Fleetwood Enterprises 10-Q 2006
WASHINGTON, DC 20549
Commission File Number: 1-7699
FLEETWOOD ENTERPRISES, INC.
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule12b-2 of the Exchange Act (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
TABLE OF CONTENTS
This Quarterly Report on Form 10-Q contains statements that may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (Exchange Act). These statements are based on the beliefs of the Companys management as well as assumptions made by it, and information currently available to it. In some cases, you can identify forward-looking statements by terminology such as may, will, should, expects, intends, plans, anticipates, believes, estimates, predicts, potential or continue, or the negative of these terms or other comparable terminology. Forward-looking statements regarding future events and the future performance of the Company involve risks and uncertainties that could cause actual results to differ materially. These risks and uncertainties include, without limitation, the following items:
· the lack of assurance that the Company will regain sustainable profitability in the foreseeable future;
· the Companys ability to comply with financial tests and covenants on existing debt obligations and to obtain future financing needed in order to execute its business strategies;
· the volatility of the Companys stock price;
· the impact of ongoing weakness in the manufactured housing market and more recent weakness in the recreational vehicle market;
· the effect of global tensions, fuel prices, interest rates, and other factors on consumer confidence, which in turn may reduce demand for Fleetwoods products;
· the availability and cost of wholesale and retail financing for both manufactured housing and recreational vehicles;
· repurchase agreements with floorplan lenders, which could result in increased costs;
· the cyclical and seasonal nature of both the manufactured housing and recreational vehicle industries;
· potential increases in the frequency of product liability, wrongful death, class action, and other legal actions;
· expenses and uncertainties associated with the manufacturing, development and introduction of new products;
· the potential for excessive retail inventory levels in the manufactured housing and recreational vehicle industries;
· the highly competitive nature of our industries; and
· lack of acceptance of Fleetwoods products.
Although management believes that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Undue reliance should not be placed on these forward-looking statements, which speak only as of the date of this report. Fleetwood undertakes no obligation to publicly release the results of any revisions to these forward-looking statements that may arise from changing circumstances or unanticipated events. Additionally, other risks and uncertainties are described in our Annual Report on Form 10-K for the fiscal year ended April 30, 2006, filed with the Securities and Exchange Commission, under Item 1A. Risk Factors, and Item 7. Managements Discussion and Analysis of Results of Operations and Financial Condition, including the section therein entitled Business Outlook.
Report of Independent Registered Public Accounting Firm
To the Board of Directors
We have reviewed the condensed consolidated balance sheet of Fleetwood Enterprises, Inc. as of October 29, 2006, the related condensed consolidated statements of operations for the thirteen-week periods ended October 29, 2006 and October 30, 2005, the related condensed consolidated statements of operations and condensed consolidated statements of cash flows for the twenty-six-week period ended October 29, 2006 and twenty-seven-week period ended October 30, 2005, and the condensed consolidated statement of changes in shareholders equity for the twenty-six-week period ended October 29, 2006. These financial statements are the responsibility of the Company's management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Fleetwood Enterprises, Inc. as of April 30, 2006, and the related consolidated statements of operations, changes in stockholders equity, and cash flows for the year then ended (not presented herein) and in our report dated July 7, 2006, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of April 30, 2006, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
FLEETWOOD ENTERPRISES, INC.
(Amounts in thousands, except per share data)
See accompanying notes to condensed consolidated financial statements.
See accompanying notes to condensed consolidated financial statements.
(Amounts in thousands)
See accompanying notes to condensed consolidated financial statements.
See accompanying notes to condensed consolidated financial statements.
FLEETWOOD ENTERPRISES, INC.
October 29, 2006
1) Basis of Presentation
Fleetwood Enterprises, Inc. (the Company) is one of the nations leaders in producing both recreational vehicles and manufactured housing. In addition, the Company operates three supply companies that provide components for the recreational vehicle and housing operations, while also generating outside sales.
Fleetwoods business began in 1950 through the formation of a California corporation. The present Company was incorporated in Delaware in September 1977, and succeeded by merger to all the assets and liabilities of the predecessor company. Fleetwood conducts manufacturing activities in 16 states within the U.S., and to a much lesser extent in Canada. The Company formerly operated a manufactured housing retail business, Fleetwood Retail Corp. (FRC), and a financial services subsidiary, HomeOne Credit Corp. (HomeOne). These businesses were designated as discontinued operations in March 2005 and were sold during the second quarter of fiscal 2006. The accompanying financial statements consolidate the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated. Certain amounts previously reported have been reclassified to conform to the Companys fiscal 2007 presentation.
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the accompanying financial statements. Actual results could differ from those estimates. Significant estimates made in preparing these financial statements include accrued warranty costs, depreciable lives, insurance reserves, accrued post-retirement health care benefits, legal reserves, the deferred tax asset valuation allowance and the assumptions used to determine the expense recorded for share-based payments.
