**UNITED
      STATES**


**SECURITIES
      & EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-K**





**(Mark
      One)**





**x**
            **ANNUAL
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT
                **OF
                1934****




**For
      the fiscal year ended December 31, 2006**




**OR**




**o**
            **TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
**ACT
                OF 1934****




**For
      the transition period from _________________ to
      ________________**





Commission
      File Number 1-9792





**Cavalier
      Homes, Inc.**


(Exact
      name of registrant as specified in its charter)





**Delaware**
            
            **63-0949734**(State
                or other jurisdiction of
              incorporation
                or organization)
            
            (IRS
                Employer
              Identification
                No.)





**32
      Wilson Boulevard 100, Addison, Alabama 35540**


(Address
      of principal executive offices) (Zip Code)





**(256)
      747-9800**


(Registrant’s
      telephone number, including area code)





Securities
      registered pursuant to Section 12(b) of the Act:





Title
                of each class
            
            Name
                of each exchange on which registered**Common
                Stock, $0.10 Par Value**
            
            **American
                Stock Exchange**





Securities
      registered pursuant to Section 12(g) of the Act:


**None**





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act. Yes o No x




Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act. Yes o No x





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 xNo
o





Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the best
      of registrant’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form 10-K. [__]





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 Rule 12b-2 of the Exchange Act. (Check
      one):





Large
      Accelerated Filer oAccelerated
      Filer xNon-Accelerated
      Filer o





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). Yes o No x





The
      aggregate market value of the voting common equity held by non-affiliates
      computed by reference to the closing price of such stock on the American Stock
      Exchange as of July 1, 2006, was $79,503,376.





The
      number of shares outstanding of each of the registrant’s classes of common
      stock, as of March 2, 2007.


**Common,
      $0.10 par value: 18,344,580**





**Documents
      Incorporated by Reference**


Part
      III
      of this report incorporates by reference certain portions of the Registrant’s
      Proxy Statement for


its
      Annual Meeting of Stockholders to be held May 22, 2007.







**CAVALIER
      HOMES, INC.**


**ANNUAL
      REPORT ON FORM 10-K**


**FOR
      THE YEAR ENDED DECEMBER 31, 2006**





**PART
      I**





**ITEM
                1.**
              **BUSINESS*****(all
                  dollars in
                  thousands)***





**Overview**





Cavalier
      Homes, Inc., incorporated in 1984, is a Delaware corporation with its executive
      offices located at 32 Wilson Boulevard 100, Addison, Alabama 35540. Unless
      otherwise indicated by the context, references in this report to the terms
“we,”
“us,” “our” or to “Cavalier” include Cavalier Homes, Inc., its subsidiaries,
      divisions of these subsidiaries and their respective predecessors, if any.
      Cavalier is engaged in the production, sale, financing and insuring of
      manufactured homes.





We
      have
      three reportable segments: home manufacturing, financial services, and retail
      home sales. Our reportable segments are organized around products and services.
      Revenue, operating income (loss), identifiable assets and other financial data
      of our industry segments for the three years ended December 31, 2006 are
      contained in Note 12 of Notes to Consolidated Financial Statements in Part
      II.





During
      2005, we entered into agreements as a subcontractor to provide 2,638 homes
      to
      the Federal Emergency Management Agency (“FEMA”) as part of that agency’s
      hurricane relief efforts. In September 2005, we re-opened our Winfield, Alabama
      facility in order to assist in the production of the FEMA units. Revenue for
      shipments of homes to FEMA under these agreements was recorded in the last
      two
      quarters of 2005 and the first quarter of 2006. Shipments under these agreements
      had a significant impact on our results of operations and the manufactured
      housing industry during these three quarters.





**Home
      Manufacturing Operations**





At
      December 31, 2006, we owned seven home manufacturing facilities (excludes idled
      facilities) engaged in the production of manufactured homes, one plant that
      manufactures laminated wallboard and a cabinet manufacturing/assembly operation.
      See “Item 2. Properties.” Our operating home manufacturing facilities normally
      function on a single-shift, five-day week basis with the approximate annual
      capacity to produce approximately 19,000 floors depending on model mix and
      geographic demand.





The
      management of each of our home manufacturing units typically consists of a
      president or general manager, a production manager, a controller, a service
      manager, a purchasing manager and a quality control manager. These mid-level
      management personnel manage our home manufacturing operations, and typically
      participate in an incentive compensation system based upon their respective
      operation’s profitability.





The
      following table sets forth certain sales information for 2006, 2005, and
      2004:




**For
                  the Year Ended December 31,****2006**
              
              **2005**
              
              **2004**Number
                  of homes sold:Floor
                  shipments:HUD
                  code
              
              
              8,261
              
              
              91
              %
              
              10,648
              
              
              94
              %
              
              10,372
              
              
              96
              %Modular
              
              
              840
              
              
              9
              %
              
              641
              
              
              6
              %
              
              400
              
              
              4
              %Total
                  floor shipments
              
              
              9,101
              
              
              100
              %
              
              11,289
              
              
              100
              %
              
              10,772
              
              
              100
              %Home
                  shipments:Single
                  section
              
              
              1,669
              
              
              31
              %
              
              3,221
              
              
              45
              %
              
              1,949
              
              
              31
              %Multi
                  section
              
              
              3,678
              
              
              69
              %
              
              4,005
              
              
              55
              %
              
              4,387
              
              
              69
              %Total
                  home shipments
              
              
              5,347
              
              
              100
              %
              
              7,226
              
              
              100
              %
              
              6,336
              
              
              100
              %





We
      design
      and manufacture a wide range of homes with a focus on serving the low- to
      medium-priced manufactured housing market in the South Central and South
      Atlantic regions of the United States. Over the past five to six years, we
      have
      implemented plans to standardize parts and specifications to facilitate our
      ability to interchange production between home manufacturing facilities to
      better manage both order backlog and delivery cost. Additionally, basic product
      design and price point strategies are managed from an overall Company
      perspective to maximize dealer and retail customer penetration and minimize
      costs both from a manufacturing standpoint as well as for material
      purchases.




2




Construction
      of a home begins by welding steel frame members together and attaching axles,
      wheels and tires. The frame is then moved through the plant, stopping at a
      number of workstations where various components and sub-assemblies are attached.
      Certain sub-assemblies, such as floors, cabinets, ceilings and wall systems,
      are
      assembled at offline workstations. Sheetrock is being used on a frequent basis
      for wall construction, which may increase the manufacturing time. It takes
      approximately two to six days to complete construction of a home, depending
      on
      the particular size and options. The completed home is sold ready for connection
      to customer-supplied utilities. We believe the efficiency gained in producing
      many homes of similar design in a controlled manufacturing environment affords
      us faster completion time, greater consistency to specifications, and more
      predictable costs than a traditional site-built home.





The
      principal raw materials we purchase are steel, lumber, panels, sheetrock, vinyl
      siding, roofing materials, insulating materials, electrical supplies,
      appliances, roof trusses, plumbing fixtures, floor covering, and windows.
      Currently, we maintain approximately two to four weeks’ inventory of raw
      materials. We are dependent on a single source of supply for insulation, foam
      seal, and shingles. Our inability to obtain any materials used in the production
      of our homes, whether due to material shortages, destruction of manufacturing
      facilities or other events affecting production of these component parts, could
      affect our ability to meet or maintain production requirements.





Our
      component manufacturing/assembly subsidiaries provide most laminated wallboards
      and cabinets for our home manufacturing facilities. Additionally, certain of
      our
      home manufacturing facilities currently purchase lumber and roof trusses from
      joint ventures in which we own an interest. We believe prices we obtain for
      these products, from our joint ventures, are competitive with our other sources
      of supply.





Because
      the cost of transporting a manufactured home is significant, there is a
      practical limit to the distance between a manufacturing facility and our
      dealers. We believe that the location of our manufacturing facilities in
      multiple states allows us to serve more dealers in more markets. We generally
      arrange, at the dealer’s expense, for the transportation of finished homes to
      dealers using independent trucking companies. Dealers are responsible for
      placing the home on site, combining of multi-section homes, making utility
      connections and providing and installing certain accessory items and
      appurtenances, such as decks, air conditioning, carports and
      foundations.





**Products**





Our
      homes
      include both single-section and multi-section models, with the substantial
      majority of such products being “HUD Code Homes” which are manufactured homes
      that meet the specifications of the National Manufactured Home Construction
      and
      Safety Standards Act of 1974, as amended, and administered by the U.S.
      Department of Housing and Urban Development (“HUD”). Additionally, we produce
      multi-section modular homes, which are constructed to either local or regional
      building codes. The sections of some of the modular homes we produce are built
      on wooden floor systems and transported on carriers that are subsequently
      removed when positioned at the home site. Single-section homes are typically
      16
      feet wide and 80 feet in length and contain approximately 1,200 square feet.
      The
      multi-section models consist of two or more floor sections that are joined
      at
      the home site, vary in length from 48 to 80 feet and contain approximately
      1,200
      to 2,300 square feet. We provided specialized homes for FEMA’s disaster relief
      efforts in both 2004 and 2005. Disaster relief products were single-section
      homes 14 feet wide and 66 feet in length (2004) and 14 feet wide and 60 feet
      in
      length (2005) and contained approximately 900 square feet.





We
      currently offer approximately 250 different models of manufactured homes,
      including modular homes, with a variety of décors that are marketed under
      multiple brand names. The homes typically include a living room, dining area,
      kitchen, two to four bedrooms and two bathrooms. Each home contains a cook
      top/range and oven, refrigerator, microwave, dishwasher, water heater and
      central heating. Customers also may choose from available options including
      gas
      appliances, style and color of kitchen cabinets, various décor packages,
      recessed frames for use with permanent foundations and wind load and thermal
      options for use in certain geographic areas.





Our
      product development and engineering personnel design homes in consultation
      with
      operating management, sales representatives and dealers. They also evaluate
      new
      materials and construction techniques and use computer-aided and other design
      methods in a continuous program of product development, design and enhancement.
      Our product development activities do not require significant capital
      investments.




3




Our
      sales
      backlog was approximately $4,000
      at December 31, 2006 compared to approximately $36,600 at December 31, 2005.
      Our
      inventory levels, taking into account the number of operating facilities, are
      historically lower at year end during the idle period and return to normal
      levels at the end of the first quarter of each year. Inventory levels and sales
      backlog were higher than normal at December 31, 2005 due to restrictions by
      FEMA
      on our shipments, which prevented us from producing and delivering a number
      of
      finished homes in December 2005. These homes were subsequently delivered in
      the
      first quarter of 2006.





**Independent
      Dealer Network, Sales and Marketing**





At
      December 31, 2006, we had 75 participating dealer locations selling our homes
      under our Exclusive Dealer Program, which included four Company-owned retail
      locations. In addition, we market our homes through approximately 262 active
      non-exclusive independent dealer locations.





Since
      1991, we have sold homes through our independent exclusive dealer network.
      Our
      independent exclusive dealers market and sell only homes manufactured by us,
      while our independent non-exclusive dealers typically will choose to offer
      the
      products of other manufacturers in addition to ours. Our number of independent
      exclusive dealers and the percentage of our sales represented by them are
      summarized in the following table:


**As
                    of December 31,**
                
                **2006**
                
                **2005**
                
                **2004**Number
                    of independent exclusive dealer locations
                
                
                71
                
                
                113
                
                
                127Percentage
                    of manufactured home sales (excluding FEMA sales)
                
                
                58
                %
                
                70
                %
                
                62
                %


A
      significant majority of the decrease in exclusive dealer locations from 2005
      to
      2006 represents dealers who transferred to a Cavalier dealer program other
      than
      our exclusive dealer program.





Through
      our finance subsidiary, CIS Financial Services, Inc. (“CIS”), we purchase
      qualifying retail installment sales contracts primarily for manufactured homes
      sold through our dealer network.





Approximately
      93.7% of our sales in 2006 (excluding FEMA) were to dealers operating sales
      centers in our core states as follows: Louisiana - 19.7%, North Carolina -
      14.2%, Alabama - 12.8%, Mississippi - 9.6%, Georgia - 9.4%, Arkansas - 8.8%,
      South Carolina - 7.5%, Florida - 4.3%, Missouri - 3.5%, Tennessee - 2.1%, and
      Oklahoma - 1.8%.





Generally,
      we have written agreements with our independent dealers, which may be terminated
      at any time by either party, with or without cause, after a short notice period.
      We do not have any control over the operations of, or financial interests in,
      any of our independent dealers, including any of our independent exclusive
      dealers. The largest independent dealer accounted for approximately 7.0% of
      sales in 2006, excluding FEMA-related sales. During 2006 and 2005, hurricane
      disaster relief homes accounted for 5.7% and 25.6%, respectively, of total
      sales.





We
      believe that our independent dealer network enables us to avoid the substantial
      investment in management, capital and overhead associated with company-owned
      sales centers. To enable dealers to maximize retail market penetration and
      enhance customer service, typically only one dealer within a given market area
      distributes a particular product line of ours. We believe our strategy of
      selling homes through independent dealers helps to ensure that our homes are
      competitive with those of other manufacturers in terms of consumer
      acceptability, product design, quality and price.  Accordingly,
      a component of our business strategy is to continually strengthen our dealer
      relations. We believe our relations with our independent dealers, including
      our
      independent exclusive dealers, are good.





Our
      sales
      force is generally organized based on a geographic region with a regional sales
      manager and sales representatives who are compensated primarily on a commission
      basis. The sales representatives are charged with the day-to-day servicing
      of
      the needs of our independent dealers, including our exclusive dealers. We market
      our homes through product promotions, participation in regional manufactured
      housing shows, advertisements in local media and trade publications. As of
      December 31, 2006, we maintained a sales force of 29 full-time salesmen and
      four **** full-time
      general sales managers.





**Retail
      Financing and Insurance Activities**





A significant factor affecting sales of manufactured homes is the availability
      and
      terms of financing. CIS purchases qualifying retail installment sales contracts
      for manufactured homes sold primarily through our dealer network  and
      offers conventional, FHA, land/home and non-conforming mortgage products
      directly and indirectly. Additionally, we sell commissioned insurance products
      primarily to retail purchasers of our homes.




4




CIS
      seeks
      to provide competitive financing terms to customers of our dealers. CIS
      currently offers various conventional loan programs which require a down-payment
      or land equity ranging from 5% to 20% of the purchase price. Repayment terms
      generally range from 180 to 360 months, depending upon the type of home and
      amount financed, the amount of the down payment and the customer’s
      creditworthiness. CIS’s loans are secured by a purchase money security interest
      in the manufactured home and, in instances with land pledged as collateral,
      a
      real estate mortgage. As of December 31, 2006, all of CIS’s outstanding loans
      were secured. Loans purchased by CIS normally provide a fixed rate of interest
      with equal monthly payments and are non-recourse to the dealer. The interest
      rates applicable to CIS’s loan portfolio as of such date generally ranged from
      7.5% to 14%, and the approximate weighted average annual percentage interest
      rate was 9.2%. Currently, CIS is qualified to do business in twenty states
      as a
      retail finance company and is qualified in fifteen of these states as a full
      service mortgage bank.





For
      those
      retail customers who meet CIS’s lending standards, CIS strives to provide prompt
      credit approvals and funding of loans. CIS continually reviews its policies
      and
      procedures to facilitate prompt decision-making on loan applications. In the
      event an installment sale contract becomes 10 days delinquent, CIS normally
      contacts the customer promptly in an effort to cure the delinquency. Once a
      customer has failed to cure a default, CIS begins repossession procedures.
      After
      repossession, CIS normally has the home delivered to a dealer’s sales center
      where CIS attempts to resell the home or contracts with an independent party
      to
      resell the home. To a limited extent, CIS sells repossessed homes at
      wholesale.





Beginning
      in 1998, the business focus of CIS changed from building, holding and servicing
      a portfolio of loans to purchasing loans from retail customers of its dealers
      and originating direct mortgage loans that are subsequently sold to other
      financial institutions, with limited recourse. Recourse is applicable in the
      case of fraud or misrepresentation. CIS may also be required to repurchase
      the
      loan from certain third party financial institutions if any of the first four
      payments on a loan become 90 days delinquent. We have never been obligated
      to
      repurchase the loans under the limited recourse provisions of these contracts.
      Additionally, we are growing our volume of mortgage loans, many of which are
      construction loans, for which the length of time involved in closing the sale
      transaction is greater in comparison to a typical chattel (home only) loan.
      These loans are also sold to third party financial institutions. CIS does not
      retain the servicing function and does not earn interest income on those sold
      loans. Although
      the level of CIS’s future activities cannot presently be determined, we expect
      to utilize internally generated working capital and amounts generated from
      sales
      of loans under the retail finance agreements and mortgage agreements discussed
      in the previous paragraph to fund the purchase of retail installment sale
      contracts on homes sold by our dealers and may use borrowings to develop a
      portfolio of such installment sale contracts. We believe that our relationships
      with our dealers and brokers will assist the development of this business
      strategy.





We
      maintain a reserve for estimated credit losses on installment sale contracts
      owned by CIS to provide for future losses based on our historical loss
      experience, current economic conditions and portfolio performance.  Amounts
      provided for credit losses were $145, $857, and $75 in 2006, 2005, and 2004,
      respectively. Additionally, as a result of defaults, early payoffs and
      repossessions, net of recoveries, $272, $842, and $152 were charged against
      the
      reserve in 2006, 2005, and 2004, respectively. The reserve for credit losses
      at
      December 31, 2006 was $841 as compared to $968 at December 31,
      2005.





In
      2006,
      2005, and 2004, CIS repossessed 22, 16, and 14 homes, respectively. Our
      inventory of repossessed homes was 5 homes at December 31, 2006 as compared
      to 9
      homes at December 31, 2005. Our net losses resulting from repossessions on
      CIS
      purchased loans as a percentage of the average principal amount of such loans
      outstanding for fiscal 2006, 2005, and 2004 was 2.16%, 6.87%, and 1.53%,
      respectively. There
      can
      be no assurance that our future results with respect to delinquencies and
      repossessions will be consistent with our past experience.





The
      loan
      portfolio contains loans identified as presenting
      uncertainty with respect to collectibility (customers in bankruptcy) .
      These
      loans totaled $544 (16 loans) and $631 (16 loans) at December 31, 2006 and
      2005,
      respectively, and are excluded from the following two tables.





At
      December 31, 2006 and December 31, 2005, delinquencies, except for loans
      identified as presenting uncertainty with respect to collectibility, expressed
      as a percentage of the total number of installment sale contracts which CIS
      owned were as follows:


**Delinquency
                    Percentage****December
                    31,**
                
                **Total
                    Numberof Contracts**
                
                **30
                    Days**
                
                **60
                    Days**
                
                **90
                    Days**
                
                **Total**2006
                
                249
                
                
                1.72
                %
                
                1.29
                %
                
                0.43
                %
                
                3.44
                %2005
                
                320
                
                
                1.56
                %
                
                0.00
                %
                
                0.00
                %
                
                1.56
                %
  5
 At
        December 31, 2006 and December 31, 2005, delinquencies, except for loans
        identified as presenting uncertainty with respect to collectibility, expressed
        as a percentage of the total outstanding principal balance of installment
        sale
        contracts which CIS owned were as follows:


**Delinquency
                    Percentage****December
                    31,**
                
                **Total
                      Value**of
                      Contracts
                
                **30
                    Days**
                
                **60
                    Days**
                
                **90
                    Days**
                
                **Total**2006
                
                $
                12,265
                
                
                1.77
                %
                
                0.95
                %
                
                0.56
                %
                
                3.28
                %2005
                
                $
                15,067
                
                
                1.46
                %
                
                0.00
                %
                
                0.00
                %
                
                1.46
                %


Certain
      operating data relating to CIS are set forth in the following
      table:


**December
                    31,****2006**
                
                **2005**
                
                **2004**Total
                    loans receivable
                
                $
                12,265
                
                $
                15,067
                
                $
                8,839Allowance
                    for credit losses
                
                $
                841
                
                $
                968
                
                $
                953Number
                    of loans outstanding
                
                
                249
                
                
                320
                
                
                221Net
                    loss ratio on average outstanding principal balance
                
                
                2.16
                %
                
                6.87
                %
                
                1.53
                %Weighted
                    average annual percentage rate
                
                
                9.2
                %
                
                10.4
                %
                
                11.0
                %


Since
      its
      inception, CIS has been restricted in the amount of loans it could purchase
      based on underwriting standards, as well as the availability of working capital
      and funds borrowed under its credit line with its primary lender. From time
      to
      time, we evaluate the potential to sell all or a portion of our remaining
      installment loan portfolio, in addition to the periodic sale of installment
      contracts purchased by CIS in the future. CIS is currently selling loans to
      lenders under various retail finance contracts and mortgage contracts. We
      believe the periodic sale of installment and mortgage contracts under these
      retail finance and mortgage agreements will reduce requirements for both working
      capital and borrowings, increase our liquidity, reduce our exposure to interest
      rate fluctuations and enhance the ability of CIS to increase its volume of
      loan
      purchases. There can be no assurance, however, that additional sales will be
      made under these agreements, or that we will be able to realize the expected
      benefits from ** such
      agreements.





