company may also from time to time seek to acquire businesses that would complement the Company’s current business, and any such acquisition could require additional financing. There can be no assurance that additional financing will be available if required or on terms deemed favorable by the Company.
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As is typical in the recreational vehicle industry, many of the Company’s retail dealers utilize wholesale floor plan financing arrangements with third party lending institutions to finance their purchases of the Company’s products. Under the terms of these floor plan arrangements, institutional lenders customarily require the recreational vehicle manufacturer to agree to repurchase any unsold units if the dealer defaults on its credit facility from the lender, subject to certain conditions. The Company has agreements with several institutional lenders under which the Company currently has repurchase obligations. The Company’s contingent obligations under these repurchase agreements are reduced by the proceeds received upon the sale of any repurchased units. The Company’s obligations under these repurchase agreements vary from period to period up to 15 months. At March 31, 2007, approximately $576.8 million of products sold by the Company to independent dealers were subject to potential repurchase under existing floor plan financing agreements with approximately 5.5% concentrated with one dealer. Historically, the Company has been successful in mitigating losses associated with repurchase obligations. During the first quarter of 2007, the losses associated with the exercise of repurchase agreements were approximately $99,000. Dealers for the Company undergo credit review prior to becoming a dealer and periodically thereafter. Financial institutions that provide floor plan financing also perform credit reviews and floor checks on an ongoing basis. We closely monitor sales to dealers that are a higher credit risk. The repurchase period is limited, usually to a maximum of 15 months. We believe these activities help to minimize the number of required repurchases. Additionally, the repurchase agreement specifies that the dealer is required to make principal payments during the repurchase period. Since the Company repurchases the units based on the schedule of principal payments, the repurchase amount is typically less than the original invoice amount. This lower repurchase amount helps mitigate our loss when we offer the inventory to another dealer at an amount lower than the original invoice as incentive for the dealer to take the repurchased inventory. This helps minimize the losses we incur on repurchased inventory.
OFF-BALANCE SHEET ARRANGEMENTS
As of March 31, 2007, the Company did not have any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on the Company’s consolidated financial condition, results of operations, liquidity, capital expenditures or capital resources.
CONTRACTUAL OBLIGATIONS
As part of the normal course of business, we incur certain contractual obligations and commitments which will require future cash payments. The following tables summarize the significant obligations and commitments (dollars in thousands).
| | PAYMENTS DUE BY PERIOD | |
Contractual Obligations | | 1 year or less | | 1 to 3 years | | 4 to 5 years | | Thereafter | | Total | |
Long-Term Debt (1) | | $ | 5,714 | | $ | 11,928 | | $ | 15,715 | | $ | 0 | | $ | 33,357 | |
Operating Leases (2) | | 1,229 | | 1,582 | | 1,402 | �� | 1,593 | | 5,806 | |
| | | | | | | | | | | |
Total Contractual Cash Obligation | | $ | 6,943 | | $ | 13,510 | | $ | 17,117 | | $ | 1,593 | | $ | 39,163 | |
| | AMOUNT OF COMMITMENT EXPIRATION BY PERIOD | |
Other Commitments | | 1 year or less | | 1 to 3 years | | 4 to 5 years | | Thereafter | | Total | |
Line of Credit (3) | | $ | 0 | | $ | 105,000 | | $ | 0 | | $ | 0 | | $ | 105,000 | |
Guarantees (4) | | 14,302 | | 0 | | 0 | | 0 | | 14,302 | |
Repurchase Obligations (5) | | 0 | | 576,767 | | 0 | | 0 | | 576,767 | |
| | | | | | | | | | | |
Total Commitments | | $ | 14,302 | | $ | 681,767 | | $ | 0 | | $ | 0 | | $ | 696,069 | |
(1) See Note 5 of the Condensed Consolidated Financial Statements.
(2) Various leases including manufacturing facilities, aircraft, and machinery and equipment.
(3) See Note 4 of the Condensed Consolidated Financial Statements. The amount listed represents available borrowings on the line of credit at March 31, 2007.