In the opinion of the Companys management, the accompanying consolidated financial statements include all normal recurring adjustments necessary for a fair presentation of the financial position at October 29, 2006, and the results of operations for the 13 and 26-week periods ended October 29, 2006, and the 13 and 27-week periods ended October 30, 2005. The consolidated financial statements do not include footnotes and certain financial information normally presented annually under U.S. generally accepted accounting principles and, therefore, should be read in conjunction with the Companys Annual Report on Form 10-K for the year ended April 30, 2006. The Companys businesses are seasonal and its results of operations for the 13 and 26-week periods ended October 29, 2006 and 13 and 27-week periods ended October 30, 2005, respectively, are not necessarily indicative of results to be expected for the full year.
Cash and Cash Equivalents:
Cash includes cash on hand, cash in banks, demand deposit accounts, money market funds and readily marketable securities with original maturities of 90 days or less.
Recent Accounting Pronouncements:
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based Payment. Previously, the Company accounted for share-based payments under the provisions of Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees and disclosed share-based payment expense as if accounted for under the provisions of SFAS No. 123, Accounting for Stock-Based Compensation. Under the provisions of SFAS No. 123R, a public entity is required to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award.
The Company adopted SFAS No. 123R effective with the beginning of the first quarter of fiscal 2007, as discussed further in Note 2.
In November 2005, the FASB issued FASB Staff Position (FSP) SFAS 123R-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards. FSP SFAS 123R-3 provides an elective alternative transition method to SFAS 123R in accounting for the tax effects of share-based payment awards to employees. The elective method utilizes a computational component that establishes a beginning balance of the Additional Paid-In Capital (APIC) pool related to employee compensation and a simplified method to determine the subsequent impact on the APIC pool of employee awards that are fully vested and outstanding upon the adoption of SFAS 123R. The impact on the APIC pool of awards partially vested upon, or granted after, the adoption of SFAS 123R is determined in accordance with the guidance in SFAS 123R. The Company did not adopt the transition election of FSP SFAS 123R-3.
In November 2004, the FASB issued SFAS No. 151, Inventory CostsAn Amendment of Accounting Research Bulletin No. 43, Chapter 4. SFAS No. 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be expensed as incurred and not included in overhead. Further, SFAS No. 151 requires that allocation of fixed and production facilities overhead to conversion costs should be based on normal capacity of the production facilities.
The provisions in SFAS No. 151 were effective for inventory costs incurred subsequent to the beginning of the first quarter of fiscal 2007 and did not have a material impact on the Companys results of operations or financial position.
Life Insurance Policies
In March 2006, the FASB issued FSP No. FTB 85-4-1, Accounting for Life Settlement Contracts by Third Party Investors. FSP FTB 85-4-1 provides for a contract-by-contract irrevocable election to account for life settlement contracts on either a fair value basis, with changes in fair value recognized in the condensed consolidated statements of operations, or through use of the investment method. Under the investment method, the initial investment and continuing costs are capitalized; however, no income is recognized until death of the insured party. The guidance of FSP FTB 85-4-1 will be effective for fiscal years beginning after June 15, 2006. The Company plans to adopt FSP FTB 85-4-1 on April 30, 2007, and its adoption is not expected to have a material impact on its condensed consolidated financial statements.
Variable Interest Entities
In April 2006, the FASB issued FSP FIN 46R-6, Determining the Variability to Be Considered in Applying FASB Interpretation No. 46R, which requires the variability of an entity to be analyzed based on the design of the entity. The nature and risks in the entity, as well as the purpose for the entitys creation, are examined to determine the variability in applying FASB Interpretation No. (FIN) 46R, Consolidation of Variable Interest Entities. The variability is used in applying FIN 46R to determine whether an entity is a Variable Interest Entity (VIE), which interests are variable interests in the entity, and who is the primary beneficiary of the VIE. This statement is effective for all reporting periods beginning after June 15, 2006 and was adopted by the Company at the beginning of the second quarter of fiscal 2007. This statement did not have a significant impact on the Companys financial condition or results of operations.
In June 2006, the FASB issued FIN No. 48, Accounting for Uncertainty in Income Taxes, which supplements SFAS No. 109, Accounting for Income Taxes, by defining the confidence level that a tax position must meet in order to be recognized in the financial statements. FIN No. 48 requires that the tax effects of a position be recognized only if it is more-likely-than-not to be sustained based solely on its technical merits as of the reporting date. The more-likely-than-not threshold represents a positive assertion by management that a company is entitled to the economic benefits of a tax position. If a tax position is not considered more-likely-than-not to be sustained based solely on its technical merits, no benefits of the position are to be recognized. Moreover, the more-likely-than-not
threshold must continue to be met in each reporting period to support continued recognition of a benefit. At adoption, companies must adjust their financial statements to reflect only those tax positions that are more-likely-than-not to be sustained as of the adoption date. Any necessary adjustment would be recorded directly to retained earnings in the period of adoption and reported as a change in accounting principle. This Interpretation is effective as of the beginning of the first fiscal year beginning after December 15, 2006. Management is assessing the potential impact on the Companys financial condition and results of operations.
Defined Benefit Pension and Other Post-retirement Plans
In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Post-retirement Plans. SFAS No. 158 requires employers to fully recognize the obligations associated with single-employer defined benefit pension, retiree healthcare and other post-retirement plans in their financial statements. The provisions of SFAS No. 158 are effective as of the end of the fiscal year ending April 29, 2007. The Company is currently evaluating the impact of the provisions of SFAS No. 158.