In
      late
      2006, CIS was awarded up to $40,000 by the Federal National Mortgage Association
      (“Fannie Mae”) to implement a “High End Product Pilot Program” for HUD code
      manufactured multi-section homes. This program will allow “site-built”
comparables, pricing and underwriting for high end HUD code multi-section homes
      for which enhanced property eligibility requirements are met. CIS expects to
      sell loans originated under this program, but will retain servicing of the
      loans. The first loan under this program is expected to be closed in the first
      quarter of 2007.





**Wholesale
      Dealer Financing and Repurchase Obligations**





In
      accordance with manufactured housing industry practice, our dealers finance
      a
      majority of their purchases of manufactured homes through wholesale “floor plan”
financing arrangements. Under a typical floor plan financing arrangement, a
      financial institution provides the dealer with a loan for the purchase price
      of
      the home and maintains a security interest in the home as collateral. The
      financial institution which provides financing to the dealer customarily
      requires us to enter into a separate repurchase agreement with the financial
      institution under which we are obligated, upon default by the dealer, to
      repurchase the financed homes at a declining price based upon our original
      invoice date and price. A portion of purchases by dealers are pre-sold to retail
      customers and are paid through retail financing commitments.





The
      risk
      of loss under repurchase agreements is lessened by the fact that (i) sales
      of
      our manufactured homes are spread over a relatively large number of independent
      dealers, the largest of which accounted for approximately 7.0% of sales in
      2006,
      excluding FEMA-related homes, (ii) the price we are obligated to pay under
      such
      repurchase agreements declines based on predetermined amounts over the period
      of
      the agreement (generally 18 to 24 months) and (iii) we historically have been
      able to resell homes repurchased from lenders. As of December 31, 2006, the
      maximum amount for which we are contingently liable under such agreements was
      approximately $62,000 for which we had a recorded reserve for repurchase
      commitments of $1,513. See “Item 7. Management’s Discussion and Analysis:
      Critical Accounting Estimates.”





6




**Quality
      Control, Warranties and Service**





We
      believe the quality in materials and workmanship, continuous refinement in
      design and production procedures as well as price and other market factors,
      are
      important elements in the market acceptance of manufactured homes. We maintain
      a
      quality control inspection program at various production stages. Our
      manufacturing facilities and the plans and specifications of our HUD-code
      manufactured homes have been approved by a HUD-designated agency. An
      independent, HUD-approved third-party regularly inspects our HUD-code
      manufactured homes for compliance during construction. Modular product is also
      inspected and/or certified on a state-by-state basis.





We
      provide the initial retail homebuyer with a one-year limited warranty against
      manufacturing defects in the home’s construction. Warranty services after the
      sale are performed, at our expense, by our personnel, dealers or independent
      contractors. Additionally, direct warranties often are provided by the
      manufacturers of specific components and appliances.





We
      generally employ a full-time service manager at each of our home manufacturing
      units and at December 31, 2006, employed 114 full-time service personnel to
      provide administrative and on-site service and to correct production
      deficiencies that are attributable to the manufacturing process. Warranty
      service constitutes a significant cost to us, and our management continues
      to
      place emphasis on diagnosing potential problem areas to help minimize costly
      field repairs. At December 31, 2006, we had established a reserve for future
      warranty claims of $11,900 relating to homes sold, based upon management’s
      assessment of historical experience factors and current industry
      trends.





**Competition**





The
      manufactured housing industry is highly competitive, characterized by low
      barriers to entry and severe price competition. Competition is based primarily
      on price, product features and quality, reputation for service quality, depth
      of
      field inventory, delivery capabilities, warranty repair service, dealer
      promotions, merchandising and terms of dealer (wholesale) and retail (consumer)
      financing. We also compete with other manufacturers, some of which maintain
      their own retail sales centers, for quality independent dealers. In addition,
      our manufactured homes compete with other forms of low-cost housing, including
      site-built, prefabricated, modular homes, apartments, townhouses and
      condominiums. The selection by retail buyers of a manufactured home rather
      than
      an apartment or other alternative forms of housing is significantly affected
      by
      their ability to obtain satisfactory financing. We face direct competition
      from
      numerous manufacturers, many of which possess greater financial, manufacturing,
      distribution and marketing resources.





According
      to the Manufactured Housing Institute’s (“MHI”) Monthly Economic Report, in
      December 2006 there were 67 manufacturers of manufactured homes which operated
      205 facilities compared to 67 manufacturers which operated 217 facilities in
      December 2005. Our market share industry wide was 4.0% and 4.3% in 2006 and
      2005, respectively. In our core states, our market share was 9.0% at December
      31, 2006 and 9.4% at December 31, 2005. At December 31, 2006, our core states
      consisted of Alabama, Arkansas, Florida, Georgia, Louisiana, Mississippi,
      Missouri, North Carolina, Oklahoma, South Carolina and Tennessee.





Our
      business strategy currently includes the continued operation of financial
      services provided through CIS. We believe that operations of CIS have a positive
      impact on our efforts to sell our products and enhance our competitive ability
      within the industry. However, due to strong competition in the retail finance
      segment of the industry from companies much larger than CIS, there can be no
      assurance that CIS will be able to expand its operations or that it will have
      a
      positive impact on our ability to compete.





**Regulation**





Our
      businesses are subject to a number of federal, state and local laws, regulations
      and codes. Construction of manufactured housing is governed by the National
      Manufactured Home Construction and Safety Standards Act of 1974, as amended,
      and
      regulations issued thereunder by HUD, which have established comprehensive
      national construction standards. The HUD regulations cover all aspects of
      manufactured home construction, including structural integrity, fire safety,
      wind loads, thermal protection and ventilation. Such regulations preempt state
      and local regulations on such matters. We cannot presently determine what,
      if
      any, legislation may be adopted by Congress or state or local governing bodies,
      or the effect any such legislation may have on us or the manufactured housing
      industry.





Our
      manufacturing facilities and the plans and specifications of our manufactured
      homes have been approved by a HUD-designated agency. Furthermore, an
      independent, HUD-approved third-party regularly checks our manufactured homes
      for compliance during construction. Failure to comply with the HUD regulations
      could expose us to a wide variety of sanctions, including closing our
      manufacturing facilities. We believe our manufactured homes meet or surpass
      all
      present HUD requirements.




7




HUD
      has
      promulgated regulations with respect to structural design, wind loads and energy
      conservation. Our operations were not materially affected by the regulations;
      however, HUD and other state and local governing bodies have these and other
      regulatory matters under continuous review, and we cannot predict what effect
      (if any) additional regulations promulgated by HUD or other state or local
      regulatory bodies would have on us or the manufactured housing
      industry.





Certain
      components of manufactured and modular homes are subject to regulation by the
      U.S. Consumer Product Safety Commission (“CPSC”), which is empowered to ban the
      use of component materials believed to be hazardous to health and to require
      the
      repair of defective components. The CPSC, the Environmental Protection Agency
      and other governmental agencies are evaluating the effects of formaldehyde.
      Regulations of the Federal Trade Commission also require disclosure of a
      manufactured home’s insulation specifications. Manufactured, modular and
      site-built homes may be built with compressed board, wood paneling and other
      products that contain formaldehyde resins. Since February 1985, HUD has
      regulated the allowable concentration of formaldehyde in certain products used
      in manufactured homes and required manufacturers to warn purchasers concerning
      formaldehyde associated risks. We currently use materials in our manufactured
      homes that we believe meet HUD standards for formaldehyde emissions and
      otherwise comply with HUD regulations in this regard.





The
      transportation of manufactured homes on highways is subject to regulation by
      various federal, state and local authorities. Such regulation may prescribe
      size
      and road use limitations and impose lower than normal speed limits and various
      other requirements.





Our
      manufactured homes are subject to local zoning and housing regulations. A number
      of states require manufactured home producers to post bonds to ensure the
      satisfaction of consumer warranty claims. A number of states have adopted
      procedures governing the installation of manufactured homes. Utility connections
      are subject to state and local regulation.





We
      are
      subject to the Magnuson-Moss Warranty Federal Trade Commission Improvement
      Act,
      which regulates the descriptions of warranties on products. The description
      and
      substance of our warranties are also subject to a variety of state laws and
      regulations.





Our
      operations are subject to federal, state and local laws and regulations relating
      to the generation, storage, handling, emission, transportation and discharge
      of
      materials into the environment. We currently do not believe we will be required
      under existing environmental laws and enforcement policies to expend amounts
      which will have a material adverse effect on our results of operations or
      financial condition. However, the requirements of such laws and enforcement
      policies have generally become stricter in recent years. Accordingly, we are
      unable to predict the ultimate cost of compliance with environmental laws and
      enforcement policies.





A
      variety
      of federal laws affect the financing of manufactured homes, including the
      financing activities conducted by CIS. The Consumer Credit Protection Act
      (Truth-in-Lending) and Regulation Z promulgated thereunder require substantial
      disclosures to be made in writing to a consumer with regard to various aspects
      of the particular transaction, including the amount financed, the annual
      percentage rate, the total finance charge, itemization of the amount financed
      and other matters. The Equal Credit Opportunity Act and Regulation B promulgated
      thereunder prohibit discrimination against any credit applicant based on certain
      prohibited bases, and also require that certain specified notices be sent to
      credit applicants whose applications are denied. The Fair Credit Reporting
      Act
      promulgated thereunder regulates how customer credit reports are obtained and
      handled. The Federal Trade Commission has adopted or proposed various trade
      regulation rules to specify and prohibit certain unfair credit and collection
      practices and also to preserve consumers’ claims and defenses. The Government
      National Mortgage Association (“GNMA”) specifies certain credit underwriting
      requirements in order for installment manufactured home sale contracts to be
      eligible for inclusion in a GNMA program. HUD also has promulgated substantial
      disclosure and substantive regulations and requirements in order for a
      manufactured home installment sale contract to qualify for insurance under
      the
      Federal Housing Authority (“FHA”) program, and the failure to comply with such
      requirements and procedures can result in loss of the FHA guaranty protection.
      In addition, the financing activities of CIS also may become subject to the
      reporting and disclosure requirements of the Home Mortgage Disclosure Act.
      In
      addition to the extensive federal regulation of consumer credit matters, many
      states also have adopted consumer credit protection requirements that may impose
      significant requirements for consumer credit lenders. For example, many states
      require that a consumer credit finance company such as CIS obtain certain
      regulatory licenses or permits in order to engage in such business in that
      state, and many states also set forth a number of substantive contractual
      limitations regarding provisions that permissibly may be included in a consumer
      contract, as well as limitations upon the permissible interest rates, fees
      and
      other charges that may be imposed upon a consumer. Our failure to comply with
      the requirements of federal or state law pertaining to consumer credit could
      result in the invalidity of the particular contract for the affected consumer,
      civil liability to the affected customers, criminal liability and other adverse
      results. The sale of insurance products by us is subject to various state
      insurance laws and regulations, which govern allowable charges and other
      insurance practices.





8




**Employees**





As
      of
      December 31, 2006, we had 1,771 employees, of whom 1,422 were engaged in home
      manufacturing and supply distribution, 33 in sales, 114 in warranty and service,
      152 in general administration, 2 in delivery, 32 in finance and insurance
      services and 16 in the operation of retail locations . At
      year-end, none of our employees were covered by a collective bargaining
      agreement. Management considers our relations with our employees to be
      good.




**Available
      Information**





Additional
      information regarding our executive officers and Board of Directors may be
      obtained in the Proxy Statement relating to our 2007 Annual Meeting of
      Stockholders. In addition, we periodically file reports and other information
      with the Securities and Exchange Commission (“SEC”) under the *Securities
      Exchange Act of 1934.* The
      public may read and copy any materials at the SEC’s Public Reference Room at 100
      F Street, NE, Washington, DC 20549. The public may obtain information on the
      operation of the Public Reference Room by calling the SEC at 1.800.SEC.0330.
      The
      public reports, proxy and information statements filed with the SEC of
      electronic filers can be accessed via the SEC’s Internet website *(http://www.sec.gov).* Additionally,
      the public may request copies of our documents by calling our Investor Relations
      Department at 256.747.9800; or visit our website at *http://www.cavhomesinc.com* .
      We make
      available, free of charge, through the Investor Relations portion of our
      website, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q,
      Current Reports on Form 8-K, and amendments to such reports filed or furnished
      pursuant to Section 13(a) or 15(d) of the *Securities
      Exchange Act of 1934* ,
      as
      amended, as soon as reasonably practicable after we electronically file such
      material with, or furnish it to, the SEC.





**ITEM
              1A.**
            **RISK
                FACTORS**


If
      you
      are interested in making an investment in Cavalier, you should carefully
      consider the following risk factors concerning our business, in addition to
      the
      other information contained in this Report on Form 10-K:





***The
      manufactured housing industry is both cyclical and seasonal in nature, and
      the
      industry as a whole has declined significantly over the past eight
      years.***





The
      manufactured housing industry is highly cyclical and seasonal and has
      experienced wide fluctuations in aggregate sales in the past, resulting in
      the
      failure of many manufacturing concerns. Many of the same national and regional
      economic and demographic factors that affect the broader housing industry also
      affect the market for manufactured homes. Historically, most sectors of the
      home
      building industry, including the manufactured housing industry, have been
      affected by the following, among other things:





·
            changes
                in general economic conditions;


·
            inflation;


·
            levels
                of consumer confidence;


·
            employment
                and income levels;


·
            housing
                supply and demand;


·
            availability
                of alternative forms of housing;


·
            availability
                of wholesale (dealer) financing;


·
            availability
                of retail (consumer) financing;


·
            the
                level and stability of interest rates;
                and


·
            the
                availability of raw materials.





MHI
      reported that from 1983 to 1991, aggregate domestic shipments of manufactured
      homes declined 42%. According to industry statistics, after a ten-year low
      in
      floor shipments in 1991, the industry recovered significantly. Between 1992
      and
      1998, floor shipments increased each year, as set forth in the table below,
      although the growth rate gradually slowed and began to decline in 1999, and
      has
      declined significantly since.





9




Percentage
      Increase (Decrease) in Floor Shipments through 2006:


1992
                
                
                21
                %
                
                1997
                
                
                1
                %
                
                2002
                
                
                (11
                )%1993
                
                
                22
                %
                
                1998
                
                
                8
                %
                
                2003
                
                
                (21
                )%1994
                
                
                23
                %
                
                1999
                
                
                (4
                )%
                
                2004
                
                
                (3
                )%1995
                
                
                12
                %
                
                2000
                
                
                (26
                )%
                
                2005
                
                
                6
                %1996
                
                
                10
                %
                
                2001
                
                
                (21
                )%
                
                2006
                
                
                (16
                )%


During
      much of the 1990s, the manufactured housing industry experienced increases
      in
      both the number of retail dealers and manufacturing capacity, which we believe
      ultimately created slower retail turnover, higher dealer inventories and
      increased price competition. Industry results for 2005 posted the first increase
      since 1998 with floor shipments increasing over 2004 by 6% due to industry
      wide
      orders by FEMA as part of that agency’s hurricane disaster relief efforts. MHI
      estimated FEMA shipments in the last four months of 2005 totaled approximately
      21,000 floors and approximately 4,000 floors in 2004. Some manufactured housing
      wholesale and retail lenders have discontinued business in the industry, and
      some of the remaining lenders have raised their interest rates and tightened
      their credit standards. We believe these conditions reflect that the
      manufactured housing industry is in a down cycle, which has had a material
      adverse effect on our results of operations and financial condition. Sales
      in
      the manufactured housing industry are also seasonal in nature, with sales of
      homes traditionally being stronger in April through October and weaker during
      the first and last part of the calendar year. While seasonality did not
      significantly impact our business from 1992 through 1996, when industry
      shipments were steadily increasing, the continued tightening of competitive
      conditions seems to signal a return to the industry’s traditional seasonal
      patterns. Approximately 93.7% of our sales in 2006 were to dealers operating
      sales centers in our core states. We cannot predict how long the tightening
      of
      competitive and industry conditions will last, or what the extent of their
      impact will be on our future results of operations and financial condition.
      Industry projections for wholesale home shipments in 2007 are in the range
      of
      112,000 to 120,000.





***Our
      business strategy includes plans to grow our business in a competitive
      environment, and we may not be able to sustain profitability if we fail to
      maintain and strengthen our market share.***





Our
      current business strategies are to:





·
            control
                costs in light of currently prevailing industry
                conditions;


·
            improve
                manufacturing cost efficiencies;


·
            attempt
                to generate an increase in sales in an increasingly competitive
                environment;


·
            improve
                brand management and penetration;


·
            increase
                market share;


·
            maintain
                consistent profitability;


·
            develop
                our exclusive and independent dealer
                network;


·
            pursue
                the financing, insurance and other activities of CIS and the financial
                services segment;


·
            attempt
                to further develop modular home sales base in part by alternative
                distribution channels; and


·
            eliminate
                redundant products to streamline production in an effort to reduce
                costs.





Downturns
      in shipments in the manufactured housing industry and a decline in the demand
      for our homes have had a material adverse effect on us. Our ability to execute
      our business strategy depends on a number of factors, including the following:





·
            general
                economic and industry conditions;


·
            our
                ability to control costs if industry production capacity decreases
                beyond
                current levels;


·
            competition
                from other companies in our
                industry;


·
            our
                ability to attract, retain or sell to additional independent dealers,
                especially exclusive dealers;


·
            the
                availability of semi-skilled workers in the areas in which our
                manufacturing facilities are located;


·
            the
                ability of CIS and our insurance and component parts operations to
                be
                competitive;


·
            the
                availability of capital and financing;


·
            the
                ability of our independent dealers and retail locations to compete
                under
                current industry conditions;


·
            the
                ability to produce modular and HUD code products within the same
                manufacturing plants;


·
            the
                availability and terms of wholesale and retail financing from lenders
                in
                the manufactured housing industry;
                and


·
            market
                acceptance of product offerings.





10




There
      are
      other factors in addition to those listed above, many of which are beyond our
      control. We cannot assure investors that our business strategy will be
      successful. If our strategy is unsuccessful, this may have a material adverse
      effect upon our results of operations or financial condition.