(4) Guarantees related to aircraft operating lease.
(5) Reflects obligations under manufacturer repurchase commitments. See Note 10 of the Condensed Consolidated Financial Statements.
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INFLATION
During 2006 and the first quarter of 2007, the Company experienced increases in the prices of certain commodity items that we use in the manufacturing of our products. These include, but are not limited to, steel, copper, aluminum, petroleum, and wood. While price increases for these raw materials are not necessarily indicative of widespread inflationary trends, they had an impact on the Company’s production costs. To date, the Company has been successful in passing along most of these increases through increasing the selling prices of its products. However, there is no certainty that the Company will be able to successfully pass these along in the future. The current trend in these prices, could have a materially adverse impact on the Company’s business going forward.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to warranty costs, product liability, and impairment of goodwill. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies and related judgments and estimates affect the preparation of our consolidated financial statements.
WARRANTY COSTS Estimated warranty costs are provided for at the time of sale of products with warranties covering the products for up to one year from the date of retail sale (five years for the front and sidewall frame structure, and three years on the Roadmaster chassis). These estimates are based on historical average repair costs, as well as other reasonable assumptions as have been deemed appropriate by management.
PRODUCT LIABILITY The Company provides an estimate for accrued product liability based on current pending cases, as well as for those cases which are incurred but not reported. This estimate is developed by legal counsel based on professional judgment, as well as historical experience.
IMPAIRMENT OF GOODWILL The Company assesses the potential impairment of goodwill in accordance with Financial Accounting Standards Board (FASB) Statement No. 142. This annual test involves management comparing the fair value of each of the Company’s reporting units, to the respective carrying amounts, including goodwill, of the net book value of the reporting unit, to determine if goodwill has been impaired. The Company uses an estimate of discounted future cash flows to determine fair value for each reporting unit.
INVENTORY ALLOWANCE The Company writes down its inventory for obsolescence, and the difference between the cost of inventory and its estimated fair market value. These write-downs are based on assumptions about future sales demand and market conditions. If actual sales demand or market conditions change from those projected by management, additional inventory write-downs may be required.
INCOME TAXES In conjunction with preparing its consolidated financial statements, the Company must estimate its income taxes in each of the jurisdictions in which it operates. This process involves estimating actual current tax expense together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the consolidated balance sheets. The Company must then assess the likelihood that the deferred tax assets will be recovered from future taxable income, and to the extent management believes that recovery is not likely, a valuation allowance must be established. Significant management judgment is required in determining the Company’s provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against net deferred tax assets.
The Company adopted FIN 48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FAS 109,” as of the beginning of fiscal year 2007. See Note 6 to the Company’s consolidated quarterly financial statements included with this Quarterly Report on Form 10-Q.
REPURCHASE OBLIGATIONS Upon request of a lending institution financing a dealer’s purchases of the Company’s product, the Company will execute a repurchase agreement. The Company has recorded a liability associated with the disposition of repurchased inventory. To determine the appropriate liability, the Company calculates a reserve, based on an estimate of potential net losses, along with qualitative and quantitative factors, including dealer inventory turn rates, and the financial strength of individual dealers.
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NEWLY ISSUED FINANCIAL REPORTING PRONOUNCEMENTS
FIN 48
In June 2006, the Board issued FIN 48, “Accounting for Uncertainty in Income Taxes” (the “Interpretation”). The Interpretation clarifies the accounting for uncertainty in income taxes recognized in accordance with FASB 109, “Accounting for Income Taxes” by defining a criterion that an individual tax position must be met for any part of the benefit to be recognized in the financial statements. The Interpretation is effective for fiscal years beginning after December 15, 2006.
We have adopted the Interpretation as of the beginning of fiscal year 2007 and there was no significant impact to the financial statements.
FAS 157
In September 2006, the Board issued FAS 157, “Fair Value Measurements.” The Statement defines fair value, establishes a framework for measuring fair value, and expands disclosure requirements regarding fair value measurements.