Fair Value Measurements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurement where the FASB has previously determined that under those pronouncements fair value is the appropriate measurement. This statement does not require any new fair value measurements but may require companies to change current practice. This statement is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of the adoption of SFAS No. 157 where fair value measurements are used.
2) Supplemental Financial Information
Earnings Per Share:
Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Stock options, restricted stock units and convertible securities were determined to be anti-dilutive for all periods presented, except that stock options were dilutive for the quarter ended October 30, 2005.
The table below shows the components for the calculation of both basic and diluted earnings (loss) per share for the three and six months ended October 29, 2006 and October 30, 2005 (amounts in thousands):
Anti-dilutive securities outstanding for the three and six months ended October 29, 2006 and October 30, 2005 are as follows (amounts in thousands):
Common stock reserved for future issuance at October 29, 2006 was 16,413 shares.
Stock-Based Incentive Compensation:
Prior to May 1, 2006, in accordance with the provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Share-Based PaymentTransition and Disclosure, the Company accounted for share-based payment using the intrinsic value method under APB No. 25, Accounting for Stock Issued to Employees. The Company grants stock options under its stock-based incentive compensation plan and its non-employee directors plan with an exercise price no less than the fair market value of the underlying common shares on the date of grant. Vesting is generally based on three years of continuous service, and the options typically have a 10-year contractual term. Certain option and share awards provide for accelerated vesting if there is a change in control (as defined in the Plan). Accordingly, under APB No. 25, no compensation cost was previously recognized for stock options granted under either plan.
Effective May 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123R, Share-Based Payment, using the modified prospective transition method. Under the modified prospective transition method, compensation cost recognized for the six months ended October 29, 2006 included (1) compensation cost for all share-based awards granted prior to, but not yet vested as of, May 1, 2006 based on the grant date fair value determined in accordance with SFAS No.123, and (2) compensation cost for all share-based awards granted subsequent to May 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R. Results of prior periods have not been restated.
As a result of adopting SFAS No. 123R on May 1, 2006, total share-based payment cost of $1.1 million and $1.7 million was recognized during the 13 and 26 weeks ended October 29, 2006 as a component of general and administrative expenses.
The Company expects to recognize similar amounts of share-based payment costs over the remainder of the fiscal year.
As of October 29, 2006, there was $4.3 million of total unrecognized compensation cost related to non-vested stock options granted under the Companys stock-based incentive compensation plans which will be recognized over the remaining weighted average vesting period of 1.90 years.
If the fair value method under SFAS 123 had been applied in measuring share-based payment expense for the 13 and 27 weeks ended October 30, 2005, the pro forma effect on net loss and net loss per share would have been as follows, as previously disclosed (in thousands, except per share amounts):
Inventories are valued at the lower of cost (first-in, first-out) or market. Work in process and finished goods costs include materials, labor and manufacturing overhead. Inventories consist of the following (amounts in thousands):
Product Warranty Reserve:
Fleetwood typically provides customers of its products with a one-year warranty covering defects in material or workmanship with longer warranties on certain structural components. This warranty period typically commences upon delivery to the end user of the product. The Company records a liability based on the best estimate of the amounts necessary to settle existing and future claims on products sold as of the balance sheet date. Factors used in estimating the warranty liability include a history of units sold to customers, the average cost incurred to repair a unit and a profile of the distribution of warranty expenditures over the warranty period. The historical warranty profile is used to estimate the classification of the reserve between long-term and short-term on the balance sheet. Changes in the Companys product warranty liability are as follows (amounts in thousands):
Accumulated Other Comprehensive Loss:
Comprehensive loss includes all revenues, expenses, gains, and losses that affect the capital of the Company aside from issuing or retiring shares of stock. Net loss is one component of comprehensive loss. Based on the Companys current activities, the only other components of comprehensive loss consist of foreign currency translation gains or losses and changes in the unrealized gains or losses on marketable securities.
The difference between net loss and total comprehensive loss is shown below (amounts in thousands):
Post-Retirement Health Care Benefits:
The Company provides health care benefits to certain retired employees from date of retirement to when they become eligible for Medicare coverage. Employees become eligible for benefits after meeting certain age and service requirements. The cost of providing retiree health care benefits is actuarially determined and accrued over the service period of the active employee group.
The components of the net periodic post-retirement benefit cost are as follows (amounts in thousands):
The total amount of employers contributions expected to be paid during the current fiscal year is $611,000.
3) Industry Segment Information
Information with respect to industry segments is shown below (amounts in thousands):
In addition to the third-party revenues shown above, the Supply Group also generated the following intercompany revenues with the RV and Housing Groups:
4) Other Operating (Income) Expense, net
Other operating (income) expense, net consisted of $1.8 million in net gains from the sale of fixed assets during the quarter ended October 2006, offset by $2.6 million in restructuring costs. The prior year expense consisted of restructuring and impairment costs, as well as gains and losses from the sale of fixed assets. Restructuring costs, related to the reorganization of certain functions within the Company, consisted primarily of severance costs. Impairment costs related to the write-down of idle facilities held-for-sale.