***Our
      industry suffers from a lack of third-party financing, and our financial
      condition and results of operations could be negatively affected if additional
      third-party financing for the purchases of our homes does not become
      available.***





Third-party
      lenders generally provide consumer financing for manufactured home purchases.
      Our sales depend in large part on the availability and cost of financing for
      manufactured home purchasers and dealers as well as our own retail locations.
      The availability and cost of such financing is further dependent on the number
      of financial institutions participating in the industry, the departure of
      financial institutions from the industry, the financial institutions’ lending
      practices, and the strength of the credit markets generally, governmental
      policies and other conditions, all of which are beyond our control. Throughout
      the past eight years the industry has been impacted significantly by reduced
      financing available at both the wholesale and retail levels, with several
      lenders exiting the marketplace or limiting their participation in the industry,
      coupled with more restrictive credit standards and increased home repossessions
      which re-enter home distribution channels and limit wholesale shipments of
      new
      homes. The much-anticipated infusion of new and competitive lending capacity,
      which we believe is essential to support demand at higher levels, has not yet
      materialized. Until there is substantial entry of finance resources to the
      manufactured housing market, we believe a meaningful expansion for the industry
      will be delayed. In late 2006, CIS was awarded up to $40,000 by Fannie Mae
      to
      implement a “High End Product Pilot Program” for HUD code manufactured
      multi-section homes. This program will allow “site-built” comparables, pricing
      and underwriting for high end HUD code multi-section homes for which enhanced
      property eligibility requirements are met. We are unable to determine if this
      pilot program will develop into an on-going Fannie Mae program and provide
      a
      source of financing our industry needs for growth. Unfavorable changes in the
      availability and terms of financing in the industry may have a material adverse
      effect on our results of operations or financial condition.





***Industry
      inventories of completed homes can vary, which may impact retail demand and
      our
      ability to sell additional homes at current prices.***





Changes
      in the level of retail inventories in the manufactured housing industry, either
      up or down, can have a significant impact on our operating results. For example,
      due to the rapid expansion of the retail distribution network in the
      manufactured housing industry that occurred in much of the 1990’s, there was an
      imbalance between industry retail inventories and consumer demand for
      manufactured homes. The deterioration in the availability of retail financing,
      along with competition from repossessed homes, extended the inventory adjustment
      period beyond what was originally expected. If these trends were to continue,
      or
      if retail demand were to weaken further, the inventory overhang could result
      in
      even greater intense price competition, further pressure profit margins within
      the industry, and have a material adverse effect on us. The inventory of
      Cavalier manufactured homes at all retail locations, including Company-owned
      retail sales centers, increased in 2006 to $87,400 from $71,000 in 2005.
      Significant unfavorable developments or further deterioration within the
      industry would undoubtedly have an adverse impact on Company operating
      results.





***We
      depend on independent dealers for substantially all retail sales of our
      manufactured homes, and the failure or market exit of a significant number
      of
      these dealers could negatively affect our financial condition and results of
      operations.***





We
      depend
      on independent dealers for substantially all retail sales of our manufactured
      homes. Typically only one dealer within a given market area distributes a
      particular brand of ours. Our relationships with our dealers are cancelable
      on
      short notice by either party. The manufactured housing industry recently has
      experienced a trend of increasing competition for quality independent dealers.
      In addition, a number of dealers in the industry are experiencing difficulty
      in
      the current market conditions, as a number of retail dealers have failed and
      more dealers may fail before the current downturn ends. While we believe that
      our relations with our independent dealers are generally good, we cannot assure
      our investors that we will be able to maintain these relations, that these
      dealers will continue to sell our homes, that these dealers will be successful,
      or that we will be able to attract and retain quality independent
      dealers.


11


***Competition
      from other manufactured housing providers may adversely affect our
      profitability*** .





The
      production and sale of manufactured homes is a highly competitive industry,
      characterized by low barriers to entry and severe price competition. Competition
      is based primarily on the following factors:




·
            price;


·
              product
                  features and quality;
 ·
              reputation
                  for service quality;
 ·
              depth
                  of field inventory;
 ·
              delivery
                  capabilities;
 ·
              warranty
                  repair service;
 ·
              dealer
                  promotions;
 ·
              merchandising;
                  and
 ·
              terms
                  of wholesale (dealer) and retail (consumer) financing.




In
      addition, we compete with other manufacturers, some of which maintain their
      own
      retail sales centers, for independent dealers. Manufactured homes also compete
      with other forms of low-cost housing, including site-built, prefabricated and
      modular homes, apartments, townhouses and condominiums. We face direct
      competition from numerous manufacturers, many of which possess greater
      financial, manufacturing, distribution and marketing resources. As a result
      of
      these competitive conditions, we may not be able to sustain past levels of
      sales
      or profitability.





***We
      sell a majority of our homes to dealers who finance the purchases under floor
      plan arrangements, which requires us to enter into contingent repurchase
      agreements to repurchase the homes from the lender in certain
      circumstances.***





Manufactured
      housing companies customarily enter into repurchase and other recourse
      agreements with lending institutions, which have provided wholesale floor plan
      financing to dealers. A majority of our sales are made to dealers located
      primarily in the South Central and South Atlantic regions of the United States
      pursuant to repurchase agreements with lending institutions. These agreements
      generally provide that we will repurchase our products from the lending
      institutions at a declining price based upon our original invoice date and
      price
      in the event such product is repurchased upon a dealer’s default. The risk of
      loss under repurchase agreements is lessened by the fact that (i) sales of
      our
      manufactured homes are spread over a relatively large number of independent
      dealers; (ii) the price that we are obligated to pay under such repurchase
      agreements generally declines over the period of the agreement and also declines
      during such period based on predetermined amounts; and (iii) we have been able
      to resell homes repurchased from lenders. While we have established a reserve
      for possible repurchase losses, we cannot assure investors that we will not
      incur material losses in excess of these reserves in the future.





***Our
      decisions regarding credit risk could be inaccurate and our reserve for credit
      losses could be inadequate, which could adversely affect our financial condition
      and results of operations.***





We
      purchase retail installment finance loans that have been originated by our
      dealers and originate mortgage loans. We maintain a reserve for estimated credit
      losses on installment sale contracts and mortgage loans we own to provide for
      future losses based on our historical loss experience, current economic
      conditions and portfolio performance. It is difficult to predict with any
      certainty the appropriate reserves to establish, and we cannot assure investors
      that we will not experience losses that exceed our loss reserves and have a
      material adverse effect on our results of operations and financial condition.
      Volatility or a significant change in interest rates might also materially
      affect our business, results of operations or financial condition.





Our
      strategy currently includes the continued operation of the financial services
      segment of our business. We also may engage in other transactions, such as
      selling portions of our installment loan portfolio, that are designed to
      facilitate our ability to purchase and/or originate an increased volume of
      loans
      and to reduce our exposure to interest rate fluctuations and installment loan
      losses. Accordingly, we may incur additional debt, or other forms of financing,
      in order to continue to fund such growth. We are currently re-selling
      installment loan contracts to other financial institutions. We believe the
      periodic sale of mortgage loans and installment contracts under various retail
      finance agreements reduces requirements for both working capital and borrowings,
      increase our liquidity, reduce our exposure to interest rate fluctuations and
      enhance our ability to increase the volume of loan purchases. However, we cannot
      assure investors that we will be able to make additional sales. We also cannot
      offer any assurance that possible additional financing, or the aforementioned
      transactions involving our installment and mortgage loan portfolio, will be
      available on terms acceptable to us. If not, we may be forced to curtail our
      financial services business and to alter our other strategies.





***We
      obtain our raw materials from a limited number of suppliers, and unavailability
      or price increases in raw materials could have a material adverse effect on
      our
      financial condition and results of operations.***





The
      availability and pricing of raw materials used in the production of homes may
      significantly affect our operating costs. Sudden increases in demand for these
      construction materials caused by natural disasters or other market forces,
      which
      occurred in the last quarter of 2005, can greatly increase the costs of
      materials or limit the availability of such materials. Increases in costs cannot
      always be reflected immediately in prices, especially in competitive times,
      and,
      consequently, may adversely impact our profitability. Further, a reduction
      in
      the availability of raw materials also may affect our ability to meet or
      maintain production requirements.





12




We
      obtain
      a substantial amount of our supply of laminated wallboard from a wholly-owned
      subsidiary, and obtain a majority of our supply of cabinetry from another
      wholly-owned subsidiary. We depend upon these subsidiaries for a significant
      portion of the materials used to construct portions of our manufactured homes.
      The inability of either of these subsidiaries to provide laminated wallboard
      or
      cabinetry to us, whether due to materials shortages, destruction of
      manufacturing facilities or other events affecting production of these component
      parts, may affect our ability to meet or maintain production
      requirements.





***If
      manufactured housing sites are limited by zoning laws or other local regulation,
      our financial condition and results of operations could be materially adversely
      affected*** .





Any
      limitation on the growth of the number of sites for placement of manufactured
      homes or on the operation of manufactured housing communities could adversely
      affect the manufactured housing business. Manufactured housing communities
      and
      individual home placements are subject to local zoning ordinances and other
      local regulations relating to utility service and construction of roadways.
      In
      the past, property owners often have resisted the adoption of zoning ordinances
      permitting the location of manufactured homes in residential areas, which we
      believe has adversely affected the growth of the industry. We cannot assure
      investors that manufactured homes will receive widespread acceptance or that
      localities will adopt zoning ordinances permitting the location of manufactured
      home areas. The inability of the manufactured home industry to gain such
      acceptance and zoning ordinances could have a material adverse effect on our
      financial condition or results of operations.





***We
      are dependent on the services of our management team, and the unexpected loss
      of
      key officers may adversely affect our operations.***





Our
      success depends highly upon the personal efforts and abilities of our current
      executive officers. Specifically, we rely on the efforts of our President and
      Chief Executive Officer, David A. Roberson, our Chief Operating Officer, Gregory
      A. Brown, and our Vice President, Chief Financial Officer and
      Secretary-Treasurer, Michael R. Murphy. The loss of the services of one or
      more
      of these individuals could have a material adverse effect upon our business.
      We
      do not have employment or non-competition agreements with any of our executive
      officers. Our ability to continue to work through the industry’s current
      downturn will depend upon our ability to retain, and attract if necessary,
      experienced management personnel.





***We
      are subject to extensive regulation affecting the production, sale, financing
      and insuring of manufactured housing, which could adversely affect our
      profitability*** *.*





We
      are
      subject to a variety of federal, state and local laws and regulations affecting
      the production, sale, financing and insuring of manufactured housing. We suggest
      you refer to the section above under the heading “Regulation” for a description
      of many of these laws and regulations. Our failure to comply with such laws
      and
      regulations could expose us to a wide variety of sanctions, including closing
      one or more manufacturing facilities. Governmental bodies have regulatory
      matters affecting our operations under continuous review and we cannot predict
      what effect, if any, additional laws and regulations promulgated by HUD would
      have on us or the manufactured housing industry. Failure to comply with laws
      or
      regulations applicable to or affecting us, or the passage in the future of
      new
      and more stringent laws affecting us, may adversely affect our financial
      condition or results of operations.





***We
      must comply with extensive environmental regulation, and failure in our
      compliance efforts could result in damages, expenses or liabilities that
      individually or in the aggregate would have a material adverse affect on our
      financial condition and results of operations***





Federal,
      state and local laws and regulations relating to the generation, storage,
      handling, emission, transportation and discharge of materials into the
      environment govern our operations. In addition, third parties and governmental
      agencies in some cases have the power under such laws and regulations to require
      remediation of environmental conditions and, in the case of governmental
      agencies and entities, to impose fines and penalties. The requirements of such
      laws and enforcement policies have generally become stricter in recent years.
      Accordingly, we cannot assure investors that we will not be required to incur
      response costs, remediation expenses, fines, penalties or other similar damages,
      expenses or liabilities, or to incur operational shut-downs, business
      interruptions or similar losses, associated with compliance with environmental
      laws and enforcement policies that either individually or in the aggregate
      would
      have a material adverse effect on our results of operations or financial
      condition.





13




***Our
      liability for estimated warranties may be inadequate, which could materially
      and
      adversely affect our business, financial condition and results of
      operations.***





We
      are
      subject to warranty claims in the ordinary course of business. Although we
      maintain reserves for such claims, which to date have been adequate, there
      can
      be no assurance that warranty expense levels will remain at current levels
      or
      that such reserves will continue to be adequate. A large number of warranty
      claims exceeding our current warranty expense levels could have a material
      adverse effect on our results of operations.





**ITEM
              1B.**
            **UNRESOLVED
                STAFF COMMENTS**





None





**ITEM
              2.**
            **PROPERTIES**





The
      following table sets forth the location and approximate square footage of our
      facilities, separated by segment, as of December 31, 2006:


**Locations**
                  
                  **Use
                      (Number of home**
                    **manufacturing
                      lines)**
                  
                  **Approximate**
                    **Square**
                    **Footage**
                  
                  **Owned
                      (a)**
                    **or
                      Leased****Home
                      Manufacturing - operating**Addison,
                      Alabama
                  
                  Manufacturing
                      facilities (2)
                  
                  458,000
                  
                  OwnedHamilton,
                      Alabama
                  
                  Manufacturing
                      facility (1)
                  
                  200,000
                  
                  OwnedMillen,
                      Georgia
                  
                  Manufacturing
                      facilities (2)
                  
                  179,000
                  
                  OwnedNashville,
                      North Carolina
                  
                  Manufacturing
                      facility (1)
                  
                  182,000
                  
                  OwnedWinfield,
                      Alabama
                  
                  Manufacturing
                      facility (1)
                  
                  134,000
                  
                  Owned**Home
                      Manufacturing - idled (b)**Addison,
                      Alabama
                  
                  Manufacturing
                      facility
                  
                  86,000
                  
                  OwnedConway,
                      Arkansas
                  
                  Manufacturing
                      facility
                  
                  222,000
                  
                  OwnedCordele,
                      Georgia
                  
                  Manufacturing
                      facility
                  
                  179,000
                  
                  OwnedShippenville,
                      Pennsylvania
                  
                  Manufacturing
                      facility
                  
                  120,000
                  
                  Owned**Component
                      & Supply Companies**Hamilton,
                      Alabama
                  
                  Manufacturing
                      facility
                  
                  60,000
                  
                  OwnedHaleyville,
                      Alabama (2 facilities)
                  
                  Manufacturing
                      facilities
                  
                  169,000
                  
                  Owned**Financial
                      Services**Hamilton,
                      Alabama
                  
                  Administrative
                      Office
                  
                  9,000
                  
                  Owned**General
                      Corporate**Addison,
                      Alabama
                  
                  Administrative
                      Office
                  
                  10,000
                  
                  OwnedWichita
                      Falls, Texas
                  
                  Administrative
                      Office
                  
                  1,000
                  
                  Leased





(a)
                Certain
                    of the facilities listed as owned are financed under industrial
                    development bonds.


(b)
            Certain
                of the idled facilities are leased to third parties under leasing
                arrangements, which, in some cases, include options to
                purchase.





In
      general, our manufacturing facilities are in good condition and are operated
      at
      capacities which ranged from approximately 35% to 54% in 2006.





**ITEM
              3.**
            **LEGAL
                PROCEEDINGS**





Litigation
      is subject to uncertainties and we cannot predict the probable outcome or the
      amount of liability of individual litigation matters with any level of
      assurance. We are engaged in various legal proceedings that are incidental
      to
      and arise in the course of our business. Certain of the cases filed against
      us
      and other companies engaged in businesses similar to ours allege, among other
      things, breach of contract and warranty, product liability, personal injury
      and
      fraudulent, deceptive or collusive practices in connection with their
      businesses. These kinds of suits are typical of suits that have been filed
      in
      recent years, and they sometimes seek certification as class actions, the
      imposition of large amounts of compensatory and punitive damages and trials
      by
      jury. Our liability under some of this litigation is covered in whole or in
      part
      by insurance. Anticipated legal fees and other losses, in excess of insurance
      coverage, associated with these lawsuits are accrued at the time such cases
      are
      identified or when additional information is available such that losses are
      probable and reasonably estimable. In the opinion of management, the ultimate
      liability, if any, with respect to the proceedings in which we are currently
      involved is not presently expected to have a material adverse effect on our
      results of operations, financial position or liquidity.





14




**ITEM
              4.**
            **SUBMISSION
                OF MATTERS TO A VOTE OF SECURITY
                HOLDERS**





No
      matters were submitted to the shareholders during the last quarter of the fiscal
      year.




15







**PART
      II**





**ITEM
              5.**
            **MARKET
                FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
                PURCHASES OF EQUITY SECURITIES*****(all
                dollars in thousands, except per share
                amounts)***





Our
      common stock began trading on the American Stock Exchange under the symbol
“CAV”
on March 5, 2004, having moved from the New York Stock Exchange. The following
      table sets forth, for each of the periods indicated, the reported high and
      low
      closing sale prices per share on the American Stock Exchange for our common
      stock:





Closing
                Sales PriceHigh
            
            LowYear
                ended December 31, 2006:Fourth
                Quarter
            
            $
            4.26
            
            $
            3.06Third
                Quarter
            
            
            5.55
            
            
            3.02Second
                Quarter
            
            
            7.19
            
            
            5.06First
                Quarter
            
            
            7.26
            
            
            6.23Year
                ended December 31, 2005Fourth
                Quarter
            
            $
            6.60
            
            $
            5.45Third
                Quarter
            
            
            8.04
            
            
            4.50Second
                Quarter
            
            
            5.45
            
            
            3.24First
                Quarter
            
            
            5.56
            
            
            5.10





As
      of
      February 28, 2007, we had 308 shareholders of record and approximately 5,500
      beneficial holders of our common stock, based upon information in securities
      position listings by registered clearing agencies upon request of our transfer
      agent.





We
      discontinued payments of dividends in the fourth quarter of 2000. While we
      do
      not expect to recommence cash dividend payments in the foreseeable future,
      the
      future payment of dividends on our common stock will be determined by our Board
      of Directors in light of conditions then existing, including our earnings,
      our
      funding requirements and financial conditions, certain loan restrictions and
      applicable laws and governmental regulations. Our present loan agreement
      contains restrictive covenants, which, among other things, limit the aggregate
      dividend payments and purchases of treasury stock to 50% of our consolidated
      net
      income for the two most recent fiscal years.





**Securities
      Authorized for Issuance Under Equity Compensation Plans**





The
      following table provides information as of December 31, 2006 regarding
      compensation plans (including individual compensation arrangements) under which
      our common stock is authorized for issuance.





(a)
            
            (b)
            
            (c)Plan
                Category
            
            Number
                of securities to be issued upon exercise of outstanding options,
                warrants
                and rights
            
            Weighted-average
                exercise price of outstanding options, warrants and rights
            
            Number
                of securities remaining available for future issuance under equity
                compensation plans (excluding securities reflected in column
                (a))Equity
                compensation plans approved by stockholders
            
            
            1,356,813
            
            $
            8.38
            
            
            1,725,177Equity
                compensation plans not approved by stockholders
            
            
            17,000
            
            $
            3.40
            
            
            —Total
            
            
            1,373,813
            
            $
            8.32
            
            
            1,725,177





See
      Note
      8 of Notes to Consolidated Financial Statements for information regarding the
      material features of the above plans. Each of the above plans provides that
      the
      number of shares with respect to which options may be granted, and the number
      of
      shares of our common stock subject to an outstanding option, shall be
      proportionately adjusted in the event of a subdivision or consolidation of
      shares or the payment of a stock dividend on our common stock, and the purchase
      price per share of outstanding options shall be proportionately
      revised.





16




**Common
      Stock Purchases**





Pursuant
      to a common stock repurchase program approved by our Board of Directors, a
      total
      of 3,168,800 shares were purchased at a cost of $24,842 during the four year
      period ended December 31, 2001. We retired 2,151,500 of the repurchased shares
      at December 31, 1999, with the remaining shares being recorded as treasury
      stock. During 2005, we reissued 34,000 treasury shares upon the exercise of
      stock options. We did not repurchase any of our common stock during the quarter
      ended December 31, 2006. At December 31, 2006, we had authority under the
      program to acquire up to 831,200 additional shares. We currently do not have
      plans to acquire any additional shares under this program.





**Performance
      Graph**





The
      following indexed graph compares the yearly percentage change in our cumulative
      total stockholder return on our common stock with the cumulative total return
      of
      (i) the Standard and Poor’s 500 Stock Index and (ii) a group of public
      companies, each of which is engaged in the business of designing, producing
      and
      selling manufactured homes. The industry group companies included in the index
      are Champion Enterprises, Inc., Fleetwood Enterprises, Inc., Liberty Homes,
      Inc., Nobility Homes, Inc., Palm Harbor Homes, Inc., and Skyline Corporation.
      In
      prior years, Southern Energy Homes, Inc. had been included in our peer group.
      With the acquisition of Southern Energy Homes, Inc. in 2006 by another company,
      they have been removed from our peer group for purposes of this
      graph.