FAS 157 is effective for fiscal years beginning after November 15, 2007. We are reviewing the provisions of the Statement and will adopt it for the fiscal year beginning 2008.
FAS 159
In February 2007, the Board issued FAS 159, “Fair Value Option for Financial Assets and Financial Liabilities.” This statement permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value.
FAS 159 is effective for fiscal years beginning after November 15, 2007. We are reviewing the provisions of this statement and will adopt it for the fiscal year beginning 2008.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management including our principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure, and that such information is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures will prevent all error and all fraud. Because of inherent limitations in any system of disclosure controls and procedures, no evaluation of controls can provide absolute assurance that all instances of error or fraud, if any, within the Company may be detected. However, our management, including our Chief Executive Officer and our Chief Financial Officer, have designed our disclosure controls and procedures to provide reasonable assurance of achieving their objectives and have, pursuant to the evaluation discussed above, concluded that our disclosure controls and procedures are, in fact, effective at this reasonable assurance level.
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There was no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1A. RISK FACTORS
We have listed below various risks and uncertainties relating to our businesses. This list is not inclusive of all the risks and uncertainties we face, but any of these could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this report or that we may issue from time to time in the future.
WE MAY EXPERIENCE UNANTICIPATED FLUCTUATIONS IN OUR OPERATING RESULTS FOR A VARIETY OF REASONS Our net sales, gross margin, and operating results may fluctuate significantly from period to period due to a number of factors, many of which are not readily predictable. These factors include the following:
· The varying margins associated with the mix of products we sell in any particular period.
· The fact that we typically ship a large amount of products near quarter-end.
· Our ability to utilize and expand our manufacturing resources efficiently.
· Shortages of materials used in our products.
· Commodity pricing and the effects of inflation on the costs of materials used in our products.
· Fuel costs and fuel availability.
· A determination by us that goodwill or other intangible assets are impaired and have to be written down to their fair values, resulting in a charge to our results of operations.
· Our ability to introduce new models that achieve consumer acceptance.
· The introduction, marketing and sale of competing products by others, including significant discounting offered by our competitors.
· The addition or loss of our dealers.
· The timing of trade shows and rallies, which we use to market and sell our products.
· Factors affecting the recreational vehicle industry as a whole, including economic and seasonal factors.
· Our inability to acquire and develop key pieces of property for on-going resort activity.
· Fluctuations in demand for our resort lots due to changing economic and other conditions.
Our overall gross margin may decline in future periods to the extent that we increase the percentage of sales of lower gross margin towable products or if the mix of motor coaches we sell shifts to lower gross margin units. In addition, a relatively small variation in the number of recreational vehicles we sell in any quarter can have a significant impact on total sales and operating results for that quarter.
Demand in the recreational vehicle industry generally declines during the winter months, while sales are generally higher during the spring and summer months. With the broader range of products we now offer, seasonal factors could have a significant impact on our operating results in the future. Additionally, unusually severe weather conditions in certain markets could delay the timing of shipments from one quarter to another.
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We attempt to forecast orders for our products accurately and commence purchasing and manufacturing prior to receipt of such orders. However, it is highly unlikely that we will consistently be able to accurately forecast the timing, rate, and mix of orders. This aspect of our business makes our planning inexact and, in turn, affects our shipments, costs, inventories, operating results, and cash flow for any given quarter.
THE RECREATIONAL VEHICLE INDUSTRY IS CYCLICAL AND SUSCEPTIBLE TO SLOWDOWNS IN THE GENERAL ECONOMY The recreational vehicle industry has been characterized by cycles of growth and contraction in consumer demand, reflecting prevailing economic, demographic, and political conditions that affect disposable income for leisure-time activities. Our business is particularly influenced by cycle swings in the Class A market. While there has been strong secular demand for recreational vehicles since the early 90’s, it has been driven by demand for towable recreational products. Since 2004 there has been a notable divergence in growth rates between towable and motorized recreational vehicles.