Year-to-date other operating (income) expense, net included approximately $3.8 million of gains from the sale of idle facilities, partially offset by $2.6 million of restructuring costs, primarily severance payments. Prior year-to-date other operating (income) expense, net consisted of $4.3 million of severance costs and $1.0 million of impairment charges on idle facilities.
5) Income Taxes
The current quarter tax benefit relates to state and foreign tax liabilities.
The year-to-date tax provision is mainly attributable to a $3.6 million decrease in deferred tax assets. The utilization of the deferred tax assets occurred as a result of the Company realizing income through the repurchase of 1,000,000 shares of the Companys 6% convertible trust preferred securities. Prior to the repurchase, the unrealized gains on the securities were identified as a source of future income to support deferred tax assets, principally income realized
from the potential repurchase of the Companys 6% convertible trust preferred securities. The provision also includes state tax liabilities in several states, with no offsetting tax benefits in others. The prior period tax provision resulted primarily from the effect of increasing the partial valuation allowance attributed to the Companys deferred tax assets by $10.5 million. This change resulted from a reduction in the estimated benefit of various available tax strategies, which, if executed, would generate sufficient taxable income to realize the remaining net deferred tax asset. The provision also included state tax liabilities in several states, with no offsetting tax benefits in other states, and foreign tax benefits.
At October 29, 2006, the Company has identified unrealized sources of income, sufficient to support a deferred tax asset of $65.5 million compared to $69.1 million at fiscal year-end.
6) Discontinued Operations
On March 30, 2005, the Company announced plans to exit its manufactured housing retail and financial services businesses and completed the sale of the majority of the assets of these businesses by August 2005. The Company exited these businesses to stem losses that were being incurred in the retail operations. The return to a traditional focus on manufacturing operations was part of the Companys stated goal of achieving sustained profitability. As of October 29, 2006, and April 30, 2006, the remaining assets and liabilities from discontinued operations were not material.
Operating results of these businesses, including impairment charges, are classified as discontinued operations for all periods presented. Loss from discontinued operations, net consist of the following (amounts in thousands):
For the six months ended October 30, 2005, the net loss before impairment charges included interest expense on the retail flooring liability and the warehouse line of credit, which were repaid upon sale of their related collateral, of $1.2 million. No tax provision (benefit) was recorded on discontinued operations in fiscal 2006 or 2007. The Company expects to incur minor ongoing operating losses that are not expected to be material to the Companys overall financial results or to the Companys financial position.
7) Short-Term Borrowings
Secured Credit Facility:
During May 2004, the Companys credit facility was renewed and extended until July 31, 2007. As amended and restated, the facility includes a revolver, supplemented by a term loan. The aggregate short-term balance outstanding on the revolver and term loan as of October 29, 2006 and April 30, 2006 was $18.7 million and $5.7 million, respectively. As of April 30, 2006, an additional $16.5 million of the term loan was included in long-term borrowings. The revolving credit line and term loan bear interest, at the Companys option, at variable rates based on either Bank of Americas prime rate or one, two or three-month LIBOR.
As of October 29, 2006, the loan commitments for the revolver and the term loan stood at $187.0 million and $18.9 million, respectively, with a $25 million seasonal uplift from December through April. The loan commitments
for both the revolver and the term loan incorporate a reduction that occurs on the first day of each fiscal quarter in the amounts of $750,000 and $785,715, respectively. The Companys borrowing capacity, however, is governed by the amount of available borrowing base, consisting primarily of inventories and accounts receivable, that fluctuate significantly. The borrowing base is revised weekly for changes in receivables and monthly for changes in inventory balances. At the end of the quarter, the borrowing base totaled $183.5 million. After consideration of outstanding borrowings and standby letters of credit of $61.3 million, unused borrowing capacity was approximately $103.5 million. Borrowings are secured by receivables, inventory and certain other assets, primarily real estate, and are used for working capital and general corporate purposes. Under the senior credit agreement, Fleetwood Enterprises, Inc. is a guarantor of the borrowings and letters of credit of its wholly owned subsidiary, Fleetwood Holdings, Inc. The Company is subject to a springing covenant that is tied to achieving minimum levels of earnings before interest, taxes, depreciation and amortization but only if the Company fails to comply with certain liquidity requirements. Although the Company would not currently meet the targets established for the springing covenant, the covenant is not invoked because to date the Company has exceeded these minimum liquidity requirements and expects to do so for the foreseeable future.
On May 9, 2006, the facility was amended to authorize the Company, if it should elect to do so, to engage in certain financial transactions with respect to either the outstanding 6% convertible trust preferred securities of Fleetwood Capital Trust due 2028, or the 5% convertible senior subordinated debentures due 2023, including repurchases for up to $50 million in cash, incentivized conversions, or exchange offers. Of the $50 million limitation, $31 million was utilized to repurchase 6% convertible preferred securities with a par value of $50 million in July 2006. The May 2006 amendment also made refinements to the fixed-charge coverage ratio calculation that governs various pricing factors under the revolver.