**2001**
            
            **2002**
            
            **2003**
            
            **2004**
            
            **2005**
            
            **2006**Cavalier
                Homes, Inc.
            
            $
            100.00
            
            $
            66.90
            
            $
            102.76
            
            $
            203.10
            
            $
            222.41
            
            $
            143.45S&P
                500
            
            $
            100.00
            
            $
            77.90
            
            $
            100.24
            
            $
            111.15
            
            $
            116.61
            
            $
            135.03Peer
                Group
            
            $
            100.00
            
            $
            59.87
            
            $
            79.21
            
            $
            105.16
            
            $
            109.39
            
            $
            82.55




17
 
  **ITEM
                  6.**
                **SELECTED
                    CONSOLIDATED FINANCIAL
                    DATA**
  The
          following table sets forth our selected consolidated financial data for
          the
          periods indicated. The statement of operations data and other data for
          each of
          the years in the five year period ended December 31, 2006 have been derived
          from
          our consolidated financial statements. Our audited financial statements
          as of
          December 31, 2006 and 2005, and for each of the years in the three-year
          period
          ended December 31, 2006, including the notes thereto and the related reports
          of
          our independent registered public accountants, are included elsewhere in
          this
          report. The selected consolidated financial data should be read in conjunction
          with the consolidated financial statements (including the notes thereto)
          and the
          other financial information contained elsewhere in this report, and with
          our
          consolidated financial statements and the notes thereto appearing in our
          previously filed Annual Reports on Form 10-K.
 **Year
                    Ended December 31,****2006**
                
                **2005**
                
                **2004**
                
                **2003**
                
                **2002***(dollars
                    in thousands, except per share amounts)***Statement
                    of Operations Data:**Revenue:Home
                    manufacturing net sales
                
                $
                215,186
                
                $
                259,532
                
                $
                201,358
                
                $
                208,387
                
                $
                322,216Financial
                    services
                
                
                3,335
                
                
                3,002
                
                
                2,444
                
                
                2,673
                
                
                2,690Retail
                
                
                9,416
                
                
                9,498
                
                
                7,938
                
                
                7,948
                
                
                7,908Other
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                1,274Total
                    revenue
                
                
                227,937
                
                
                272,032
                
                
                211,740
                
                
                219,008
                
                
                334,088Cost
                    of sales
                
                
                189,175
                
                
                219,435
                
                
                172,244
                
                
                182,432
                
                
                281,738Gross
                    profit
                
                
                38,762
                
                
                52,597
                
                
                39,496
                
                
                36,576
                
                
                52,350Selling,
                    general and administrative
                
                
                38,607
                
                
                40,284
                
                
                34,415
                
                
                38,199
                
                
                57,601Impairment
                    and other related charges
                
                
                —
                
                
                143
                
                
                —
                
                
                750
                
                
                5,525Operating
                    income (loss)
                
                
                155
                
                
                12,170
                
                
                5,081
                
                
                (2,373
                )
                
                (10,776
                )Other
                    income (expense):Interest
                    expense
                
                
                (1,110
                )
                
                (1,314
                )
                
                (1,075
                )
                
                (1,065
                )
                
                (1,495
                )Other,
                    net
                
                
                1,330
                
                
                851
                
                
                561
                
                
                696
                
                
                929220
                
                
                (463
                )
                
                (514
                )
                
                (369
                )
                
                (566
                )Income
                    (loss) from continuing operations before income taxes
                
                
                375
                
                
                11,707
                
                
                4,567
                
                
                (2,742
                )
                
                (11,342
                )Income
                    tax provision (benefit)
                
                
                1,049
                
                
                (32
                )
                
                75
                
                
                (518
                )
                
                5,716Equity
                    in earnings of equity-method investees
                
                
                805
                
                
                775
                
                
                980
                
                
                369
                
                
                384Income
                    (loss) from continuing operations
                
                
                131
                
                
                12,514
                
                
                5,472
                
                
                (1,855
                )
                
                (16,674
                )Income
                    (loss) from discontinued operations, including tax benefit of
                    $29 (2006)
                    and gain on disposal of $439 (2005)
                
                
                41
                
                
                (1,599
                )
                
                (2,231
                )
                
                (2,715
                )
                
                (3,834
                )Income
                    (loss) before cumulative effect of change in accounting
                    principle
                
                
                172
                
                
                10,915
                
                
                3,241
                
                
                (4,570
                )
                
                (20,508
                )Cumulative
                    effect of change in accounting principle, net of tax
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                (14,162
                )Net
                    income (loss)
                
                $
                172
                
                $
                10,915
                
                $
                3,241
                
                $
                (4,570
                )
                $
                (34,670
                )Income
                    (loss) per share:Basic:From
                    continuing operations
                
                $
                0.01
                
                $
                0.69
                
                $
                0.30
                
                $
                (0.11
                )
                $
                (0.94
                )From
                    discontinued operations
                
                
                —
                
                
                (0.09
                )
                
                (0.12
                )
                
                (0.15
                )
                
                (0.22
                )Cumulative
                    effect of change in accounting principle
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                (0.80
                )Net
                    income (loss)
                
                $
                0.01
                
                $
                0.60
                
                $
                0.18
                
                $
                (0.26
                )
                $
                (1.96
                )Weighted
                    average shares outstanding
                
                
                18,335,377
                
                
                18,118,619
                
                
                17,879,939
                
                
                17,666,192
                
                
                17,664,901Diluted:From
                    continuing operations
                
                $
                0.01
                
                $
                0.68
                
                $
                0.30
                
                $
                (0.11
                )
                $
                (0.94
                )From
                    discontinued operations
                
                
                —
                
                
                (0.09
                )
                
                (0.12
                )
                
                (0.15
                )
                
                (0.22
                )Cumulative
                    effect of change in accounting principle
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                (0.80
                )Net
                    income (loss)
                
                $
                0.01
                
                $
                0.59
                
                $
                0.18
                
                $
                (0.26
                )
                $
                (1.96
                )Weighted
                    average shares outstanding
                
                
                18,469,575
                
                
                18,356,795
                
                
                18,178,394
                
                
                17,666,192
                
                
                17,664,901**Other
                    Data:**Capital
                    expenditures
                
                $
                1,995
                
                $
                1,410
                
                $
                786
                
                $
                327
                
                $
                2,062Working
                    capital
                
                $
                25,308
                
                $
                24,216
                
                $
                12,967
                
                $
                7,813
                
                $
                12,346Total
                    assets
                
                $
                96,706
                
                $
                132,821
                
                $
                98,230
                
                $
                98,533
                
                $
                130,071Long-term
                    debt
                
                $
                4,512
                
                $
                7,631
                
                $
                11,400
                
                $
                13,089
                
                $
                22,643Stockholders’
                    equity
                
                $
                58,400
                
                $
                57,845
                
                $
                45,167
                
                $
                40,987
                
                $
                45,536


ITEM
                7.
            **MANAGEMENT’S
                DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS*****(dollars
                in thousands)***





**Overview**





Cavalier
      Homes, Inc. and its subsidiaries produce, sell and finance manufactured housing.
      The manufactured housing industry is cyclical and seasonal and is influenced
      by
      many of the same economic and demographic factors that affect the housing market
      as a whole. As a result of the growth in the industry during much of the 1990s,
      the number of retail dealerships, manufacturing capacity and wholesale shipments
      expanded significantly, which ultimately created slower retail turnover, higher
      retail inventory levels and increased price competition. Also, the industry
      has
      been impacted by an





18




increase
        in dealer failures, a severe reduction in available consumer credit and
        wholesale (dealer) financing for manufactured housing, more restrictive credit
        standards and increased home repossessions which re-enter home distribution
        channels, each of which contributed to a reduction in wholesale industry
        shipments to a 44 year low in 2006. Industry results for 2005 posted the
        first
        increase since 1998 with floor shipments increasing over 2004 by 6% due to
        industry wide orders by the Federal Emergency Management Agency (“FEMA”) as part
        of that agency’s hurricane disaster relief efforts. The Manufactured Housing
        Institute’s (“MHI”) estimate of FEMA shipments in the last four months of 2005
        and during 2004 totaled approximately 21,000 floors and 4,000 floors,
        respectively. Our estimate for FEMA shipments in the first quarter of 2006
        is
        approximately 4,000 floors. Factoring out the effects of the FEMA orders
        in 2005
        and 2004, industry shipments were down slightly. Industry shipments in 2006,
        excluding shipments to FEMA, were 10.2% below 2005 levels and 11.4% below
        2004
        levels.




**Industry/Company
      Shipments and Market Share**





MHI
      reported that wholesale floor shipments were down 64% cumulatively from January
      1, 1999 through December 31, 2006 as noted in the following table:





**Floor
                  Shipments****Nationwide**
              
              **Cavalier's
                  Core 11 States****Year**
              
              
              **Industry**
              
              
              **Increase**
                **(decrease)
                  from**
                **prior
                  year**
              
              
              **Cavalier**
              
              
              **Increase**
                **(decrease)**
                **from**
                **prior
                  year**
              
              
              **Market**
                **Share**
              
              
              **Industry**
              
              
              **Increase**
                **(decrease)**
                **from**
                **prior
                  year**
              
              
              **Cavalier**
              
              
              **Increase
                  (decrease) from prior year**
              
              
              **Market**
                **Share**1999
              
              
              582,498
              
              
              
              
              
              34,294
              
              
              
              
              
              5.9
              %
              
              284,705
              
              
              
              
              
              30,070
              
              
              
              
              
              10.6
              %2000
              
              
              431,787
              
              
              -25.9
              %
              
              18,590
              
              
              -45.8
              %
              
              4.3
              %
              
              199,276
              
              
              -30.0
              %
              
              15,941
              
              
              -47.0
              %
              
              8.0
              %2001
              
              
              342,321
              
              
              -20.7
              %
              
              21,324
              
              
              14.7
              %
              
              6.2
              %
              
              149,162
              
              
              -25.1
              %
              
              17,884
              
              
              12.2
              %
              
              12.0
              %2002
              
              
              304,370
              
              
              -11.1
              %
              
              21,703
              
              
              1.8
              %
              
              7.1
              %
              
              124,127
              
              
              -16.8
              %
              
              18,039
              
              
              0.9
              %
              
              14.5
              %2003
              
              
              240,180
              
              
              -21.1
              %
              
              12,411
              
              
              -42.8
              %
              
              5.2
              %
              
              87,265
              
              
              -29.7
              %
              
              10,584
              
              
              -41.3
              %
              
              12.1
              %2004
              
              
              232,824
              
              
              -3.1
              %
              
              10,772
              
              
              -13.2
              %
              
              4.6
              %
              
              88,958
              
              
              1.9
              %
              
              8,912
              
              
              -15.8
              %
              
              10.0
              %2005
              
              
              246,750
              
              
              6.0
              %
              
              10,648
              
              
              -1.2
              %
              
              4.3
              %
              
              105,508
              
              
              18.6
              %
              
              9,905
              
              
              11.1
              %
              
              9.4
              %2006
              
              
              206,822
              
              
              -16.2
              %
              
              8,261
              
              
              -22.4
              %
              
              4.0
              %
              
              86,748
              
              
              -17.8
              %
              
              7,774
              
              
              -21.5
              %
              
              9.0
              %




The
      table
      above has been adjusted from 2005 to only include our “HUD code homes”, which
      are manufactured homes that meet the specifications of national building
      standards administered by the U.S. Department of Housing and Urban Development
      (excludes modular homes) for the 2005 and 2006 years.





During
      2005, we entered into agreements with two companies to build 2,638
      single-section homes for delivery to FEMA as part of that agency’s disaster
      relief for the Gulf Coast states hit by hurricanes. Under the agreements, we
      shipped 2,219 single-section homes, which accounted for 25.6% of 2005 sales,
      and
      in the first quarter of 2006, we shipped the remaining 419 homes. During 2006,
      our floor shipments decreased 22.4% as compared to 2005, while industry wide
      shipments decreased 16.2%, with our market share being 4.0%. In our core states,
      our market share declined to 9.0% from 9.4% in the comparable prior year period
      due to increased competition, including new entrants in the East South Central
      region. Our market share has continued to decline over the last four years
      due
      to a variety of causes, including the intensely competitive marketplace, lack
      of
      chattel (home only) financing for all homes, consolidation of our sales force
      (2003), and the closing of six manufacturing facilities (2002). One of our
      goals
      for 2007 is to increase our share of the national market through new product
      introductions, brand awareness and a focus on operational
      efficiencies.





**Potential
      for Modular Housing Expansion**





Currently,
      the substantial majority of our homes produced are HUD code homes. Additionally,
      we produce modular homes, which are constructed to local, regional or state
      building codes. Modular homes generally have a different and more complex roof
      system than HUD code homes, are typically two or more sections, and, when
      combined with land, usually qualify for traditional mortgage financing, which
      generally has better terms than financing for a HUD code home. The national
      market for modular housing was approximately 43,000 homes in 2004 and 2005
      according to the National Modular Housing Council (“NMHC”). According to NMHC
      (which includes information from the 29 significant states), 38,300 modular
      homes were shipped industry wide in 2006, a decrease of 11.1% from 2005. We
      shipped 398 and 302 modular homes during 2006 and 2005, respectively, for a
      year
      over year increase of 31.8%. While our current participation in the modular
      market is small, we are seeking to further develop our modular home sales base
      because we are hopeful that some of those looking to replace hurricane damaged
      homes in the Gulf Coast region will consider modular homes as a viable
      alternative to traditional site-built housing. The following table summarizes
      the information with respect to the modular market:


**Units
                    Shipped****Year**
                
                **Industry
                      (1)**
                
                **Increase**
                  **(decrease)**
                  **from**
                  **prior
                    year**
                
                **Cavalier**
                
                **Increase**
                  **(decrease)**
                  **from**
                  **prior
                    year**
                
                **Market**
                  **Share**2005
                
                
                43,100
                
                
                
                
                
                302
                
                
                
                
                
                0.7
                %2006
                
                
                38,300
                
                
                -11.1
                %
                
                398
                
                
                31.8
                %
                
                1.0
                %




(1)  Source
      NMHC


19




**Industry
      Finance Environment**





A
      major
      factor contributing to the manufactured housing industry growth in the 1990s
      was
      the relaxation of credit standards due to intense competition, which ultimately
      resulted in a change in the financing approach in the industry due to
      underperforming manufactured housing loans. Throughout the past eight years,
      the
      industry has been impacted significantly by reduced financing available at
      both
      the wholesale and retail levels, with several lenders exiting the marketplace
      or
      limiting their participation in the industry, coupled with more restrictive
      credit standards and increased home repossessions, which re-enter home
      distribution channels and limit wholesale shipments of new homes. While the
      current industry trend is toward more land/home (real estate) financing rather
      than chattel or home only loans, additional chattel lending availability could
      result in renewed demand for single-section products. While land/home financing
      generally offers more favorable credit terms to the retail buyer of manufactured
      housing, the length of time involved in closing land/home transactions is
      longer. The potential infusion of new and competitive lending capacity, which
      we
      believe is essential to support demand at higher levels, has not materialized.
      In late 2006, our finance subsidiary, CIS, was awarded up to $40,000 by Fannie
      Mae to implement a “High End Product Pilot Program” for HUD code manufactured
      multi-section homes. This program will allow “site-built” comparables, pricing
      and underwriting for high end HUD code multi-section homes for which enhanced
      property eligibility requirements are met. The first loan under this program
      is
      expected to be closed in the first quarter of 2007. While we are cautiously
      optimistic about this program, we are unable to determine if this pilot program
      will be successful and provide the longer-term financing our industry needs
      for
      growth. Until there is substantial entry of finance resources to the
      manufactured housing market, we believe a meaningful expansion for the industry
      will be delayed.





**Raw
      Materials Cost and Gross Margin**





In
      2006,
      our gross margin decreased in part due to cost increases we experienced in
      substantially all raw materials as a result of rising commodity prices. Certain
      prices have continued to increase although lumber costs moderated during the
      last half of the year. While we seek to offset rising costs through increasing
      our selling prices, sudden increases in raw material costs, coupled with
      dealers’ order backlogs, can affect the timing and our ability to pass on these
      cost increases. We are uncertain at this time as to the impact the extent and
      duration of the increased costs will have on our future revenue and
      earnings.





**Capacity
      and Overhead Cost**





In
      response to the continued weakening of industry market conditions, we closed
      nine manufacturing facilities between the fourth quarter of 2002 and the first
      quarter of 2005. We generally have been able to sell to the customers of these
      plants (with the exception of the Pennsylvania and Texas plants) from one or
      more of our current operating plants. The remaining plants also handle dealer
      sales and customer service for our homes. In terms of operating costs, we have
      made cost reductions in virtually all areas of operations, including our
      exclusive dealer and marketing programs and our administrative personnel and
      associated costs. Our Winfield, Alabama facility was re-opened in September
      2005
      in order to assist in the production of the FEMA units mentioned above and
      to
      participate in the production of our other products. Excluding FEMA product
      shipments (2,219 floors in 2005 and 419 floors in 2006), our 2006 shipments
      were
      below our expectations due in part to difficult market conditions in the East
      Coast markets (primarily Florida, Georgia, North Carolina and South Carolina),
      where floors shipped were 33% below the same period last year. Lower results
      by
      our North Carolina and Georgia operations were offset partially by improvements
      in our Alabama operations, where floors shipped improved by 11% over the same
      period in 2005. We continue to monitor the relationship between demand and
      capacity.





20




**Debt
      and Liquidity**





We
      continued to improve our long-term debt position in 2006 by making scheduled
      principal repayments as well as making additional principal repayments from
      proceeds from sales of certain property, including the sale of the Adrian
      facility in the fourth quarter of 2006. During 2006, long-term debt decreased
      by
      $3,391 from $9,129 to $5,738, which included scheduled payments of $1,493 and
      additional principal payments of $1,898.





During
      the fourth quarter of 2005, we borrowed $17,750 under the revolving line of
      credit in order to fund our short term cash needs required to fulfill the
      FEMA-related order. During the first quarter of 2006, the line of credit balance
      was paid in full. We did not have any amounts outstanding under the revolving
      line of credit at December 31, 2006.




**Outlook**





While
      the
      manufactured housing industry posted an increase in shipments for 2005 over
      2004, the increase was due to the impact of FEMA orders after hurricanes
      devastated housing in many areas in the Gulf Coast region. The following table
      illustrates the continuing softness of the underlying HUD code
      business:


**Industry
                    Home Shipments by Year****2006**
                
                **2005**
                
                **2004**Total
                    home shipments
                
                
                117,369
                
                
                146,744
                
                
                130,802Less
                    Estimated FEMA (1)
                
                
                (4,000
                )
                
                (21,000
                )
                
                (4,000
                )Industry
                    Shipments (less FEMA)
                
                
                113,369
                
                
                125,744
                
                
                126,802


**(1)
        2006 FEMA shipments as estimated by us.**


We
      continue to believe the substantial hurricane damage in the Gulf Coast region
      will create opportunities for our industry beyond the temporary housing supplied
      through FEMA orders in 2005 and the first quarter of 2006. We expect that strain
      on conventional home building resources will likely cause some of those looking
      to replace damaged homes to consider manufactured housing, including modular
      homes, as a viable alternative to traditional site-built housing. However,
      we
      also expect rebuilding efforts to impose greater strains on the availability
      of
      certain building materials, which will likely result in increased costs. It
      is
      hard to predict the timing of the recovery effort because of zoning, insurance
      settlements, flood plain restrictions, customer and community acceptance, as
      well as local economic conditions.





Longer
      term, substantial entry of competitive lending capacity in the industry, which
      we believe is essential to support demand at higher levels, is needed for a
      meaningful expansion for the industry.