Class A unit shipments peaked at approximately 37,300 units in 1994 and declined to approximately 33,000 units in 1995. The Class A segment then went on a steady climb and in 1999 recorded the highest year, in recent history, of Class A shipments, approximately 49,400. Over the next two years, motorhome shipments declined to 33,400 in 2001. Class A shipments then rose for the next 3 years and in 2004 reached 46,300. Over the last two years, however, shipments of Class A motorhomes have dropped, reaching a pre-1994 level of 32,700 in 2006.
The towable segment moved through many of the same cyclical peaks and troughs historically. The shipment level peaked in 1994 at 201,100, dropping-off to 192,200 in 1996 and then growing to 249,600 in 1999. Towable unit shipments suffered a two-year decline in 2000 and 2001, dropping to 207,600. Since then the market has expanded significantly reaching 334,600 in 2006. Unlike the Class A market, the towables segment did not experience a slow down over the last two years because manufacturers have successfully introduced popular new models and the segment was significantly aided by units sold to support the hurricane relief efforts in the Gulf Coast.
Our business is subject to the cyclical nature of this industry and principally the Class A segment. Some of the factors that contribute to this cyclicality include fuel availability and costs, interest rate levels, the level of discretionary spending, and availability of credit and overall consumer confidence. Increasing interest rates and fuel prices over the last two years have adversely affected the Class A recreational vehicle market. An extended continuation of these conditions would materially affect our business, results of operations, and financial condition.
WE RELY ON A RELATIVELY SMALL NUMBER OF DEALERS FOR A SIGNIFICANT PERCENTAGE OF OUR SALES Although our products were offered by over 700 dealerships located primarily in the United States and Canada as of March 31, 2007, a significant percentage of our sales are concentrated among a relatively small number of independent dealers. For the quarter ended March 31, 2007, sales to one dealer, Lazy Days RV Center, accounted for 10.3% of total sales compared to 9.2% of sales in the same period ended last year. For quarters ended April 1, 2006 and March 31, 2007, sales to our 10 largest dealers, including Lazy Days RV Center, accounted for a total of 36.1% and 35.4% of total sales, respectively. The loss of a significant dealer or a substantial decrease in sales by any of these dealers could have a material impact on our business, results of operations, and financial condition.
WE MAY HAVE TO REPURCHASE A DEALER’S INVENTORY OF OUR PRODUCTS IN THE EVENT THAT THE DEALER DOES NOT REPAY ITS LENDER As is common in the recreational vehicle industry, we enter into repurchase agreements with the financing institutions used by our dealers to finance their purchases of our products. These agreements require us to repurchase the dealer’s inventory in the event that the dealer defaults on its credit facility with its lender. Obligations under these agreements vary from period to period, but totaled approximately $576.8 million as of March 31, 2007, with approximately 5.5% concentrated with one dealer. If we were obligated to repurchase a significant number of units under any repurchase agreement, our business, operating results, and financial condition could be adversely affected.
OUR ACCOUNTS RECEIVABLE BALANCE IS SUBJECT TO RISK We sell our product to dealers who are predominantly located in the United States and Canada. The terms and conditions of payment are a combination of open trade receivables and commitments from dealer floor plan lending institutions. For our RV dealers, terms are net 30 days for units that are financed by a third party lender. Terms of open trade receivables are granted by us, on a very limited basis, to dealers who have been subjected to evaluative credit processes conducted by us. For open receivables, terms vary from net 30 days to net 180 days, depending on the specific agreement. Agreements for payment terms beyond 30 days generally require additional collateral, as well as security interest in the inventory sold. As of March 31, 2007, total trade receivables were $88.4 million, with approximately $63.9 million, or 72.3% of the outstanding accounts receivable balance concentrated among floor plan lenders. The remaining $24.5 million of trade receivables were concentrated substantially all with one dealer. For resort lot customers, funds are required at the time of closing.