8) Convertible Subordinated Debentures
As discussed further in the Companys Annual Report on Form 10-K, the Company owns a Delaware business trust that issued optionally redeemable convertible trust preferred securities convertible into shares of the Companys common stock. The combined proceeds from the sale of the securities and from the purchase by the Company of the common shares of the business trust were tendered to the Company in exchange for convertible subordinated debentures. These debentures represent the sole assets of the business trust and are presented as a long-term liability in the accompanying balance sheets.
Distributions on the securities held by the trust are payable quarterly in arrears at an annual rate of 6 percent. The Company has the right to elect to defer distributions for up to 20 consecutive quarters under the trust indenture governing the 6% convertible trust preferred securities. When the Company defers a distribution on the 6% convertible trust preferred securities, it is prevented from declaring or paying dividends on its common stock during the period of the deferral.
The Company purchased and cancelled 1,000,000 shares or 24.8 percent of its previously outstanding 6% convertible trust preferred securities in July 2006. The transaction price of $31 per share represented a discount of approximately 39 percent from the par value of $50 per share, taking into account accrued and unpaid interest. Long-term debt was reduced by $50 million and the Company recorded a pre-tax gain of approximately $18.5 million as other income in the first quarter of fiscal 2007.
9) Commitments and Contingencies
Producers of recreational vehicles and manufactured housing customarily enter into repurchase agreements with lending institutions that provide wholesale floorplan financing to independent dealers. These agreements generally provide that, in the event of a default by a dealer in its obligation to these credit sources, the Company will repurchase vehicles or homes sold to the dealer that have not been resold to retail customers. With most repurchase agreements, the Companys obligation ceases when the amount for which the Company is contingently liable to the lending institution has been outstanding for more than 12, 18 or 24 months, depending on the terms of the agreement. The contingent liability under these agreements approximates the outstanding principal balance owed by the dealer for units subject to the repurchase agreement, less any scheduled principal payments waived by the lender. Although the maximum potential contingent repurchase liability approximated $162 million for inventory at
manufactured housing dealers and $321 million for inventory at RV dealers as of October 29, 2006, the risk of loss is reduced by the potential resale value of any products that are subject to repurchase, and is spread over numerous dealers and financial institutions. The gross repurchase obligation will vary depending on the season and the level of dealer inventories. Typically, the fiscal third quarter repurchase obligation is greater than other periods due to higher RV dealer inventories. The RV repurchase obligation is greater than the manufactured housing obligation due to motor homes having a higher average selling price per unit and dealers holding more units in inventory. Past losses under these agreements have not been significant and lender repurchase demands have been funded out of working capital. Through the first six months of fiscal year 2007, the Company repurchased $1.8 million of product, which is consistent with the same period in the prior year, with a repurchase loss of $542,000 incurred this year compared to a repurchase loss of $434,000 in the prior year.
As part of the sale of the Companys manufactured housing retail business, there are currently approximately 76 leased manufactured housing retail locations assigned to the buyers. Although the Company received indemnification from the assignees, if the assignees were to become unable to continue making payments under the assigned leases, the Company estimates its maximum potential obligation with respect to the assigned leases to be $11.1 million as of October 29, 2006. The Company will remain contingently liable for such lease obligations for the remaining lease terms, which range from one month to nine years.
As of October 29, 2006, the Company was a party to 10 limited guarantees, aggregating $4.0 million, to obligations of certain retailers to floorplan lenders and an additional two unsecured guarantees aggregating $3.5 million for other obligations.
Fleetwood is also a party to certain guarantees that relate to its credit arrangements. These are more fully discussed in Note 12 of the Companys fiscal 2006 Annual Report on Form 10-K.
The fair value of the commitments and contingencies noted above is not material at October 29, 2006.
The Company is regularly involved in legal proceedings in the ordinary course of its business. Because of the uncertainties related to the outcome of the litigation and range of loss on cases other than breach of warranty, the Company is generally unable to make a reasonable estimate of the liability that could result from an unfavorable outcome. In other cases, including products liability and personal injury cases, the Company prepares estimates based on historical experience, the professional judgment of the Companys legal counsel, and other assumptions that are believed to be reasonable. As additional information becomes available, the Company reassesses the potential liability related to pending litigation and revises the related estimates. Such revisions and any actual liability that greatly exceed the Companys estimates could materially impact the results of operations and financial position.
In May 2003, the Company filed a complaint in state court in Kansas, in the 18th Judicial District, District Court, Sedgwick County, Civil Department, against The Coleman Company, Inc. (Coleman) in connection with a dispute over the use of the Coleman brand name. The lawsuit sought declaratory and injunctive relief. On June 6, 2003, Coleman filed an answer and counterclaimed against us alleging various counts, including breach of contract and trademark infringement. On November 17, 2004, after a hearing, the Court granted the Companys request for a permanent injunction against Coleman prohibiting Coleman from licensing the Coleman name for recreational vehicles to companies other than Fleetwood. Coleman has appealed that ruling. At the conclusion of trial, on December 16, 2004, the jury awarded monetary damages against Fleetwood on Colemans counterclaim in the amount of $5.2 million. On January 21, 2005, the Court granted Colemans request for treble damages, making the total amount of the award approximately $14.6 million. A charge to record this award was reflected in the Companys results for the third fiscal quarter of 2005. Payment has been stayed pending Fleetwoods appeal, which has been filed. The Company anticipates that the appeals will be argued early in calendar 2007. Pending its appeal, Fleetwood was required to post a letter of credit for $18 million, representing the full amount of the judgment plus an allowance for attorneys fees and interest. The Company is pursuing all available appellate remedies.
