Management’s Discussion and Analysis of Financial Condition and Results of Operations
Business Outlook
Recreational Vehicles
Favorable demographics suggest that sustainable growth in the number of RV buyers will likely be realized in at least the next several years as baby boomers reach the age brackets that historically have accounted for the bulk of retail RV sales. Additionally, in recent years, younger buyers have also shown greater interest in the RV lifestyle. These conclusions received strong support from the University of Michigan 2005 national survey of recreational vehicle owners, sponsored by the Recreation Vehicle Industry Association.
Industry conditions during calendar year 2006, and so far in calendar 2007, were adversely affected by concerns about interest rates, fuel prices and diminished home equity financings. Industry motor home retail sales posted a second year of decline in calendar 2006, with most of the continued weakness in the higher-end Class A gas and mid- and high-priced Class C segments. Recent market conditions and demand have been mixed, and a firm recovery has yet to materialize. Travel trailer retail sales were down slightly for the industry in calendar 2006 due to significant falloff in the latter part of the year and have shown continuing signs of weakness, combined with more competitive pricing thus far in calendar 2007. After briefly stabilizing in early calendar 2006, the market for folding trailers is also showing weakness so far in calendar 2007.
Our overall market position in motor homes has been slightly impacted by lower industry demand in product segments that have traditionally been an area of relative strength for us. We are, however, seeing a benefit from recent introductions of low-end Class A gas products and improvements made to several diesel brands. In the Class C category, we have introduced a completely new product in the currently popular entry-level category and intend to introduce a fuel-efficient model later this year.
Our market share for travel trailers had been in decline for several years but began to stabilize during the middle of calendar 2006 following the launch of a number of new 2007 model year products. These new products introduced last spring and summer have been well received by our dealers and appear to have gained shelf space on dealer lots. Industry retail demand for travel trailers was down towards the end of the year, however, causing dealers to reduce orders of new products until their inventories get back in balance with demand. Beginning in the third quarter, we rationalized our travel trailer plants and their respective products with an emphasis on achieving manufacturing efficiencies, improving quality and reducing the number of brands and floorplans produced at each factory location. This process evolved in conjunction with our evaluation of plant capacity requirements given the recent downturn in the travel trailer market. As a result, we closed four travel trailer plants during or shortly after our fourth fiscal quarter. We will close a fifth plant before the end of the first fiscal quarter in fiscal 2008. We expect to see improved efficiencies in the remaining facilities as a result of higher production volume. We may also see reduced market share in segments and regions in which we choose to no longer compete but expect to be more competitive in markets in which we place emphasis.
We are the dominant producer of folding trailers and our market share improved during calendar 2006. Our focus will be on improving the efficiency and financial results of this operation in fiscal 2008.
Although our processes associated with manufacturing quality and service continue to improve for our entire RV business, the full benefits will only be realized over the longer term through lower warranty and service costs and a strong competitive advantage over other manufacturers.
Housing
We expect longer-term demand for affordable housing to grow as a result of the rebuilding requirements in the Gulf states, greater numbers of baby boomers reaching retirement age, and the continuing high cost of site-built homes, notwithstanding the pricing pressures placed on conventional homes in certain regions due to the recent retrenchment by the subprime financing industry. We believe that improvements in engineering and design will continue to position manufactured and modular homes as viable options in meeting the demand for affordable housing in new markets, such as suburban tracts and military sites, as well as in existing markets such as rural areas and manufactured housing communities and parks, especially over the longer term if retail financing for manufactured homes becomes more competitive versus financing for conventional housing.
Despite these improvements, the manufactured housing market has experienced a steep decline that began in 1999, and a 45-year low in shipments was established in 2006. The industry has been adversely affected by a shortage of retail financing, relatively high retail interest rates (especially when compared to low mortgage rates on conventional homes), more stringent lending standards for manufactured housing, and competition from repossessed manufactured homes and, more recently, foreclosed-upon conventional homes.