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WE MAY EXPERIENCE A DECREASE IN SALES OF OUR PRODUCTS DUE TO AN INCREASE IN THE PRICE OR A DECREASE IN THE SUPPLY OF FUEL An interruption in the supply, or a significant increase in the price or tax on the sale, of diesel fuel or gasoline on a regional or national basis could significantly affect our business. Diesel fuel and gasoline have, at various times in the past, been either expensive or difficult to obtain.
WE DEPEND ON SINGLE OR LIMITED SOURCES TO PROVIDE US WITH CERTAIN IMPORTANT COMPONENTS THAT WE USE IN THE PRODUCTION OF OUR PRODUCTS A number of important components for our products are purchased from a single or a limited number of sources. These include chassis from Workhorse and Ford for gas motor coaches and diesel chassis from our newly formed joint venture with International Truck and Engine Corporation. The joint venture sources turbo diesel engines from Cummins and Caterpillar, substantially all transmissions from Allison and axles from Dana. We have no long-term supply contracts with these suppliers or their distributors, and we cannot be certain that these suppliers will be able to meet our future requirements. Consequently, the Company has periodically been placed on allocation of these and other key components. The last significant allocation occurred in 1997 from Allison, and in 1999 from Ford. An extended delay or interruption in the supply of any components that we obtain from a single supplier or from a limited number of suppliers could adversely affect our business, results of operations, and financial condition.
OUR INDUSTRY IS VERY COMPETITIVE. WE MUST CONTINUE TO INTRODUCE NEW MODELS AND NEW FEATURES TO REMAIN COMPETITIVE The market for our products is very competitive. We currently compete with a number of manufacturers of motor coaches, fifth wheel trailers, and travel trailers. Some of these companies have greater financial resources than we have and extensive distribution networks. These companies, or new competitors in the industry, may develop products that customers in the industry prefer over our products.
We believe that the introduction of new products and new features is critical to our success. Delays in the introduction of new models or product features, quality problems associated with these introductions, or a lack of market acceptance of new models or features could affect us adversely. For example, unexpected costs associated with model changes have affected our gross margin in the past. Further, new product introductions can divert revenues from existing models and result in fewer sales of existing products.
OUR PRODUCTS COULD FAIL TO PERFORM ACCORDING TO SPECIFICATIONS OR PROVE TO BE UNRELIABLE, CAUSING DAMAGE TO OUR CUSTOMER RELATIONSHIPS AND OUR REPUTATION AND RESULTING IN LOSS OF SALES Our customers require demanding specifications for product performance and reliability. Because our products are complex and often use advanced components, processes and techniques, undetected errors and design flaws may occur. Product defects result in higher product service, warranty and replacement costs and may cause serious damage to our customer relationships and industry reputation, all of which would negatively affect our sales and business.
OUR BUSINESS IS SUBJECT TO VARIOUS TYPES OF LITIGATION, INCLUDING PRODUCT LIABILITY AND WARRANTY CLAIMS We are subject to litigation arising in the ordinary course of our business, typically for product liability and warranty claims that are common in the recreational vehicle industry. While we do not believe that the outcome of any pending litigation, net of insurance coverage, will materially adversely affect our business, results of operations, or financial condition, we cannot provide assurances in this regard because litigation is an inherently uncertain process.*
To date, we have been successful in obtaining product liability insurance on terms that we consider acceptable. The terms of the policy contain a self-insured retention amount of $500,000 per occurrence, with a maximum annual aggregate self-insured retention of $3.0 million. Overall product liability insurance, including umbrella coverage, is available to a maximum amount of $100.0 million for each occurrence, as well as in the aggregate. We cannot be certain we will be able to obtain insurance coverage in the future at acceptable levels or that the costs of such insurance will be reasonable. Further, successful assertion against us of one or a series of large uninsured claims, or of a series of claims exceeding our insurance coverage, could have a material adverse effect on our business, results of operations, and financial condition.