Brodhead et al v. Fleetwood Enterprises, Inc. was filed in federal court in the Central District of California on June 22, 2005. The complaint states a claim for damages growing out of certain California statutory claims with respect to alleged defects in a specific type of plastic roof installed on folding trailers from 1995 through 2003. The plaintiffs have further clarified and narrowed the class for which they are seeking certification, which now encompasses all original owners of folding trailers produced by Fleetwood Folding Trailers, Inc. with this type of roof but not including original purchasers who received an aluminum roof replacement and did not pay for freight. The subject matter of the claim is similar to a putative class action previously filed in California state court in Griffin et al v. Fleetwood Enterprises, Inc. et al. The California trial court denied class action certification in the Griffin matter on April 28, 2005, and the State of CaliforniaCourt of Appeal upheld the denial in a ruling issued on May 11, 2006. The plaintiffs did not appeal the Court of Appeal ruling in Griffin. Proceedings relating to the class certification in the Brodhead matter have been stayed pending the outcome of the state court certification in Griffin. It is not possible at this time to properly assess the risk of an adverse verdict or the magnitude of any possible exposure with respect to the Brodhead complaint. Fleetwood is vigorously defending the matter.
Fleetwood is one of the nations leaders in producing both recreational vehicles and manufactured housing. The RV Group or segment consists of the motor home, travel trailer and folding trailer divisions. The Housing Group or segment consists of the wholesale manufacturing operation.
In fiscal 2006, we sold 54,574 recreational vehicles. In calendar 2005, we had a 12.5 percent share of the overall recreational vehicle market, consisting of a 17.5 percent share of the motor home market, an 8.7 percent share of the travel trailer market and a 38 percent share of the folding trailer market.
In fiscal 2006, we shipped 22,681 manufactured homes, and were the second largest producer of HUD-Code homes in the United States in terms of units sold. In calendar 2005, we had a 16.2 percent share of the manufactured housing wholesale market.
Our business began in 1950 as a California corporation producing travel trailers and quickly evolved to what are now termed manufactured homes. We re-entered the recreational vehicle business with the acquisition of a travel trailer operation in 1964. The present company was incorporated in Delaware in 1977, and succeeded by merger to all the assets and liabilities of the predecessor company. Our manufacturing activities are conducted in 16 states within the U.S., and to a much lesser extent in Canada. We distribute our manufactured products primarily through a network of independent dealers throughout the United States and Canada. In fiscal 1999, we entered the manufactured housing retail business through a combination of key acquisitions and internal development of new retail sales centers. We later established a financial services subsidiary to provide finance and insurance products to the retail operation. We subsequently decided to divert these businesses and designated them as discontinued operations in March 2005 and selling them during the second quarter of fiscal 2006.
Favorable demographics suggest sustainable growth will likely be realized for RVs at least through the end of the decade as baby boomers reach the age brackets that historically have accounted for the bulk of retail RV sales. Additionally, 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 have been adversely affected by concerns about interest rates, fuel prices and diminished home equity financings. Industry motor home retail sales are expected to post a decline in calendar 2006, albeit smaller than in the prior year, with most of the continued weakness in the higher-end Class A and mid-priced Class C segments. However, if recent stability of economic factors extends into next calendar year, we may see the motor home market begin to rebound. Travel trailer retail sales are down slightly for the industry in calendar 2006 and have shown recent signs of weakness, combined with more competitive pricing and some discounting. After being in decline for several years, we believe the market for folding trailers should benefit from the move toward products that are less expensive and more fuel efficient to tow, as suggested by some recent signs of improvement in wholesale shipments.
Our overall market position in motor homes has been slightly impacted by industry weakness in products that have traditionally been an area of relative strength for Fleetwood. We are seeing a benefit from recent introductions of low-end Class A gas products and improvements made to our higher-end diesel units. In the Class C category, we intend to offer new products in the currently popular entry-level and fuel-efficient categories during 2007.
Our market share for travel trailers has been in decline for several years but initiatives to reverse these trends are well underway and are expected to take effect over time. Our 2007 model year product launch is essentially complete and early indications of dealer acceptance for most new models has been favorable resulting in stabilized or slightly improved market share, as well as improved shelf space on dealer lots.
We are the dominant producer of folding trailers and our market share has improved during calendar 2006. The business is well positioned to benefit from a rebound of this market sector.
We have renewed our focus on dealer development activities and have restructured our sales organizations to focus on individual brands and/or products in order to address the loss of shelf space in certain parts of our dealer network and to help ensure that our products are being appropriately represented, especially travel trailers in the East and Midwestern regions and Class C products on the East Coast.