We
      have
      taken steps in recent years to reduce costs and lower our breakeven point.
      We
      will continue to focus on internal projects and plans to increase manufacturing
      efficiencies in 2007 to further reduce costs. Industry shipments in 2007 are
      expected to be comparable to the 2006 levels, excluding the impact from FEMA,
      based on industry analysts estimates in the range of 112,000 to 120,000 floors.
      As we noted above, our focus is to increase our market share in 2007, but we
      believe 2007 will be a challenging year. Further changes in general economic
      conditions that affect consumer purchases, availability of adequate financing
      sources, increases in repossessions or dealer failures and further commodity
      price increases could affect our results of operations.





21




**Results
      of Operations**





The
      following table summarizes certain financial and operating data, including,
      as
      applicable, the percentage of total revenue:


**For
                      the Year Ended December 31,****2006**
                  
                  **2005**
                  
                  **2004**STATEMENT
                      OF OPERATIONS DATARevenue:Home
                      manufacturing net sales
                  
                  $
                  215,186
                  
                  
                  
                  
                  $
                  259,532
                  
                  
                  
                  
                  $
                  201,358Financial
                      services
                  
                  
                  3,335
                  
                  
                  
                  
                  
                  3,002
                  
                  
                  
                  
                  
                  2,444Retail
                  
                  
                  9,416
                  
                  
                  
                  
                  
                  9,498
                  
                  
                  
                  
                  
                  7,938Total
                      revenue
                  
                  
                  227,937
                  
                  
                  100.0
                  %
                  
                  272,032
                  
                  
                  100.0
                  %
                  
                  211,740
                  
                  
                  100.0
                  %Cost
                      of sales
                  
                  
                  189,175
                  
                  
                  83.0
                  %
                  
                  219,435
                  
                  
                  80.7
                  %
                  
                  172,244
                  
                  
                  81.3
                  %Gross
                      profit
                  
                  
                  38,762
                  
                  
                  17.0
                  %
                  
                  52,597
                  
                  
                  19.3
                  %
                  
                  39,496
                  
                  
                  18.7
                  %Selling,
                      general and administrative
                  
                  
                  38,607
                  
                  
                  16.9
                  %
                  
                  40,284
                  
                  
                  14.8
                  %
                  
                  34,415
                  
                  
                  16.3
                  %Impairment
                      and other related charges
                  
                  
                  —
                  
                  
                  0.0
                  %
                  
                  143
                  
                  
                  0.1
                  %
                  
                  —
                  
                  
                  0.0
                  %Operating
                      income
                  
                  
                  155
                  
                  
                  0.1
                  %
                  
                  12,170
                  
                  
                  4.5
                  %
                  
                  5,081
                  
                  
                  2.4
                  %Other
                      income (expense):Interest
                      expense
                  
                  
                  (1,110
                  )
                  
                  -0.5
                  %
                  
                  (1,314
                  )
                  
                  -0.5
                  %
                  
                  (1,075
                  )
                  
                  -0.5
                  %Other,
                      net
                  
                  
                  1,330
                  
                  
                  0.6
                  %
                  
                  851
                  
                  
                  0.3
                  %
                  
                  561
                  
                  
                  0.3
                  %220
                  
                  
                  0.1
                  %
                  
                  (463
                  )
                  
                  -0.2
                  %
                  
                  (514
                  )
                  
                  -0.2
                  %Income
                      from continuing operations before income taxes
                  
                  
                  375
                  
                  
                  0.2
                  %
                  
                  11,707
                  
                  
                  4.3
                  %
                  
                  4,567
                  
                  
                  2.2
                  %Income
                      tax provision (benefit)
                  
                  
                  1,049
                  
                  
                  0.5
                  %
                  
                  (32
                  )
                  
                  0.0
                  %
                  
                  75
                  
                  
                  0.0
                  %Equity
                      in earnings of equity-method investees
                  
                  
                  805
                  
                  
                  0.4
                  %
                  
                  775
                  
                  
                  0.3
                  %
                  
                  980
                  
                  
                  0.5
                  %Income
                      from continuing operations
                  
                  
                  131
                  
                  
                  0.1
                  %
                  
                  12,514
                  
                  
                  4.6
                  %
                  
                  5,472
                  
                  
                  2.6
                  %Income
                      (loss) from discontinued operations, including tax benefit
                      of $29 (2006)
                      and gain on disposal of $439 (2005)
                  
                  
                  41
                  
                  
                  0.0
                  %
                  
                  (1,599
                  )
                  
                  -0.6
                  %
                  
                  (2,231
                  )
                  
                  -1.1
                  %Net
                      income
                  
                  $
                  172
                  
                  
                  0.1
                  %
                  $
                  10,915
                  
                  
                  4.0
                  %
                  $
                  3,241
                  
                  
                  1.5
                  %OPERATING
                      DATA SUMMARYHome
                      manufacturing sales:Floor
                      shipments:HUD
                      Code
                  
                  
                  8,261
                  
                  
                  90.8
                  %
                  
                  10,648
                  
                  
                  94.3
                  %
                  
                  10,372
                  
                  
                  96.3
                  %Modular
                  
                  
                  840
                  
                  
                  9.2
                  %
                  
                  641
                  
                  
                  5.7
                  %
                  
                  400
                  
                  
                  3.7
                  %Total
                      floor shipments
                  
                  
                  9,101
                  
                  
                  100.0
                  %
                  
                  11,289
                  
                  
                  100.0
                  %
                  
                  10,772
                  
                  
                  100.0
                  %Home
                      shipments:Continuing
                      operations:Single
                      section
                  
                  
                  1,669
                  
                  
                  31.2
                  %
                  
                  3,201
                  
                  
                  44.3
                  %
                  
                  1,874
                  
                  
                  29.6
                  %Multi
                      section
                  
                  
                  3,678
                  
                  
                  68.8
                  %
                  
                  3,941
                  
                  
                  54.5
                  %
                  
                  3,844
                  
                  
                  60.7
                  %Total
                      continuing
                  
                  
                  5,347
                  
                  
                  100.0
                  %
                  
                  7,142
                  
                  
                  98.8
                  %
                  
                  5,718
                  
                  
                  90.3
                  %Discontinued
                      operations
                  
                  
                  —
                  
                  
                  0.0
                  %
                  
                  84
                  
                  
                  1.2
                  %
                  
                  618
                  
                  
                  9.7
                  %Total
                      home shipments
                  
                  
                  5,347
                  
                  
                  100.0
                  %
                  
                  7,226
                  
                  
                  100.0
                  %
                  
                  6,336
                  
                  
                  100.0
                  %Shipments
                      to company owned retail locations
                  
                  
                  (157
                  )
                  
                  -2.9
                  %
                  
                  (188
                  )
                  
                  -2.6
                  %
                  
                  (175
                  )
                  
                  -2.8
                  %FEMA
                      shipments (all single section)
                  
                  
                  (419
                  )
                  
                  -7.8
                  %
                  
                  (2,219
                  )
                  
                  -30.7
                  %
                  
                  (1,023
                  )
                  
                  -16.1
                  %Wholesale
                      shipments to independent retailers
                  
                  
                  4,771
                  
                  
                  89.3
                  %
                  
                  4,819
                  
                  
                  66.7
                  %
                  
                  5,138
                  
                  
                  81.1
                  %Retail
                      sales:Single
                      section
                  
                  
                  51
                  
                  
                  30.2
                  %
                  
                  53
                  
                  
                  27.0
                  %
                  
                  49
                  
                  
                  25.7
                  %Multi
                      section
                  
                  
                  118
                  
                  
                  69.8
                  %
                  
                  143
                  
                  
                  73.0
                  %
                  
                  142
                  
                  
                  74.3
                  %Total
                      retail sales
                  
                  
                  169
                  
                  
                  100.0
                  %
                  
                  196
                  
                  
                  100.0
                  %
                  
                  191
                  
                  
                  100.0
                  %Cavalier
                      produced homes sold
                  
                  
                  148
                  
                  
                  87.6
                  %
                  
                  178
                  
                  
                  90.8
                  %
                  
                  165
                  
                  
                  86.4
                  %Used
                      homes sold
                  
                  
                  21
                  
                  
                  12.4
                  %
                  
                  18
                  
                  
                  9.2
                  %
                  
                  26
                  
                  
                  13.6
                  %Installment
                      loan purchases
                  
                  $
                  42,916
                  
                  
                  
                  
                  $
                  42,235
                  
                  
                  
                  
                  $
                  33,323Capital
                      expenditures
                  
                  
                  1,995
                  
                  
                  
                  
                  
                  1,410
                  
                  
                  
                  
                  
                  786Home
                      manufacturing facilities - operating
                  
                  
                  7
                  
                  
                  
                  
                  
                  7
                  
                  
                  
                  
                  
                  7Independent
                      exclusive dealer locations
                  
                  
                  71
                  
                  
                  
                  
                  
                  113
                  
                  
                  
                  
                  
                  127Company
                      owned stores
                  
                  
                  4
                  
                  
                  
                  
                  
                  4
                  
                  
                  
                  
                  
                  4








22




**2006
        Compared to 2005**
 
 ***Revenue***
 
 Total
        revenue for 2006 was $227,937, decreasing $44,095, or 16.2%, from 2005 revenue
        of $272,032. Home manufacturing net sales accounted for virtually the entire
        decrease, declining to $215,186 from $259,532 in 2005. Home shipments from
        continuing operations were 5,347 in 2006 as compared to 7,142 in 2005,
        decreasing 25.1 %, with floor shipments decreasing by 19.4%. Single-section
        home
        shipments, as a percentage of total shipments, decreased to 31.2% in 2006
        from
        44.3% in 2005, primarily due to our participation in building single-section
        homes as part of the FEMA disaster relief for victims of the 2005 hurricanes,
        of
        which 419 homes were shipped in 2006 compared to 2,219 homes in 2005. Of
        these
        shipments, excluding FEMA units, 58% in 2006 and 70% in 2005 were to exclusive
        dealers. We attribute the decrease in sales and shipments primarily to the
        FEMA
        units shipped. Inventory of our product at all retail locations, including
        Company-owned retail sales centers, increased 23.1% to approximately $87,400
        at
        December 31, 2006 from $71,000 at year end 2005.




Revenue
      from CIS, our wholly-owned finance subsidiary, increased for 2006 to $3,335
      compared to $3,002 in 2005. For 2006, CIS purchased contracts of $42,916 and
      sold installment contracts totaling $44,589. In 2005, CIS purchased contracts
      of
      $42,235 and re-sold installment contracts totaling $34,625. CIS does not retain
      the servicing function and does not earn the interest income on these re-sold
      loans. The decrease in the installment loan portfolio at December 31, 2006
      is
      primarily from sales of outstanding loans at December 31, 2005, including
      land/home loans, many of which are construction loans. Included in the
      installment loan portfolio at December 31, 2006 is $5,457 of land/home loans.
      At
      December 31, 2005, our installment loan portfolio included $6,972 of land/home
      loans.





Revenue
      from the retail segment was $9,416 for 2006 compared to $9,498 for
      2005.





***Gross
      Profit***





Gross
      profit was $38,762 or 17.0% of total revenue for 2006, versus $52,597, or 19.3%
      of total revenue in 2005. The $13,835 decrease in gross profit and 2.3% decrease
      in gross margin is primarily the result of lower sales volume, especially in
      the
      last half of the year, and increased raw material prices. Gross profit was
      favorably impacted in 2005 by higher production levels of a large number of
      homes with like specifications for the FEMA related orders, primarily in the
      fourth quarter. We have experienced price increases in substantially all raw
      materials (certain prices continue to increase) and overall commodity pressures
      due in part to global demand, capacity constraints and rising oil
      prices.





***Selling,
      General and Administrative***





Selling,
      general and administrative expenses during 2006 were $38,607, or
      16.9% **** of
      total
      revenue, versus $40,284 or 14.8% of total revenue in 2005, a decrease of $1,677
      or 4.2%. The overall decrease included (1) a $1,554 decrease in insurance costs
      as a result of a retrospective liability insurance credit of $1,300, (2) a
      $1,232 decrease in salaries and incentive compensation attributable to a
      decrease in incentive compensation on lower profits offset by an increase in
      overall salaries, and (3) a $712 decrease in losses on our installment loan
      portfolio, including homes repossessed. These net decreases were offset by
      a
      $2,044 increase in employee benefit costs, primarily for health insurance
      expense on a higher level of average employment during the year and an increase
      in health care costs per employee. We adopted SFAS No. 123R, *Share-Based
      Compensation,* effective as of January 1, 2006 using the modified prospective method. Stock
      based compensation totaling $235 was included in selling, general and
      administrative expenses in 2006. See Notes 1 and 8 of Notes to Consolidated
      Financial Statements for additional information.





***Impairment
      and Other Related Charges***





No
      impairment charges were recorded in 2006. During 2005, we recorded impairment
      and other related charges of $143 ($143 after tax or $0.00 per diluted share)
      to
      write-down property, plant and equipment in connection with the valuation of
      a
      home manufacturing facility closed in a prior year.





***Operating
      Income***





Operating
      income for 2006 was $155 compared to $12,170 in 2005. Segment operating results
      were as follows: (1) Home manufacturing operating income, before intercompany
      eliminations, was $4,282 in 2006 as compared to $18,121 in 2005. The decreased
      home manufacturing operating income is primarily due to our participation in
      building single-section homes as part of the FEMA disaster relief in 2005 as
      discussed above and raw material price increases. (2) Financial services
      operating income was $929 in 2006 as compared to $34 in 2005. The slight revenue
      increase from the financial services segment and the decrease in losses on
      our
      installment loan portfolio as discussed above are the primary factors for the
      increase in operating income. (3) The retail segment’s operating loss of $267 in
      2006 compares to almost breakeven in 2005. (4) General corporate operating
      expense, which is not identifiable to a specific segment, decreased from $5,726
      in 2005 to $4,539 in 2006 primarily due to decreased incentive compensation
      costs.





***Other
      Income (Expense)***





Interest
      expense decreased in 2006 to $1,110 from $1,314 in 2005 primarily due to lower
      levels of borrowings, including the March 2006 repayment of amounts outstanding
      under the revolving line of credit of $17,750, which we borrowed in the fourth
      quarter of 2005 to fund short term cash requirements to complete the FEMA order.
      Additional principal payments during the year from proceeds of sales of certain
      properties also reduced overall interest expense. As noted above, long-term
      debt
      decreased in 2006 by $3,391 from $9,129 to $5,738, which included scheduled
      payments of $1,493 and additional principal payments of $1,898.





23




Other,
      net is comprised primarily of interest income (unrelated to financial services)
      and gains related to cost-method investments. Other, net increased $479 due
      to
      an increase in interest income earned in 2006 of $162 and an increase in gains
      on cost-method investments of $317.





***Income
      from Continuing Operations before Income Taxes***





Our
      2006
      pre-tax income from continuing operations was $375, reflecting a decrease from
      $11,707 in 2005, due to the factors discussed above.





***Income
      Tax Provision (Benefit)***





We
      recorded an income tax provision from continuing operations of $1,049 for 2006
      as compared to an income tax benefit of $32 for 2005.The income tax provision
      for 2006 includes (1) federal income tax benefit totaling $351 for carry back
      of
      the 2006 net operating loss to 2005, (2) state income taxes currently payable
      of
      $71, (3) additional state income tax payable of $225 related to a state audit
      that occurred in 2006, reduced by $153 accrued in a prior year, (4) an increase
      in the valuation allowance for deferred tax assets of $927, and (5) a deferred
      income tax provision of $387 for normal operating activities, including
      adjustments to state tax net operating loss carryforwards (“NOL”) (i) in one
      state to increase the NOL as a result of the completion of that state’s audit
      and (ii) in another state to reduce the NOL as a result of discussions we had
      during the year with that state with regard to an NOL that had expired at the
      end of 2005. In 2005, our income tax benefit of $32 included a current provision
      of $1,282 offset by the reversal of a portion of the deferred tax asset
      valuation allowance that provided a $1,314 tax benefit.





We
      assess
      the need for a valuation allowance against our deferred tax assets in accordance
      with SFAS No. 109, *Accounting
      for Income Taxes.* Realization
      of deferred tax assets (net of recorded valuation allowances) is largely
      dependent upon future profitable operations and future reversals of existing
      taxable temporary differences. In assessing the need for a valuation allowance,
      we consider all positive and negative evidence, including anticipated operating
      results, scheduled reversals of deferred tax liabilities, and tax planning
      strategies.





In
      2006,
      our assessment of the valuation allowance considered the following factors:
      (1)
      our 2006 operating performance, which was significantly below previous
      projections, (2) a 44 year industry low in 2006 for shipments of manufactured
      housing with each quarter’s shipments lower than the previous quarter, (3)
      projected shipments for 2007 that could be relatively flat compared to 2006
      shipments, and (4) our lack of visibility with respect to our 2007 results.
      Due
      to these factors, we recorded an adjustment to our valuation allowance to fully
      reserve our deferred tax assets, which totaled $14,709 as of December 31,
      2006.





In
      2005,
      as a result of continuing improvements in operating performance and projected
      income and tax liability for 2006, we reversed a portion of the deferred tax
      asset valuation allowance and realized $1,314 in deferred tax benefits. Because
      we believed challenging industry conditions would persist in 2006, we further
      believed that under the standards of SFAS No. 109 it was not appropriate to
      record income tax benefits in excess of the benefit projected to be realized
      in
      2006. As of December 31, 2005, we maintained a valuation allowance of
      $13,782.





The
      valuation allowance may be reversed to income in future periods to the extent
      that the related deferred income tax assets are realized or the valuation
      allowances are otherwise no longer required.





***Equity
      in Earnings of Equity-Method Investees***





Our
      equity in earnings of equity-method investees was $805 for 2006 as compared
      to
      $775 for 2005.





***Income
      (Loss) from Discontinued Operations***





In
      February 2005, we announced our decision to close an underperforming home
      manufacturing plant in Ft. Worth, Texas and subsequently sold the facility
      in
      the second quarter of 2005. Income from discontinued operations totaled $41
      in
      2006, including an allocated tax benefit of $29.





The
      Ft.
      Worth plant employed approximately 150 people, each of whom received a severance
      benefit paid at the date the employee ceased rendering service. We recorded
      involuntary termination benefits of $878 in 2005 and sold the Ft. Worth facility
      in June 2005 realizing a gain of $439. These amounts are included in “Income
      (loss) from discontinued operations” in the accompanying consolidated statements
      of operations.





24




***Net
      Income***





Our
      net
      income for 2006 was $172 or $0.01 per diluted share, as compared to $10,915
      or
      $0.59 per diluted share in 2005.





**2005
      Compared to 2004**





***Revenue***





Total
      revenue for 2005 was $272,032, increasing $60,292, or 28.5%, from 2004 revenue
      of $211,740. Home manufacturing net sales accounted for virtually the entire
      increase, rising to $259,532 from $201,358 in 2004. Home shipments from
      continuing operations were 7,142 in 2005 as compared to 5,718 in 2004,
      increasing 24.9 %, with floor shipments increasing by 15.9%. Single-section
      home
      shipments, as a percentage of total shipments, increased to 44.3% in 2005 from
      29.6% in 2004, primarily due to our participation in building single-section
      homes as part of the FEMA disaster relief for victims of the 2005 hurricanes,
      of
      which 2,219 homes were shipped in 2005 compared to 1,023 homes in 2004. Of
      these
      shipments, excluding FEMA units, 70% in 2005 and 62% in 2004 were to exclusive
      dealers. We attribute the increase in sales and shipments primarily to the
      FEMA
      units shipped. Inventory of our product at all retail locations, including
      Company-owned retail sales centers, decreased 28.7% to approximately $71,000
      at
      December 31, 2005 from $99,600 at year end 2004, with $13,300 of the reduction
      resulting from the closure of the Ft. Worth, Texas facility in February
      2005.