Many of the factors that have historically affected manufactured housing volumes have been in flux recently. Positive trends include a normalized inventory level of repossessed manufactured homes, improving performance of manufactured housing loan portfolios, tightening of credit for site-built homes, and higher rents and lower vacancies in apartments. On the other hand, the overall slowing of the housing market and an increase in conventional housing inventories may negatively impact manufactured housing conditions in the near term. Altogether, we anticipate that manufactured housing industry conditions may improve over the course of calendar 2007, albeit modestly.
Manufactured housing industry shipments decreased by 19.7 percent in calendar 2006, but were down nearer to 10% excluding sales of homes that were built to FEMA specifications for disaster relief, which were estimated at 21,000 in calendar year 2005 and 4,000 in 2006.
Market conditions are mixed by region. Some smaller markets in the central states have shown improvement but other regions have softened. California, Arizona and Florida, which traditionally have been some of our strongest markets, are down sharply in recent months. The outlook in most areas continues to be uncertain.
Our own market position was adversely affected by the sale of our retail operations in August 2005. This impact on our market position was expected given the immediate closure of approximately 50 stores combined with reduced purchases by the remaining operating stores. This situation will continue to affect our sales volume and market share until we fully replace or augment the closed outlets. We also had fewer sales to national operators of manufactured home communities, which have significantly reduced their activity over the last 18 months. In response to these conditions, we have reduced manufacturing capacity by consolidating four plants into two during fiscal 2007.
Current activity in the Gulf Coast region by builders and developers is increasing with a substantial portion of the rebuilding efforts likely to include modular products, which we are prepared to provide. Development of this new distribution channel, combined with a longer sales cycle for these types of projects, will temper our progress in this area. The sale of our network of company-owned stores, which had a high concentration in the Gulf Coast region, may lessen our ability to fully participate in the upswing in more traditional dealer sales of manufactured housing until we can rebuild our independent dealer distribution network in the area.
In response to the weak market conditions, our dealers throughout the country are maintaining low inventory levels, and dealers in previously stronger markets such as Arizona, California, and Florida are continuing to reduce their inventories. Although this reduction of inventories impacts current order levels, it typically enables the dealers to continue to operate more profitably, albeit at a reduced level of activity. The inventory reduction also enables dealers to dispose of older units so that when market conditions improve, they can quickly add new products. Despite this effort, dealer failures and losses from repurchase commitments are likely to increase in the current market climate and increased competition among manufacturers may squeeze margins. We continue to initiate programs designed to increase our product representation by creating incentives for our sales personnel and dealers to sell aged inventory and replace it with new products on their lots. In addition, we continue to focus on adding new distribution points. We will also continue to pursue other opportunities to supplement our business, such as increased emphasis on sales of modular homes to builder/developers and military projects.
Summary
We continue to place emphasis on new products in all areas of our business that are feature-rich, innovative, and price competitive. As a result, we generally expect to improve our market share position over the course of the next fiscal year. Restructuring actions, which were primarily focused on reducing corporate and other general and administrative expenses, have resulted in a more cost-effective management structure that has been in full effect since the beginning of calendar 2007. Market conditions in all segments remain at or below prior-year levels and continue to slow our progress toward sustainable profitability. Also, the extent to which we are successful in our restructuring and turnaround of the travel trailer business will be a key element to our financial progress in fiscal 2008. At current sales volumes and gross margins, the recently completed plant and product rationalization will not be sufficient to generate profitable operations without further improvements in the efficiencies and/or effectiveness of our manufacturing and service operations. The travel trailer business is unlikely to see a profitable quarter of operations until such improvements have taken full effect, which we expect to occur over the next 12 months. Overall, with the help of a seasonal uplift, new model year product introductions, lower costs, and capacities that are more in line with current demand, we expect operating income (before interest and tax expense) to be close to breakeven in the first quarter of fiscal 2008.