Manufacturing quality processes and servicing continue to improve for our entire RV business and, although improvements are currently apparent in our finished products, the full financial benefits will only be realized over the longer term, through lower warranty and service costs. An evaluation and rationalization process for both our plants and their respective products is currently underway for travel trailers that will place emphasis on reducing the number of brands, and therefore floorplans, produced at each factory location to achieve manufacturing efficiencies. Net benefits should be apparent by the end of our fiscal year with improvements to margins and inventory levels.
Longer-term demand for affordable housing is expected to grow as a result of the rebuilding requirements in the Gulf States, greater numbers of baby boomers reaching retirement age and the escalating cost of site-built homes and conventional mortgage interest rates. Improvements in engineering and design continue to position manufactured and modular homes as a viable option 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.
Despite these improvements, the manufactured housing market has experienced a steep decline that began in 1999 before beginning to stabilize in 2004. Without the shipments generated by disaster relief activities in recent years, the industry is predicted to establish a 44-year low in 2006. Competition from repossessed homes, as well as a shortage of retail financing, relatively high retail interest rates, and more stringent lending standards for manufactured housing have adversely affected the industry.
Presently, levels of repossessed homes are closer to normal levels than they have been in recent years, and availability of financing has also stabilized as lending economics have begun to improve. A slowing of the overall housing market may impact near-term manufactured housing conditions, although other trends such as higher apartment rents and lower vacancy rates have historically been helpful to the industry. Depending on these factors and the extent of the financing actually generated, we anticipate that manufactured housing industry conditions may improve, albeit slowly.
Industry shipments decreased by 5.5 percent in the nine months ended September 30, 2006, but were likely down by more than twice that percentage excluding sales of homes that were built to FEMA specifications for disaster relief.
Market conditions by region are mixed but generally only the Gulf states are showing improvement. Other regions have softened, while California and parts of the Southeast are down sharply in recent months. The outlook in most areas continues to be uncertain.
Our own market position has been adversely affected by the sale of our retail operations in August 2005. This effect 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 through non-traditional channels, primarily to national operators of manufactured home communities, which have significantly reduced their activity over the last 12 months. In response to
these conditions, we have reduced manufacturing capacity during the quarter by consolidating two plants and have recently announced plans to consolidate two additional facilities into one.
Current activity in the Gulf Coast region by builders and developers is picking up 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 progress in this area. The sale of our network of Company-owned stores, which had a high concentration in the regions, may lessen our ability to fully participate in the upswing in more traditional dealer sales in the areas until we are able to complete the rebuilding of our independent dealer distribution network in the area.
In response to the weak market conditions, dealers throughout the country are maintaining low inventory levels, and in previously stronger markets such as Arizona, California and Florida, dealers are continuing to reduce their inventory levels. Although this reduction of inventories impacts current order levels, it enables the dealers to continue to operate 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 our new products. We continue to initiate incentive programs for our sales personnel and dealers to increase our product representation by incentivizing sales of aged inventory, such that it can be replaced by our dealers with new products. 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 community and park operators, as well as pursuing commercial and military projects.
We believe that new products recently introduced in all areas of our business 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 corporate and other general and administrative expenses, have resulted in a more cost-effective management structure. The full impact of these changes will be in place from the beginning of the new calendar year and represent substantial progress towards achieving our goal of sustainable profitability.
In the upcoming third fiscal quarter, slower winter sales and a highly competitive travel trailer market will cause operating results to be weaker than their second quarter levels. In addition, the prior year third fiscal quarter was unusual due to the large disaster relief contracts related to the Gulf Coast, affecting comparisons with that period.
Critical Accounting Policies
Our financial statements are prepared in accordance with U.S. generally accepted accounting principles. This requires us to make estimates and assumptions that affect the amounts reported in the financial statements and notes. We evaluate these estimates and assumptions on an ongoing basis using historical experience factors and various other assumptions that we believe are reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities. Actual results could differ from these estimates under different assumptions or conditions.
The following is a list of the accounting policies that we believe reflect our more significant judgments and estimates, and that could potentially result in materially different results under different assumptions and conditions.
Certain amounts previously reported have been reclassified to conform to the fiscal 2007 presentation.
Revenue for manufacturing operations is generally recorded when all of the following conditions have been met:
· an order for a product has been received from a dealer;
· written or oral approval for payment has been received from the dealers flooring institution;
· a carrier signs the delivery ticket accepting responsibility for the product as agent for the dealer; and
· the product is removed from Fleetwoods property for delivery to the dealer who placed the order.
Most manufacturing sales are made on cash terms, with most dealers financing their purchases under flooring arrangements with banks or finance companies. Products are not ordinarily sold on consignment, dealers do not ordinarily have the right to
return products, and dealers are typically responsible for interest costs to floorplan lenders. On average, we receive payments from floorplan lenders on products sold to dealers within approximately 15 days of the invoice date.