Revenue
      from the financial services segment increased for 2005 to $3,002 compared to
      $2,444 in 2004. For 2005, CIS purchased contracts of $42,235 and sold
      installment contracts totaling $34,625. In 2004, CIS purchased contracts of
      $33,323 and re-sold installment contracts totaling $31,905. The increase in
      the
      installment loan portfolio at December 31, 2005 is primarily due to a higher
      volume of land/home loans, many of which are construction loans, for which
      the
      length of time involved in closing the sale transaction is greater in comparison
      to a typical chattel (home only) loan. Included in the installment loan
      portfolio at December 31, 2005 is $6,972 of land/home loans. At December 31,
      2004, our installment loan portfolio included $642 of land/home
      loans.





Revenue
      from the retail segment was $9,498 for 2005 compared to $7,938 for 2004, an
      increase of $1,560 primarily due to sales at the North Carolina retail location
      that was opened in October 2004.





***Gross
      Profit***





Gross
      profit was $52,597, or 19.3% of total revenue for 2005, versus $39,496, or
      18.7%
      of total revenue, in 2004. The $13,101 increase in gross profit and 0.6%
      increase in gross margin is primarily the result of higher comparable sales
      prices beginning to recover the steady increases in raw material costs during
      2005. Gross profit also was favorably impacted by higher production levels
      of a
      large number of homes with like specifications for the FEMA related orders,
      primarily in the fourth quarter of 2005. We have experienced price increases
      in
      substantially all raw materials (certain prices continue to increase) and
      overall commodity pressures (i.e., global demand and capacity constraints and
      rising oil prices).





***Selling,
      General and Administrative***





Selling,
      general and administrative expenses during 2005 were $40,284, or
      14.8% **** of
      total
      revenue, versus $34,415 or 16.3% of total revenue in 2004, an increase of
      $5,869, or 17.0%. The overall increase included (1) a $3,688 increase in
      salaries, including engineering costs, and incentive compensation based on
      our
      improved profitability, (2) increased insurance costs, primarily general and
      product liability of $814, and (3) a $782 increase in losses on our installment
      loan portfolio, including homes repossessed. These increases were offset by
      a
      $736 reduction in accounting and auditing fees associated with compliance
      efforts under Section 404 of the Sarbanes-Oxley Act of 2002.





***Impairment
      and Other Related Charges***





During
      2005, we recorded impairment and other related charges of $143 ($143 after
      tax
      or $0.00 per diluted share) to write-down property, plant and equipment in
      connection with the valuation of a home manufacturing facility closed in a
      prior
      year.





25




***Operating
      Income***





Operating
      income for 2005 was $12,170 compared to $5,081 in 2004. Segment operating
      results were as follows: (1) Home manufacturing operating income, before
      intercompany eliminations, was $18,121 in 2005 as compared to $10,235 in 2004.
      The increased home manufacturing operating income is primarily due to improved
      gross profit and our participation in building single-section homes as part
      of
      the FEMA disaster relief as discussed above. (2) Financial services operating
      income was $34 in 2005 as compared to $539 in 2004. The revenue increase from
      the financial services segment was primarily offset by increases in losses
      on
      our installment loan portfolio as discussed above. (3) The retail segment’s
      operating loss improved from $113 in 2004 to almost breakeven in 2005 primarily
      due to startup costs associated with a new retail location opened in the fourth
      quarter of 2004 that did not recur in 2005. (4) General corporate operating
      expense, which is not identifiable to a specific segment, increased from $5,472
      in 2004 to $5,726 in 2005 primarily due to increased incentive compensation
      costs paid on improved corporate earnings in 2005 offset by reduced expenses
      associated with compliance efforts under the Sarbanes-Oxley Act of
      2002.





***Other
      Income (Expense)***





Interest
      expense increased primarily due to higher interest charges on amounts
      outstanding under the retail floor plan agreement in 2005 of which lower amounts
      were outstanding in 2004 and for borrowings under the revolving line of credit
      in 2005 to fund short term cash requirements to complete the FEMA order. These
      increases in interest expense were offset somewhat by decreased interest charges
      on lower debt amounts outstanding on Industrial Development Revenue Bonds and
      the real estate term loan.





Other,
      net is comprised primarily of interest income (unrelated to financial services).
      Other, net increased $290 due to higher interest income rates earned in 2005
      on
      invested funds.





***Income
      from Continuing Operations before Income Taxes***





Our
      2005
      pre-tax income from continuing operations was $11,707, reflecting an improvement
      from $4,567 in 2004, due to the factors discussed above.





***Income
      Tax Provision (Benefit)***





In
      2005,
      we recorded a $32 income tax benefit as a result of the utilization of net
      operating loss carry forwards against current taxable income and the reduction
      of a valuation allowance for deferred tax assets. Realization of deferred tax
      assets (net of recorded valuation allowances) is largely dependent upon future
      profitable operations and future reversals of existing taxable temporary
      differences. In 2004, pursuant to SFAS No. 109, *Accounting
      for Income Taxes* ,
      because
      we had operated at a cumulative loss in our three most recent calendar years
      and
      because we believed difficult competitive and economic conditions might continue
      for the foreseeable future, a $19,607 valuation allowance was recorded to fully
      reserve net deferred tax assets. However, in 2005, as a result of continued
      improvements in operating performance and projected income and tax liability
      for
      2006, we reversed a portion of the deferred tax asset valuation allowance
      realizing $1,314 in deferred tax benefits. In assessing the need for a valuation
      allowance, we considered all positive and negative evidence, including
      anticipated operating results, scheduled reversals of deferred tax liabilities,
      and tax planning strategies. Because we expected challenging industry conditions
      would persist, we believed that under the standards of SFAS No. 109 it was
      not
      appropriate to record income tax benefits in excess of the benefit projected
      to
      be realized in 2006. As of December 31, 2005, we maintained a valuation
      allowance of $13,782.





***Equity
      in Earnings of Equity-Method Investees***





Our
      equity in earnings of equity-method investees was $775 for 2005 as compared
      to
      $980 for 2004.





***Income
      (Loss) from Discontinued Operations***





In
      February 2005, we announced our decision to close an underperforming home
      manufacturing plant in Ft. Worth, Texas, which accounted for about 10% of total
      revenue and 11% of floor shipments in 2004 and had net property, plant and
      equipment of $2,403 at December 31, 2004. During 2004, we recorded impairment
      and other related charges of $209 ($209 after tax or $0.01 per diluted share)
      for write-downs for certain property, plant and equipment related to the
      closing. The Ft. Worth plant employed approximately 150 people, each of whom
      received a severance benefit paid at the date the employee ceased rendering
      service. We incurred all expected employee termination costs, and during 2005,
      recorded involuntary termination benefits of $878 ($878 after tax or $0.06
      per
      diluted share). We sold the Ft. Worth facility in June 2005, realizing a gain
      of
      $439. These amounts are included in the line item “Income (Loss) from
      discontinued operations” in the accompanying consolidated statements of
      operations. The Ft. Worth facility’s loss was $1,599 in 2005 as compared to
      $2,231 in 2004.





26




Emerging
      Issues Task Force (EITF) No. 03-13, *Applying
      the Conditions in Paragraph 42 of SFAS No. 144, Accounting for the Impairment
      or
      Disposal of Long-Lived Assets, in Determining Whether to Report Discontinued
      Operation,* defines
      the assessment period to consider classification of a disposed component as
      discontinued operations. Such assessment period begins at the point a disposed
      component meets the criteria to be classified as held for sale or is disposed
      of
      through one year after the component is actually disposed. The disposal of
      the
      property, plant and equipment of our Ft. Worth facility met the criteria to
      be
      classified as held for sale at the end of the first quarter of 2005. Under
      the
      provisions of EITF 03-13, we updated our evaluation of our continuing
      involvement through continued sales to dealers of the Ft. Worth facility from
      our other home manufacturing plants at each quarter end after the first quarter
      of 2005. Although we had hoped to retain a greater portion of the Ft. Worth
      facility’s dealers and sales base, during the fourth quarter of 2005, the
      sustained sales had fallen below 15% of the prior year’s sales from the Ft.
      Worth plant. Accordingly, in the fourth quarter of 2005, it became appropriate
      under the provisions of SFAS No. 144, *Accounting
      for the Impairment or Disposal of Long-Lived Assets* ,
      for us
      to classify our Ft. Worth operations as discontinued and we reclassified the
      information previously reported in our consolidated statements of
      operations.





The
      Ft.
      Worth manufacturing operations generated revenue of $3,124 (2005) and $22,421
      (2004). As noted above, we have not retained the sales base of the majority
      of
      the dealers serviced by the Ft. Worth plant.





***Net
      Income***





Our
      net
      income for 2005 was $10,915, or $0.59 per diluted share, as compared to $3,241,
      or $0.18 per diluted share in 2004.





**Liquidity
      and Capital Resources**


**Balances
                    as of December 31,****2006**
                
                **2005**
                
                **2004**Cash,
                    cash equivalents & certificates of deposit
                
                $
                25,967
                
                $
                14,379
                
                $
                31,674Working
                    capital
                
                $
                25,308
                
                $
                24,216
                
                $
                12,967Current
                    ratio
                
                
                1.7
                    to 1
                
                
                1.4
                    to 1
                
                
                1.3
                    to 1Long-term
                    debt
                
                $
                4,512
                
                $
                7,631
                
                $
                11,400Ratio
                    of long-term debt to equity
                
                
                0.1
                    to 1
                
                
                0.1
                    to 1
                
                
                0.3
                    to 1Installment
                    loan portfolio
                
                $
                12,265
                
                $
                15,067
                
                $
                8,839





**2006**





Cash
      increased $11,588 to $25,967 at December 31, 2006 from $14,379 at December
      31,
      2005. Operating activities provided net cash of $32,314 primarily due
      to:





(a)
            a
                decrease in accounts receivable of $37,554, which is primarily collection
                of receivables related to FEMA disaster relief
                homes,


(b)
            an
                inventory decrease of $5,048, which represents finished homes we
                delivered
                in 2006 that could not be delivered in 2005 to FEMA due to their
                inability
                to accept receipt in a timely fashion,
                and


(c)
            the
                net purchase of installment contracts of
                $1,925,


(d)
            offset
                by decreases in accounts payable ($4,073), amounts payable under
                dealer
                incentive programs ($4,046), accrued compensation and related withholdings
                ($3,456), and other assets and liabilities ($3,505), all of which
                decreased primarily as a result of the FEMA activity at the end of
                2005
                that did not recur in 2006.





Our
      capital expenditures were $1,995 during 2006 primarily for normal property,
      plant and equipment additions and replacements as well as capital expenditures
      incurred in conjunction with reopening the Winfield, Alabama facility in 2005.
      Additionally, we had $1,555 of proceeds from the sale of property, plant and
      equipment, including the sale of a previously leased facility in Adrian,
      Georgia. Cash provided by other investing activities represents cash
      distributions from equity method investees of $622 and proceeds from the sale
      of
      stock of a cost method investment totaling $495.





The
      $17,750 we borrowed in the fourth quarter of 2005 under our revolving line
      of
      credit to fund short term cash needs related to FEMA home shipments was re-paid
      in full in the first quarter of 2006. The decrease in long-term debt for 2006
      was due to scheduled principal payments of $1,493 and $1,898 of additional
      principal payments on (i) one industrial development revenue bond and (ii)
      the
      real estate term loan using proceeds from the property sale transaction
      mentioned above. The borrowings under our retail floor plan agreement decreased
      $887 to $1,103 at December 31, 2006 from $1,990 at December 31, 2005. Proceeds
      of stock options exercised generated cash of $148 in 2006.





27




Working
      capital at year end increased by $1,092 to $25,308.





The
      decrease in the installment loan portfolio at December 31, 2006 is primarily
      from sales of loans outstanding as of December 31, 2005, including land/home
      loans. Included in the installment loan portfolio at December 31, 2006 was
      $5,457 of land/home loans. At December 31, 2005, the Company had $6,972
      land/home loans in its portfolio. As we increase our land/home loan purchases,
      short-term cash requirements will increase due to the length of time involved
      in
      consummating the sales transaction. We expect to utilize cash on hand to fund
      loan purchases.





**2005**





Cash
      decreased $17,295 from $31,674 at December 31, 2004 to $14,379 at December
      31,
      2005. Operating activities used net cash of $35,078 primarily due
      to:





(a)
            an
                increase in accounts receivable of $35,173 due to shipments of FEMA
                disaster relief homes,


(b)
            an
                inventory increase of $12,394, of which over $5,000 represents finished
                homes we were unable to deliver to FEMA due to their inability to
                accept
                receipt in a timely fashion, with most of the remaining inventory
                increase
                representing raw materials purchased to support higher levels of
                production,


(c)
            the
                net purchase of installment contracts of
                $6,817,


(d)
            a
                slight offset of the above uses of cash by an increase of $3,526
                in
                accounts payable for increased inventory purchases,
                and


(e)
            an
                offset by 2005 net income of
                $10,915.





Historically,
      FEMA receivables are outstanding for longer periods of time than our other
      receivables. Of the $35,365 receivables outstanding under the FEMA contracts
      at
      December 31, 2005, $28,746 was collected through March 9, 2006. Additionally,
      subsequent to year-end all FEMA related homes were delivered.





Our
      capital expenditures were $1,410 during 2005 primarily for normal property,
      plant and equipment additions and replacements as well as $251 of capital
      expenditures incurred in conjunction with reopening the Winfield, Alabama
      facility in late 2005. Additionally, we had $3,537 of proceeds from the sale
      of
      property plant and equipment, which were primarily from the sale of the Ft.
      Worth facility in the second quarter which were accounted for at year end as
      discontinued operations in the accompanying consolidated statements of
      operations.





During
      2005, we paid out charges for involuntary termination benefits of $878 as
      discussed above related to the closing of the Ft. Worth, Texas home
      manufacturing facility. There were no comparable payments in the 2004 period,
      and we do not expect to incur any additional impairment charges relating to
      the
      Ft. Worth, Texas facility.





The
      decrease in long-term debt for 2005 was due to scheduled principal payments
      of
      $1,626 and a $2,350 pay-down on the real estate term loan using a portion of
      the
      proceeds from the sale of the Ft. Worth, Texas property mentioned above. During
      the fourth quarter of 2005, we borrowed $17,750 under the revolving line of
      credit, in order to fund our short term cash needs required to fulfill the
      outstanding FEMA order. During the first quarter of 2006, the line of credit
      balance was paid in full. The borrowings under our retail floor plan agreement
      increased to $1,990 by December 31, 2005 from $1,071 at December 31, 2004
      primarily for the opening of a new retail location in the fourth quarter of
      2004. Proceeds of stock options generated cash of $1,109 in 2005.





Working
      capital as of December 31, 2005 improved by $11,249 to $24,216 due in part
      to
      2005 net income.





The
      increase in the installment loan portfolio at December 31, 2005 was primarily
      due to a higher volume of land/home loans, many of which were construction
      loans, for which the length of time involved in closing the sale transaction
      is
      greater in comparison to a typical chattel (home only) loan. Included in the
      installment loan portfolio at December 31, 2005 was $6,972 of land/home loans.
      As we increase our land/home loan purchases, short-term cash requirements will
      increase due to the length of time involved in consummating the sales
      transaction. We expect to utilize cash on hand to fund these loan
      purchases.





28




**2004**





Cash
      decreased $719 to $31,674 at December 31, 2004 from $32,393 at December 31,
      2003. Operating activities used net cash of $930 primarily due to:





(a)
            an
                increase in accounts receivable of $2,321 which is primarily for
                shipments
                of FEMA disaster relief homes,


(b)
            an
                inventory increase of $3,945 due in part to higher levels of production
                in
                our home manufacturing plants and some raw material purchases in
                anticipation of increasing prices,


(c)
            the
                net purchase of installment contracts of
                $959,


(d)
            a
                slight offset of the above uses of cash by an increase of $451 in
                accounts
                payable for increased inventory purchases,
                and


(e)
            an
                offset by 2004 net income of
                $3,241.





On
      average, the FEMA receivables were outstanding for a longer period of time
      than
      our other receivables; however, the outstanding FEMA-related receivables of
      $2,513 were collected in 2005.





Our
      capital expenditures were $786 during 2004 primarily for normal property, plant
      and equipment additions and replacements. Additionally, we had $2,320 of
      proceeds from the sale of property, plant and equipment, primarily from the
      sale
      of a previously idled manufacturing facility of which $1,697 was paid on
      long-term debt.





The
      decrease in long-term debt for 2004 was due to scheduled principal payments
      of
      $1,734 and a $1,697 pay-down on the real estate term loan using a portion of
      the
      proceeds from the property sales mentioned above.





We
      entered into a retail floor plan agreement during 2004 for our Company-owned
      retail stores and borrowed $1,071 to support our retail locations’ inventory
      purchases.





Proceeds
      of stock options generated cash of $939 in 2004.





**General
      Liquidity and Debt Agreements**





Historically,
      we have funded our operating activities with cash flows from operations
      supplemented by available cash on hand and, when necessary, funds from our
      principal line of credit. During the industry downturn, we benefited from the
      proceeds of sales of idle facilities as a replacement source of funds due to
      net
      operating losses. Currently, we have two previously idled facilities that are
      being marketed for sale; however, we cannot predict when or at what amounts
      the
      facilities will ultimately be sold.





Our
      trend
      of cash used in operating activities over the past several years is a direct
      result of the continuing downturn in the industry and our net losses as a
      result. The industry has been impacted by an increase in dealer failures, a
      severe reduction in available consumer credit and wholesale (dealer) financing
      for manufactured housing, more restrictive credit standards and increased home
      repossessions which re-enter home distribution channels. Each of these factors
      contributed to a reduction in wholesale industry shipments to a 44-year low
      in
      2006. However, our cash position improved in 2006 due to collection of the
      outstanding receivables from FEMA at December 31, 2005.





During
      2005, we entered into agreements as a subcontractor to provide 2,638 homes
      to
      FEMA as part of that agency’s hurricane relief efforts. In order to fund our
      short term cash needs required to fulfill the orders of FEMA homes, we amended
      our credit facility (the “Credit Facility”) with our primary lender to provide
      for an available revolving line of credit during the period of October 25,
      2005
      through April 30, 2006 (the “first temporary advance period”) of $50,000 and
      during the period of May 1, 2006 through July 31, 2006 (the “second temporary
      advance period”) of $25,000, effectively waiving temporarily the tangible net
      worth requirement listed below. On May 23, 2006, the collateral requirement
      was
      amended to exclude CIS’s loans receivable with origination dates less than 365
      days old. On February 21, 2007, subsequent to year-end, we further amended
      the
      terms of the Credit Facility, to, among other things, (i) extend the maturity
      date to April 15, 2008, (ii) reduce the interest rate on outstanding borrowings
      if TNW exceeds $62,000, and (iii) increase the annual capital expenditure limit
      to $5,000 per year.




The
      Credit Facility is comprised of a revolving line of credit which provides for
      borrowings (including letters of credit) up to $25,000 ($50,000 during the
      first
      temporary advance period) and a real estate term loan (initial term of 14 years)
      component of $10,000, which are cross-secured and cross-defaulted. The amount
      available under the revolving line of credit, up to $25,000 ($50,000 during
      the
      first temporary advance period), is equal to the lesser of an amount based
      on
      defined percentages of accounts and notes receivable and inventories or certain
      levels of tangible net worth plus all treasury stock purchases after December
      31, 2003, as noted in the following table. The change in availability due to
      the
      February 2007 amendment is shown parenthetically.




29




Tangible
                Net Worth (“TNW”)
            
            Credit
                Facility AvailableAbove
                $50,000
            
            30%
                of TNW (35% of TNW)$50,000
                –$38,000
            
            $15,000$38,000 –$23,000
            
            $15,000
                to zero (dollar for dollar
                reduction)





At
      December 31, 2006, under the revolving line of credit, $10,059 (based on defined
      percentages of accounts and notes receivable and inventories) was available
      after deducting letters of credit of $5,204. During the fourth quarter of 2005,
      we borrowed $17,750 under the revolving line of credit, in order to fund our
      short term cash needs required to fulfill the outstanding FEMA order. During
      the
      first quarter of 2006, the line of credit balance was paid in full. We did
      not
      have any amounts outstanding under the revolving line of credit at December
      31,
      2006.