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IN ORDER TO BE SUCCESSFUL, WE MUST ATTRACT, RETAIN AND MOTIVATE MANAGEMENT PERSONNEL AND OTHER KEY EMPLOYEES, AND OUR FAILURE TO DO SO COULD HAVE AN ADVERSE EFFECT ON OUR RESULTS OF OPERATIONS The Company’s future prospects depend upon retaining and motivating key management personnel, including Kay L. Toolson, the Company’s Chairman and Chief Executive Officer, and John W. Nepute, the Company’s President. The loss of one or more of these key management personnel could adversely affect the Company’s business. The prospects of the Company also depend in part on its ability to attract and retain highly skilled engineers and other qualified technical, manufacturing, financial, managerial, and marketing personnel. Competition for such personnel is intense, and there can be no assurance that the Company will be successful in attracting and retaining such personnel.
OUR RECENT GROWTH HAS PUT PRESSURE ON THE CAPABILITIES OF OUR OPERATING, FINANCIAL, AND MANAGEMENT INFORMATION SYSTEMS In the past few years, we have significantly expanded the complexity of our business. As a result, our management personnel have assumed additional responsibilities. The increase in complexity over a relatively short period of time has put pressure on our operating, financial, and management information systems. If we continue to expand, such growth would put additional pressure on these systems and may cause such systems to malfunction or to experience significant delays.
WE MAY EXPERIENCE UNEXPECTED PROBLEMS AND EXPENSES ASSOCIATED WITH OUR MANUFACTURING EQUIPMENT AUTOMATION PLAN As we continue to work towards involving automated machinery and equipment to improve efficiencies and quality, we will be subject to certain risks involving implementing new technologies into our facilities.
The expansion into new machinery and equipment technologies involves risks, including the following:
· We must rely on timely performance by contractors, subcontractors, and government agencies, whose performance we may be unable to control.
· The development of new processes involves costs associated with new machinery, training of employees, and compliance with environmental, health, and other government regulations.
· The newly developed products may not be successful in the marketplace.
· We may be unable to complete a planned machinery and equipment implementation in a timely manner, which could result in lower production levels and an inability to satisfy customer demand for our products.
WE MAY EXPERIENCE UNEXPECTED PROBLEMS AND EXPENSES ASSOCIATED WITH OUR ENTERPRISE RESOURCE PLANNING SYSTEM (ERP) IMPLEMENTATION During 2006, we began to implement a new ERP system and will be subject to certain risks including the following:
· We must rely on timely performance by contractors whose performance we may be unable to control.
· The implementation could result in significant and unexpected increases in our operating expenses and capital expenditures, particularly if the project takes longer than we expect.
· The project could complicate and prolong our internal data gathering and analysis processes.
· We may need to restructure or develop our internal processes to adapt to the new system.
· We could require extended work hours from our employees and use temporary outside resources, resulting in increased expenses, to resolve any software configuration issues or to process transactions manually until issues are resolved.
· As management focuses attention on the implementation, they could be diverted from other issues.
· The project could disrupt our operations if the transition to the ERP system creates new or unexpected difficulties or if the system does not perform as expected.
OUR STOCK PRICE HAS HISTORICALLY FLUCTUATED AND MAY CONTINUE TO FLUCTUATE The market price of our Common Stock is subject to wide fluctuations in response to quarter-to-quarter variations in operating results, changes in earnings estimates by analysts, announcements of new products by us or our competitors, general conditions in the recreational vehicle market, and other events or factors. In addition, the stocks of many recreational vehicle companies have experienced price and volume fluctuations which have not necessarily been directly related to the companies’ operating performance, and the market price of our Common Stock could experience similar fluctuations.
Item 6. Exhibits
10.3.1 | Form of 1993 Stock Plan Performance Share Agreement. |
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10.3.2 | Form of 1993 Stock Plan Restricted Stock Unit Agreement for Kay L. Toolson and John W. Nepute. |
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31.1 | Sarbanes-Oxley Section 302(a) Certification. |
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31.2 | Sarbanes-Oxley Section 302(a) Certification. |
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32.1 | Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, and Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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