We typically provide customers of our products with a one-year warranty covering defects in material or workmanship with longer warranties on certain structural components. This warranty period typically commences upon delivery to the end user of the product. We record a liability based on our best estimate of the amounts necessary to resolve future and existing claims on products sold as of the balance sheet date. Factors we use in estimating the warranty liability include a history of units sold to customers, the average cost incurred to repair a unit and a profile of the distribution of warranty expenditures over the warranty period. A significant increase in dealer shop rates, the cost of parts or the frequency of claims could have a material adverse impact on our operating results for the period or periods in which such claims or additional costs materialize.
Generally, we are self-insured for health benefits, workers compensation, products liability and personal injury insurance. Under these plans, liabilities are recognized for claims incurred (including those incurred but not reported), changes in the reserves related to prior claims and an administration fee. At the time a claim is filed, a liability is estimated to settle the claim. The liability for workers compensation claims is guided by state statute. Factors considered in establishing the estimated liability for products liability and personal injury claims are the nature of the claim, the geographical region in which the claim originated, loss history, severity of the claim, the professional judgment of our legal counsel, and inflation. Any material change in these factors could have an adverse impact on our operating results. We generally maintain excess liability insurance with outside insurance carriers to minimize our risks related to catastrophic claims or unexpectedly large cumulative claims.
Deferred tax assets and liabilities are determined based on temporary differences between income and expenses reported for financial reporting and tax reporting. We are required to record a valuation allowance to reduce our net deferred tax assets to the amount that we believe is more likely than not to be realized. In assessing the need for a valuation allowance, we historically had considered relevant positive and negative evidence, including scheduled reversals of deferred tax liabilities, prudent and feasible tax planning strategies, projected future taxable income and recent financial performance. Since we have had cumulative losses in recent years, the accounting guidance suggests that we should not look to future earnings to support the realizability of the net deferred tax asset. Beginning in fiscal 2003, we concluded that a partial valuation allowance against our deferred tax asset was appropriate and have since made adjustments to the allowance as necessary. During the first quarter of fiscal 2007, we recorded a net adjustment to the deferred tax asset of $3.6 million with a corresponding provision for income taxes. The primary reason for this reduction was the realization of the deferred tax asset associated with the net gain of approximately $18.5 million from the purchase and cancellation of 1,000,000 shares of the 6% convertible trust preferred securities at $31 per share compared to the book value of $50 per share. The potential to realize taxable income from the repurchase of the remaining securities outstanding is a tax planning strategy that continues to support a portion of the deferred tax asset. The book value of the net deferred tax asset was supported by the availability of this and other tax strategies, which, if executed, were expected to generate sufficient taxable income to realize the book value of the remaining asset. We continue to believe that the combination of relevant positive and negative factors will enable us to realize the full value of the deferred tax assets; however, it is possible that the extent and availability of tax planning strategies will change over time and impact this evaluation. If, after future assessments of the realizability of our deferred tax assets, we determine that further adjustment is required, we will record the provision or benefit in the period of such determination.
We are regularly involved in legal proceedings in the ordinary course of our business. Because of the uncertainties related to the outcome of the litigation and range of loss on cases other than breach of warranty, we are generally unable to make a reasonable estimate of the liability that could result from an unfavorable outcome. In other cases, including products liability and personal injury cases, we prepare estimates based on historical experience, the professional judgment of our legal counsel, and other assumptions that we believe are reasonable. As additional information becomes available, we reassess the potential liability related to pending litigation and revise our estimates. Such revisions and any actual liability that greatly exceeds our estimates could materially impact our results of operations and financial position.
Producers of recreational vehicles and manufactured housing customarily enter into repurchase agreements with lending institutions that provide wholesale floorplan financing to independent dealers. Our agreements generally provide that, in the event of a default by a dealer in its obligation to these credit sources, we will repurchase product. With most repurchase agreements, our obligation ceases when the amount for which we are contingently liable to the lending institution has been outstanding for more than 12, 18 or 24 months, depending on the terms of the agreement. The contingent liability under these agreements approximates the outstanding principal balance owed by the dealer for units subject to the repurchase agreement less any scheduled principal payments waived by the lender. Although the maximum potential contingent repurchase liability approximated $162 million for inventory at manufactured housing dealers and $321 million for inventory at RV dealers as of October 29, 2006, the risk of loss is reduced by the potential resale value of any products that are subject to repurchase, and is spread over numerous dealers and financial institutions. The gross repurchase obligation will vary depending on the season and the level of dealer inventories. Typically, the fiscal third quarter repurchase obligation will be greater than other periods due to higher RV dealer inventories. The RV repurchase obligation is greater than the manufactured housing obligation due to motor homes having a higher average selling price per unit and dealers holding more units in inventory. Past losses under these agreements have not been significant and lender repurchase demands have been funded out of working capital. A summary of recent repurchase activity is set forth below (dollars in thousands):
Results of Operations
The following table sets forth certain statements of operations data expressed as a percentage of net sales for the periods indicated (certain amounts in this section may not recompute due to rounding):
Current Quarter Compared to Corresponding Quarter of Last Year
The following tables present consolidated net sales and operating income (loss) by segment for the quarters ended October 29, 2006 and October 30, 2005 (amounts in thousands):