The
      applicable interest rates under the revolving line of credit are based on
      certain levels of tangible net worth as noted in the following table. The levels
      and rates as amended on February 21, 2007 are shown
      parenthetically.





Tangible
                Net Worth (“TNW”)
            
            Interest
                RateAbove
                $77,000
            (above
              $62,000)
            
            Prime
                less 0.50%
            (Prime less 1.00%)$77,000 –$65,000
            ($62,000
–$56,500)
            
            Prime
            (Prime)$65,000 –$58,000
            ($56,500
–$38,000)
            
            Prime
                plus 0.25%
            (Prime plus 0.50%)$58,000 –$38,000
            (below
              $38,000)
            
            Prime
                plus 1.00%
            (Prime plus 1.00%)Below
                $38,000
            (n/a)
            
            Prime
                plus 2.00%
            (n/a)





The
      bank’s prime rate at December 31, 2006 and 2005 was 8.25% and 7.25%,
      respectively. One of our directors served as president of the primary lender
      until August 31, 2004. We made payments to our lender in the amount $694 (2004)
      for interest, commitment fees, letter of credit and various bond related
      fees.





The
      real
      estate term loan agreement contained in the Credit Facility provided for
      borrowings of $10,000, of which $2,937 and $4,219 was outstanding at December
      31, 2006 and December 31, 2005, respectively. Interest on the term note is
      fixed
      for a period of five years from issuance at 6.5% and may be adjusted at 5 and
      10
      years. Amounts outstanding under the real estate term loan are collateralized
      by
      certain plant facilities and equipment.





The
      Credit Facility, as amended, contains certain restrictive and financial
      covenants which, among other things, limit our ability without the lender’s
      consent to (i) make dividend payments and purchases of treasury stock in an
      aggregate amount which exceeds 50% of consolidated net income for the two most
      recent years, (ii) mortgage or pledge assets which exceed in the aggregate
      $1,000, (iii) incur additional indebtedness, including lease obligations, which
      exceed in the aggregate $1,000, excluding floor plan notes payable which cannot
      exceed $3,000 and (iv) make annual capital expenditures of $3,000 for the year
      ended December 31, 2006 and $5,000 thereafter (as amended on February 21, 2007).
      In addition, the Credit Facility contains certain financial covenants requiring
      us to maintain on a consolidated basis certain defined levels of debt to
      tangible net worth ratio (not to exceed 2.5 to 1) and cash flow to debt service
      ratio of not less than 1.5 to 1 for the year ending December 31, 2006 and not
      less than 1.2 to 1 for the year ending December 31, 2007 (as amended February
      21, 2007) and thereafter, and to maintain a current ratio, as defined, of at
      least 1.0 to 1 and consolidated tangible net worth of at least $23,000. The
      Credit Facility also requires CIS to comply with certain specified restrictions
      and financial covenants. At December 31, 2006, we were in compliance with our
      debt covenants.





We
      have
      amounts outstanding under four Industrial Development Revenue Bond issues
      (“Bonds”) which totaled $2,800 and $4,910 at December 31, 2006 and 2005,
      respectively. Three of the bond issues bear interest at variable rates ranging
      from 5.0% to 5.4% and mature at various dates through April 2009. One of the
      bond issues is payable in annual installments through 2013 with interest payable
      monthly at a variable rate currently at 4.31% as determined by a remarketing
      agent. The real estate term loan and the bonds are collateralized by
      substantially all of our plant facilities and equipment.





We
      have
      $1,103 and $1,990 of notes payable under a retail floor plan agreement at
      December 31, 2006 and December 31, 2005, respectively. The notes are
      collateralized by certain Company-owned retail stores’ new home inventories and
      bear interest rates ranging from prime to prime plus 2.5% but not less than
      6%
      based on the age of the home.





Since
      its
      inception, CIS has been restricted in the amount of loans it could purchase
      based on underwriting standards, as well as the availability of working capital
      and funds borrowed under its credit line with its primary lender. From time
      to
      time, we evaluate the potential to sell all or a portion of our remaining
      installment loan portfolio, in addition to the periodic sale of installment
      contracts purchased by CIS in the future. CIS is currently re-selling loans
      to
      other lenders under various retail finance contracts. We believe the periodic
      sale of installment contracts under these retail finance agreements will reduce
      requirements for both working capital and borrowings, increase our liquidity,
      reduce our exposure to interest rate fluctuations and enhance our ability to
      increase our volume of loan purchases. There can be no assurance, however,
      that
      additional sales will be made under these agreements, or that we will be able
      to
      realize the expected benefits from such agreements.





30




We
      believe existing cash and funds available under the Credit Facility, together
      with cash provided by operations, will be adequate to fund our operations and
      plans for the next twelve months. However, there can be no assurances to this
      effect. If it is not, or if we are unable to remain in compliance with our
      covenants under our Credit Facility, we would seek to maintain or enhance our
      liquidity position and capital resources through modifications to or waivers
      under the Credit Facility, incurrence of additional short or long-term
      indebtedness or other forms of financing, asset sales, restructuring of debt,
      and/or the sale of equity or debt securities in public or private transactions,
      the availability and terms of which will depend on various factors and market
      and other conditions, some of which are beyond our control.





Projected
      cash to be provided by operations in the coming year is largely dependent on
      sales volume. Our manufactured homes are sold mainly through independent dealers
      who generally rely on third-party lenders to provide floor plan financing for
      homes purchased. In addition, third-party lenders generally provide consumer
      financing for manufactured home purchases. Our sales depend in large part on
      the
      availability and cost of financing for manufactured home purchasers and dealers
      as well as our own retail locations. The availability and cost of such financing
      is further dependent on the number of financial institutions participating
      in
      the industry, the departure of financial institutions from the industry, the
      financial institutions’ lending practices, the strength of the credit markets in
      general, governmental policies, and other conditions, all of which are beyond
      our control. Throughout the past eight years the industry has been impacted
      significantly by reduced financing available at both the wholesale and retail
      levels, with several lenders exiting the marketplace or limiting their
      participation in the industry, coupled with more restrictive credit standards
      and increased home repossessions which re-enter home distribution channels
      and
      limit wholesale shipments of new homes. Unfavorable changes in these factors
      and
      terms of financing in the industry may have a material adverse effect on our
      results of operations or financial condition.





**Off-Balance
      Sheet Arrangements**





Our
      material off-balance sheet arrangements consist of repurchase obligations,
      guarantees and letters of credit. Each of these arrangements is discussed below
      under Contractual Obligations and Commitments.





**Contractual
      Obligations and Commitments** ***(dollars
      in thousands)***





The
      following table summarizes our contractual obligations at December 31, 2006.
      For
      additional information related to these obligations, see Notes 6 and 11 of
      Notes
      to Consolidated Financial Statements. This table excludes long-term obligations
      for which there is no definite commitment period. Our debt consists primarily
      of
      fixed rate debt. However, there is one bond that has a variable interest rate.
      We estimated the interest payments due for this bond using 4.31%, which is
      a
      slight increase from the latest applicable interest rate. We do not have any
      contractual purchase obligations, and historically, have not entered into
      contracts committing us to purchase specified quantities of materials or
      equipment.




**Payments
                    Due by Period****Total**
                
                **Less
                    than 1year**
                
                **1
                    -3 years**
                
                **4
                    - 5 years**
                
                **After
                    5 years**Industrial
                    development revenue bond issues
                
                $
                2,800
                
                $
                1,025
                
                $
                730
                
                $
                780
                
                $
                265Real
                    estate term loan
                
                
                2,937
                
                
                201
                
                
                442
                
                
                506
                
                
                1,788Interest
                
                
                1,405
                
                
                304
                
                
                605
                
                
                256
                
                
                240Operating
                    leases
                
                
                169
                
                
                112
                
                
                57
                
                
                —
                
                
                —Total
                    contractual cash obligations
                
                $
                7,311
                
                $
                1,642
                
                $
                1,834
                
                $
                1,542
                
                $
                2,293


31




The
      following table summarizes our contingent commitments at December 31, 2006,
      including contingent repurchase obligations, guarantees of debt for
      equity-method investees and letters of credit. For additional information
      related to these contingent obligations, see Note 11 of Notes to Consolidated
      Financial Statements and Critical Accounting Estimates below. Contingent
      insurance plans’ retrospective premium adjustments are excluded from this table
      as there is no definite expiration period (see Critical Accounting Estimates
      below).


**Amount
                    of Commitment Expiration per Period****Total**
                
                **Less
                    than 1year**
                
                **1
                    -3 years**
                
                **4
                    - 5 years**
                
                **After
                    5 years**Repurchase
                    obligations - (1)
                
                $
                62,000
                
                $
                15,000
                
                $
                47,000
                
                $
                —
                
                $
                —Guarantees
                    - (2)
                
                
                686
                
                
                686
                
                
                —
                
                
                —
                
                
                —Letters
                    of credit - (3)
                
                
                5,204
                
                
                5,204
                
                
                —
                
                
                —
                
                
                —Total
                    commitments
                
                $
                67,890
                
                $
                20,890
                
                $
                47,000
                
                $
                —
                
                $
                —


(1)
            For
                a complete description of the contingent repurchase obligation, see
                Critical Accounting Estimates - Reserve for repurchase commitments.
                Although the commitments outstanding at December 31, 2006 have a
                finite
                life, these commitments are continually replaced as we continue to
                sell
                our manufactured homes to dealers under repurchase and other recourse
                agreements with lending institutions which have provided wholesale
                floor
                plan financing to dealers. The cost (net recoveries) of these contingent
                repurchase obligations to us was $430 (2006), $(696) (2005) and $(301)
                (2004). We have a reserve for repurchase commitments of $1,513 (2006)
                and
                $1,270 (2005) based on prior experience and an evaluation of dealers’
                financial conditions.





(2)
            We
                and certain of our equity partners have guaranteed certain debt for
                one
                company in which we own a one-third interest. The guarantees are
                limited
                to 40% of the outstanding debt. At December 31, 2006, $1,715 of debt
                was
                outstanding under the guarantees, of which we had guaranteed $686.
                Subsequent to December 31, 2006, this company sold the last of its
                properties and repaid all of the debt. Therefore, our guarantees
                related
                to this debt have expired.





(3)
            We
                have provided letters of credit to providers of certain of our surety
                bonds and insurance policies. While the current letters of credit
                have a
                finite life, they are subject to renewal at different amounts based
                on the
                requirements of the insurance carriers. The outstanding letters of
                credit
                reduce amounts available under our Credit Facility. We have recorded
                insurance expense based on anticipated losses related to these
                policies.





**Critical
      Accounting Estimates**





We
      follow
      certain significant accounting policies when preparing our consolidated
      financial statements as summarized in Note 1 of Notes to Consolidated Financial
      Statements. The preparation of our financial statements in conformity with
      accounting principles generally accepted in the United States of America
      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 and use historical experience factors, current
      economic conditions 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 as well
      as
      identifying the accounting treatment with respect to commitments and
      contingencies. Actual results could differ from these estimates under different
      assumptions or conditions. The following is a list of the accounting policies
      that we believe are most important to the portrayal of our financial condition
      and results of operations that require our most difficult, complex or subjective
      judgments as a result of the need to make estimates about the effect of matters
      that are inherently uncertain.





***Product
      Warranties***





We
      provide the initial retail homebuyer a one-year limited warranty covering
      defects in material or workmanship in home structure, plumbing and electrical
      systems. We record a liability for estimated future warranty costs relating
      to
      homes sold, based upon our assessment of historical experience factors and
      current industry trends. Factors we use in the estimation of the warranty
      liability include historical sales amounts and warranty costs related to homes
      sold and any outstanding service work orders. We have a reserve for estimated
      warranties of $11,900  (2006)
      and $13,190  (2005).
      Although we maintain reserves for such claims, based on our assessments as
      described above, which to date have been adequate, there can be no assurance
      that warranty expense levels will remain at current levels or that such reserves
      will continue to be adequate. A large number of warranty claims or per claim
      costs exceeding our current warranty expense levels could have a material
      adverse effect on our results of operations.





***Insurance***





Our
      workers’ compensation (prior to February 1, 1999, and after April 1, 2001),
      product liability and general liability insurance coverages were provided under
      incurred loss, retrospectively rated premium plans. Under these plans, we incur
      insurance expense based upon various rates applied to current payroll costs
      and
      sales. Annually, such insurance expense is adjusted by the carrier for loss
      experience factors subject to minimum and maximum premium calculations. Refunds
      or additional premiums are estimated and recorded when sufficiently reliable
      data is available. We were contingently liable at December 31, 2006 for future
      retrospective premium adjustments and recorded an estimated liability of
      approximately $4,816 (2006) and $5,002 (2005) related to these contingent
      claims. Claims exceeding our current expense levels could have a material
      adverse effect on our results of operations.





32




***Reserve
      for repurchase commitments***





Manufactured
      housing companies customarily enter into repurchase agreements with lending
      institutions, which provide wholesale floor plan financing to dealers. A
      majority of our sales are made to dealers located primarily in the South Central
      and South Atlantic regions of the United States pursuant to repurchase
      agreements with lending institutions. These agreements generally provide that
      we
      will repurchase our new products from the lending institutions in the event
      of
      dealer default. Our risk of loss under repurchase agreements is reduced by
      the
      following factors: (1) sales of our manufactured homes are spread over a
      relatively large number of independent dealers, the largest of which accounted
      for approximately 7.0% of sales in 2006, excluding FEMA-related sales; (2)
      the
      price that we are obligated to pay under such repurchase agreements declines
      based on predetermined amounts over the period of the agreement (generally
      18 to
      24 months); and (3) we historically have been able to resell homes repurchased
      from lenders.





We
      apply
      FASB Interpretation (“FIN”) No. 45, *Guarantor’s
      Accounting and Disclosure Requirements for Guarantees, Including Indirect
      Guarantees of Indebtedness to Others, an interpretation of FASB Statements
      No.
      5, 57, and 107 and a rescission of FASB Interpretation No. 3* and SFAS
      No. 5, *Accounting for Contingencies,* to
      account for our liability for repurchase commitments. Under
      the
      provisions of FIN 45, issuance of a guarantee results in two different types
      of
      obligations: (1) a non-contingent obligation to stand ready to perform under
      the
      repurchase commitment (accounted for pursuant to FIN 45) and (2) a contingent
      obligation to make future payments under the conditions of the repurchase
      commitment (accounted for pursuant to SFAS No. 5). We
      review
      the retail dealers’ inventory to estimate the amount of inventory subject to
      repurchase obligation which is used to calculate (1) the fair value of the
      non-contingent obligation for repurchase commitments and (2) the contingent
      liability based on historical information available at the time. During the
      period in which a home is sold (inception of a repurchase commitment), we record
      the greater of these two calculations as a liability for repurchase commitments
      and as a reduction to revenue.





(1)
            We
                estimate the fair value of the non-contingent portion of our
                manufacturer’s inventory repurchase commitment under the provisions of FIN
                45 when a home is shipped to dealers whose floor plan financing includes
                our repurchase commitment. The fair value of the inventory repurchase
                agreement has been estimated on a “pooled dealer” approach based on the
                creditworthiness of the independent dealers, as determined by the
                floor
                plan institution, and is derived using an income approach. Specifically,
                the fair value of the inventory repurchase agreement is determined
                by
                calculating the net present value of the difference in (a) the interest
                cost to carry the inventory over the maximum repurchase liability
                period
                at the prevailing floor plan note interest rate and (b) the interest
                cost
                to carry the inventory over the maximum repurchase liability period
                at the
                interest rate of a similar type loan without a manufacturer’s repurchase
                agreement in force.





(2)
            We
                estimate the contingent obligation to make future payments under
                our
                manufacturer’s inventory repurchase commitment for the same pool of
                commitments as used in the fair value calculation above and record
                the
                greater of the two calculations. This SFAS No. 5 contingent obligation
                is
                estimated using historical loss factors, including the frequency
                of
                repurchases and the losses we experienced for repurchased
                inventory.





Additionally,
      subsequent to the inception of the repurchase commitment, we evaluate the
      likelihood that we will be called on to perform under the inventory repurchase
      commitments. If it becomes probable that a dealer will default and a SFAS No.
      5
      loss reserve should be recorded, then such contingent liability is recorded
      equal to the estimated loss on repurchase. Based on identified changes in
      dealers’ financial conditions, we evaluate the probability of default for the
      group of dealers who are identified at an elevated risk of default and apply
      a
      probability of default to the group, based on historical default rates. In
      this
      default probability evaluation, we review repurchase notifications received
      from
      floor plan sources and review our dealer inventory for expected repurchase
      notifications based on various communications from the lenders and the dealers
      as well as for dealers who, we believe, are experiencing financial difficulty.
      Our repurchase commitments for the dealers in the category of elevated risk
      of
      default are excluded from the pool of commitments used in both of the
      calculations at (1) and (2) above. Changes in the reserve are recorded as an
      adjustment to revenue.





Following
      the inception of the commitment, the recorded reserve is reduced over the
      repurchase period and is eliminated once the dealer sells the home. The maximum
      amount for which we are contingently liable under repurchase agreements
      approximated $62,000 and $52,000 at December 31, 2006 and 2005, respectively.
      We
      have a reserve for repurchase commitments of $1,513 (2006) and $1,270
      (2005).





33




Changes
      in the level of retail inventories in the manufactured housing industry, either
      up or down, can have a significant impact on our operating results. The
      deterioration in the availability of retail financing experienced in recent
      years, along with significant competition from repossessed homes, extended
      the
      inventory adjustment period for excess industry retail inventory levels beyond
      what was originally expected. If these trends were to continue, or if retail
      demand were to significantly weaken, the inventory overhang could result in
      even
      greater intense price competition, cause further pressure on profit margins
      within the industry, and have a material adverse effect on us. The inventory
      of
      Cavalier manufactured homes at all retail locations, including Company-owned
      retail sales centers, increased 23% in 2006 from 2005 and declined 29% in 2005
      from 2004. The changes in retail inventory, and corresponding changes in
      repurchase commitments, have been impacted in the last two years by the leveling
      of retail inventory with demand and by the industry’s involvement in the
      production of FEMA-related houses that do not carry a repurchase commitment.
      In
      2006, as FEMA-related production was replaced by traditional dealer purchases
      that carry inventory repurchase commitments, the contingent portion of our
      reserve for repurchase commitments increased as we noted in our 2005 Form
      10-K.




***Impairment
      of Long-Lived Assets***





Since
      the
      latter part of 1999, the manufactured housing industry has experienced a
      downturn in business as discussed above. Due to deteriorating market conditions
      during this time, we have idled, closed or sold 17 manufactured housing
      facilities, a portion of our insurance and premium finance business, a portion
      of our supply operations and 13 under-performing retail locations. We
      periodically evaluate the carrying value of long-lived assets to be held and
      used, including goodwill and other intangible assets, when events and
      circumstances warrant such a review. The carrying value of long-lived assets
      is
      considered impaired when the anticipated undiscounted cash flow from such assets
      is less than our carrying value. In that event, a loss is recognized based
      on
      the amount by which the carrying value exceeds the fair market value of the
      long-lived assets. Fair market value is determined primarily using the
      anticipated cash flows discounted at a rate commensurate with the risk involved.
      Losses on long-lived assets to be disposed of are determined in a similar
      manner, except that the fair market values are based primarily on independent
      appraisals and preliminary or definitive contractual arrangements less costs
      to
      dispose. No impairment charges were recorded in 2006.





***Deferred
      Tax Asset***





Realization
      of deferred tax assets (net of recorded valuation allowances) is largely
      dependent upon future profitable operations and future reversals of existing
      taxable temporary differences. In 2004, pursuant to SFAS No. 109, *Accounting
      for Income Taxes* ,
      because
      we had operated at a cumulative loss in our three most recent calendar years
      and
      because we believed difficult competitive and economic conditions might continue
      for the foreseeable future, a valuation allowance was recorded to fully reserve
      net deferred tax assets. As a result of continued improvements in operating
      performance in 2005 and projected income and tax liability for 2006, we reversed
      a portion of the deferred tax asset valuation allowance realizing $1,314 in
      deferred tax benefits as of December 31, 2005. With the decline in homes shipped
      in 2006 to a 44-year industry low, we re-evaluated the need to fully reserve
      our
      net deferred tax assets. In assessing the need for the valuation allowance,
      we
      consider all positive and negative evidence, including anticipated operating
      results, scheduled reversals of deferred tax liabilities, and tax planning
      strategies. Because we believe challenging industry conditions will extend
      into
      2007 and we lack visibility with respect to our 2007 results, we have
      re-established a full valuation allowance against our deferred tax assets under
      the standards of SFAS No. 109. As of December 31, 2006, we maintained a
      valuation allowance of $14,709. We will continue to evaluate the need for a
      valuation allowance in the future, which may be reversed to income in future
      periods to the extent that the related deferred income tax assets are realized
      or the valuation allowances are otherwise no longer required.





**Related
      Party Transactions**





We
      purchased raw materials of approximately $14,698, $21,586, and $17,680 from
      MSR
      Forest Products, LLC, and Alliance Homes, Inc. during 2006, 2005 and 2004,
      respectively, which are companies in which we own a minority
      interest.





Mr.
      Thomas A. Broughton, III, one of our directors, served as the president of
      First
      Commercial Bank, our primary lender, through August 31, 2004. We made payments
      to this lender in the amount of $694 (2004) for interest, commitment, letter
      of
      credit and various bond related fees. See Note 6 of Notes to Consolidated
      Financial Statements for additional information regarding our Credit
      Facility.





We
      recorded net income of investees accounted for by the equity method of **$** 805,
      $775, and $980 for the years ended December 31, 2006, 2005, and 2004,
      respectively. Additionally, we and certain of our equity partners have
      guaranteed certain debt for two companies in which we own a one-third interest.
      For additional information related to these guarantees, see footnote (2) under
      Contractual Obligations and Commitments above.





34




We
      used
      the services of a law firm, Lowe, Mobley & Lowe, a partner of which, Mr.
      John W Lowe, is also another of our directors. We paid legal fees to this firm
      of $292 (2006), $414 (2005), and $346 (2004). In addition, this law firm
      received from the proceeds of the settlement of one of our claims, an indirect
      legal fee payment of $74 in 2005.





**Impact
      of Inflation**





We
      generally have been able to increase our selling prices to offset increased
      costs, including the costs of raw materials. Sudden increases in costs as well
      as price competition, however, can affect our ability to increase our selling
      prices. We believe that the relatively moderate rate of inflation over the
      past
      several years has not had a significant impact on our sales or profitability,
      but can give no assurance that this trend will continue in the
      future.





**Recently
      Issued Accounting Pronouncements**





In
      June
      2006, the Financial Accounting Standards Board (“FASB”) issued FASB
      Interpretation (“FIN”) No. 48, *Accounting
      for Uncertainty in Income Taxes,* an
      interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for
      uncertainty in income taxes recognized in a company’s financial statements in
      accordance with FASB Statement No. 109, *“Accounting
      for Income Taxes,”* by
      prescribing a recognition threshold and measurement attribute for the financial
      statement recognition and measurement of a tax position taken or expected to
      be
      taken in a tax return. Under FIN 48, the financial statement effect of a tax
      position should initially be recognized when it is more likely than not, based
      on the technical merits, that the position will be sustained upon examination.
      A
      tax position that meets the more-likely-than-not recognition threshold should
      initially and subsequently be measured as the largest amount of tax benefit
      that
      has a greater than fifty percent likelihood of being realized upon ultimate
      settlement with a taxing authority. This statement is effective for fiscal
      years
      beginning after December 15, 2006. The cumulative effect, if any of applying
      the
      provisions of FIN 48 will be reported as an adjustment to the opening balance
      of
      retained earnings in the period adopted. We are currently assessing the effects
      of the adoption of this statement on our consolidated financial
      statements.





In
      September 2006, the FASB issued SFAS No. 157, *Fair
      Value Measurements* ,
      which
      defines fair value, establishes guidelines for measuring fair value and expands
      disclosures regarding fair value measurements. SFAS No. 157 does not
      require any new fair value measurements but rather eliminates inconsistencies
      in
      guidance found in various prior accounting pronouncements.
      SFAS No. 157 is effective for fiscal years beginning after November
      15, 2007. Earlier adoption is permitted, provided the company has not yet issued
      financial statements, including for interim periods, for that fiscal year.
      We
      are currently evaluating the impact of SFAS No. 157, but do not expect
      the adoption of SFAS No. 157 to have a material impact on our
      consolidated financial statements.





**ITEM
              7A:**
            **QUANTITATIVE
                AND QUALITATIVE DISCLOSURES ABOUT MARKET
                RISK**





**Market
      Risk**





Market
      risk is the risk of loss arising from adverse changes in market prices and
      interest rates. We are exposed to interest rate risk inherent in our financial
      instruments, but are not currently subject to foreign currency or commodity
      price risk. We manage our exposure to these market risks through our regular
      operating and financing activities.





We
      purchase retail installment contracts from our dealers, at fixed interest rates,
      in the ordinary course of business, and periodically resell a majority of these
      loans to financial institutions under the terms of retail finance agreements.
      The periodic resale of installment contracts reduces our exposure to interest
      rate fluctuations, as the majority of contracts are held for a short period
      of
      time. Our portfolio consisted of fixed rate contracts with interest rates
      generally ranging  from
      7.5%
      to 14% and an average original term of 268 months at December 31, 2006. We
      estimated the fair value of our installment contracts receivable at $13,000
      using discounted cash flows and interest rates offered by CIS on similar
      contracts at December 31, 2006.





We
      have
      one industrial development revenue bond issue that is exposed to interest rate
      changes. Since this borrowing is floating rate debt, an increase in short-term
      interest rates would adversely affect interest expense. Additionally, we have
      three industrial development revenue bond issues at fixed interest rates. We
      estimated the fair value of our debt instruments at $5,787 using rates at which
      we believe we could have obtained similar borrowings at December 31,
      2006.





35




**Assumed
                  Annual Principal Cash Flows***(dollars
                  in thousands)*
              
              **2007**
              
              **2008**
              
              **2009**
              
              **2010**
              
              **2011**
              
              **Thereafter**
              
              **Total**
              
              **Fair
                  value**Installment
                  loan portfolio (a)
              
              $
              6,430
              
              $
              158
              
              $
              192
              
              $
              181
              
              $
              218
              
              $
              5,086
              
              $
              12,265
              
              $
              13,000(weighted
                  average interest rate - 8.5%)




**Expected
                  Principal Maturity Dates***(dollars
                  in thousands)*
              
              **2007**
              
              **2008**
              
              **2009**
              
              **2010**
              
              **2011**
              
              **Thereafter**
              
              **Total**
              
              **Fair
                  value**Notes
                  payable and long-term debt
              
              $
              1,226
              
              $
              834
              
              $
              884
              
              $
              360
              
              $
              381
              
              $
              2,053
              
              $
              5,738
              
              $
              5,787(weighted
                  average interest rate - 5.7%)


(a)
              The
                  Company has recorded an allowance for credit losses of $841, primarily
                  based upon management's assessment of historical experience factors
                  and
                  current economic conditions.




Additionally,
      we have a revolving line of credit and a note payable under a retail floor
      plan
      agreement that are exposed to interest rate changes, as they are floating rate
      debt based on the prime interest rate. These borrowings are excluded from the
      above table since there is no scheduled payout or maturity date for either
      of
      these obligations. During the fourth quarter of 2005, we borrowed $17,750 under
      the revolving line of credit, in order to fund our short term cash needs
      required to fulfill the outstanding FEMA order. During the first quarter of
      2006, the line of credit balance was paid in full. We did not have any amounts
      outstanding under the revolving line of credit at December 31, 2006. The bank’s
      prime rate at December 31, 2006 and 2005 was 8.25% and 7.25% respectively.
      We
      have $1,103 and $1,990 of notes payable under the retail floor plan agreement
      at
      December 31, 2006 and December 31, 2005, respectively. The notes bear interest
      rates ranging from prime to prime plus 2.5% but not less than 6% based on the
      age of the home.





**CAUTIONARY
      FACTORS THAT MAY AFFECT FUTURE RESULTS**





Safe
      Harbor Statement under the Private Securities Litigation Reform Act of
      1995:





Our
      disclosure and analysis in this Annual Report on Form 10-K contain some
      forward-looking statements. Forward looking statements give our current
      expectations or forecasts of future events, including statements regarding
      trends in the industry and the business, financing and other strategies of
      Cavalier. You can identify these statements by the fact that they do not relate
      strictly to historical or current facts. They generally use words such as
“estimates,” “projects,” “intends,” “believes,” “anticipates,” “expects,”
“plans,” and other words and terms of similar meaning in connection with any
      discussion of future operating or financial performance. From time to time,
      we
      also may provide oral or written forward-looking statements in other materials
      released to the public. These forward-looking statements include statements
      involving known and unknown assumptions, risks, uncertainties and other factors
      which may cause the actual results, performance or achievements to differ from
      any future results, performance, or achievements expressed or implied by such
      forward-looking statements or words. In particular, such assumptions, risks,
      uncertainties and factors include those associated with the
      following:





·
            the
                cyclical and seasonal nature of the manufactured housing industry
                and the
                economy generally;


·
            the
                severe and continuing downturn in the manufactured housing
                industry;


·
            limitations
                in our ability to pursue our business
                strategy;


·
            changes
                in demographic trends, consumer preferences and our business
                strategy;


·
            changes
                and volatility in interest rates and the availability of
                capital;


·
            changes
                in the availability of retail (consumer)
                financing;


·
            changes
                in the availability of wholesale (dealer)
                financing;


·
            changes
                in level of industry retail
                inventories;


·
            the
                ability to attract and retain quality independent dealers, executive
                officers and other key personnel;


·
            competition;


·
            contingent
                repurchase and guaranty
                obligations;


·
            uncertainties
                regarding our retail financing
                activities;


·
            the
                potential unavailability and price increases for raw
                materials;


·
            the
                potential unavailability of manufactured housing
                sites;


·
            regulatory
                constraints;


·
            the
                potential for additional warranty
                claims;


·
            litigation;


·
            the
                potential volatility in our stock price;
                and


·
            the
                potential for deficiencies in internal controls over financial reporting
                or in disclosure controls and
                procedures.




36




Any
      or
      all of the forward-looking statements in this report, in the 2006 Annual Report
      to Stockholders, in the Annual Report on Form 10-K for the year ended December
      31, 2006 and in any other public statements we make may turn out to be wrong.
      These statements may be affected by inaccurate assumptions we might make or
      by
      known or unknown risks and uncertainties. Many factors listed above will be
      important in determining future results. Consequently, no forward-looking
      statement can be guaranteed. Actual future results may vary
      materially.





We
      undertake no obligation to publicly update any forward-looking statements,
      whether as a result of new information, future events or otherwise. You are
      advised, however, to consult any further disclosures we make on related subjects
      in future filings with the Securities and Exchange Commission or in any of
      our
      press releases. Also note that, in the Annual Report on Form 10-K for the period
      ending December 31, 2006, under the heading “Risk Factors,” we have provided a
      discussion of factors that we think could cause our actual results to differ
      materially from expected and historical results. Other factors besides those
      listed could also adversely affect us. This discussion is provided as permitted
      by the Private Securities Litigation Reform Act of 1995.





**ITEM
      8.**  **FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA**





Selected
      Quarterly Financial Data (Unaudited)





The
      table
      below sets forth certain unaudited quarterly financial data for the years ended
      December 31, 2006 and 2005. We believe that the following quarterly financial
      data includes all adjustments necessary for a fair presentation, in accordance
      with accounting principles generally accepted in the United States of America.
      The following quarterly financial data should be read in conjunction with the
      other financial information contained elsewhere in this report. The operating
      results for any interim period are not necessarily indicative of results for
      a
      complete year or for any future period.


FourthQuarter
              
              ThirdQuarter
              
              SecondQuarter
              
              FirstQuarter
              
              Total2006
              
              *(dollars
                  in thousands except per share amounts)*Revenue:Home
                  manufacturing net sales
              
              $
              40,137
              
              $
              47,945
              
              $
              55,270
              
              $
              71,834
              
              $
              215,186Financial
                  services
              
              
              838
              
              
              777
              
              
              811
              
              
              909
              
              
              3,335Retail
              
              
              2,337
              
              
              2,178
              
              
              2,694
              
              
              2,207
              
              
              9,416Total
                  revenue
              
              
              43,312
              
              
              50,900
              
              
              58,775
              
              
              74,950
              
              
              227,937Gross
                  profit
              
              
              6,150
              
              
              8,541
              
              
              10,402
              
              
              13,669
              
              
              38,762Net
                  income (loss)
              
              
              (867
              )
              
              (788
              )
              
              161
              
              
              1,666
              
              
              172Basic
                  net income (loss) per share
              
              
              (0.05
              )
              
              (0.04
              )
              
              0.01
              
              
              0.09
              
              
              0.01Diluted
                  net income (loss) per share
              
              $
              (0.05
              )
              $
              (0.04
              )
              $
              0.01
              
              $
              0.09
              
              $
              0.012005Revenue:Home
                  manufacturing net sales
              
              $
              96,448
              
              $
              53,711
              
              $
              56,575
              
              $
              52,798
              
              $
              259,532Financial
                  services
              
              
              766
              
              
              942
              
              
              781
              
              
              513
              
              
              3,002Retail
              
              
              2,403
              
              
              2,638
              
              
              2,646
              
              
              1,811
              
              
              9,498Total
                  revenue
              
              
              99,617
              
              
              57,291
              
              
              60,002
              
              
              55,122
              
              
              272,032Gross
                  profit
              
              
              22,285
              
              
              11,437
              
              
              10,252
              
              
              8,623
              
              
              52,597Net
                  income (loss)
              
              
              10,715
              
              
              1,585
              
              
              769
              
              
              (2,154
              )
              
              10,915Basic
                  net income (loss) per share
              
              
              0.59
              
              
              0.09
              
              
              0.04
              
              
              (0.12
              )
              
              0.60Diluted
                  net income (loss) per share
              
              $
              0.58
              
              $
              0.09
              
              $
              0.04
              
              $
              (0.12
              )
              $
              0.59


37




**CAVALIER
      HOMES, INC. AND SUBSIDIARIES**


**FINANCIAL
      STATEMENTS AND SUPPLEMENTAL DATA**




Index
      to
      Consolidated Financial Statements and Schedule




Management’s
                  Report on Internal Control Over Financial
                  Reporting
              
              39Reports
                  of Independent Registered Public Accounting
                  Firms
              
              40Consolidated
                  Balance Sheets
              
              43Consolidated
                  Statements of Operations
              
              44Consolidated
                  Statements of Stockholders’
                  Equity
              
              45Consolidated
                  Statements of Cash Flows
              
              46Notes
                  to Consolidated Financial
                  Statements
              
              47Schedule
                    - II - Valuation and Qualifying
                    Accounts
              
              63




Schedules
      I, III, IV and V have been omitted because they are not required.





38


**MANAGEMENT’S
      REPORT ON INTERNAL CONTROL OVER FINANCIAL
      REPORTING**





Management
      is responsible for establishing and maintaining adequate internal control over
      financial reporting, as such term is defined in Exchange Act Rule 13a-15(f).
      Our
      internal control system was designed to provide reasonable assurance to
      management and the board of directors regarding the preparation and fair
      presentation of published financial statements. Under the supervision and with
      the participation of management, including our Chief Executive Officer and
      our
      Chief Financial Officer, our management conducted an evaluation of the
      effectiveness of internal control over financial reporting based on the
      framework in *Internal
      Control: Integrated Framework* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission
      (“COSO”), as of December 31, 2006.





Based
      on
      the evaluation under the criteria contained in the framework of *Internal
      Control: Integrated Framework* ,
      our
      management concluded that our internal control over financial reporting was
      effective as of December 31, 2006.




Management’s
      assessment of the effectiveness of our internal control over financial reporting
      as of December 31, 2006 has been audited by Carr, Riggs and Ingram, LLC, an
      independent registered public accounting firm, as stated in their report
      below.




/s/
                DAVID A. ROBERSONDirector
                and Principal Executive Officer


/s/
                    MICHAEL R. MURPHYChief
                    Financial Officer and Principal Accounting Officer


March
      8,
      2007





39




**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
      FIRM**





To
      the
      Board of Directors


Cavalier
      Homes, Inc.





We
      have
      audited the accompanying consolidated balance sheets of Cavalier Homes, Inc.
      and
      subsidiaries (the “Company”) as of December 31, 2006 and 2005, and the related
      consolidated statements of operations, stockholders’ equity, and cash flows for
      each of the years then ended. Our audits also included the financial statement
      schedule of the Company listed in Item 15(a) for the years ended December 31,
      2006 and 2005. We also have audited management’s assessment, included in the
      accompanying Management’s Report on Internal Control Over Financial Reporting,
      that Cavalier Homes, Inc. and subsidiaries maintained effective internal control
      over financial reporting as of December 31, 2006, based on criteria established
      in *Internal Control—Integrated Framework* issued
      by
      the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
      The
      Company’s management is responsible for these financial statements and schedule,
      for maintaining effective internal control over financial reporting, and for
      its
      assessment of the effectiveness of internal control over financial reporting.
      Our responsibility is to express an opinion on these financial statements and
      schedule, an opinion on management’s assessment, and an opinion on the
      effectiveness of the Company’s internal control over financial reporting based
      on our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audits to obtain reasonable assurance about whether the
      financial statements are free of material misstatement and whether effective
      internal control over financial reporting was maintained in all material
      respects. Our audit of financial statements included examining, on a test basis,
      evidence supporting the amounts and disclosures in the financial statements,
      assessing the accounting principles used and significant estimates made by
      management, and evaluating the overall financial statement presentation. Our
      audit of internal control over financial reporting included obtaining an
      understanding of internal control over financial reporting, evaluating
      management’s assessment, testing and evaluating the design and operating
      effectiveness of internal control, and performing such other procedures as
      we
      considered necessary in the circumstances. We believe that our audits provide
      a
      reasonable basis for our opinions.





A
      company’s internal control over financial reporting is a process designed to
      provide reasonable assurance regarding the reliability of financial reporting
      and the preparation of financial statements for external purposes in accordance
      with generally accepted accounting principles. A company’s internal control over
      financial reporting includes those policies and procedures that (1) pertain
      to
      the maintenance of records that, in reasonable detail, accurately and fairly
      reflect the transactions and dispositions of the assets of the company; (2)
      provide reasonable assurance that transactions are recorded as necessary to
      permit preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the company are
      being made only in accordance with authorizations of management and directors
      of
      the company; and (3) provide reasonable assurance regarding prevention or timely
      detection of unauthorized acquisition, use, or disposition of the company’s
      assets that could have a material effect on the financial
      statements.





Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Also, projections of any evaluation of
      effectiveness to future periods are subject to the risk that controls may become
      inadequate because of changes in conditions, or that the degree of compliance
      with the policies or procedures may deteriorate.





In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the consolidated financial position of Cavalier Homes, Inc.
      and subsidiaries as of December 31, 2006 and 2005, and the consolidated results
      of their operations and their cash flows for each of the years then ended in
      conformity with U.S. generally accepted accounting principles. Also, in our
      opinion, the related financial statement schedule, when considered in relation
      to the basic consolidated financial statements taken as a whole, presents fairly
      in all material respects the information set forth therein. Also in our opinion,
      management’s assessment that Cavalier Homes, Inc. and subsidiaries maintained
      effective internal control over financial reporting as of December 31, 2006,
      is
      fairly stated, in all material respects, based on criteria established
      in *Internal Control—Integrated Framework* issued
      by
      the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
      Furthermore, in our opinion, Cavalier Homes, Inc. and subsidiaries maintained,
      in all material respects, effective internal control over financial reporting
      as
      of December 31, 2006, based on criteria established in *Internal Control—Integrated Framework* issued
      by
      the Committee of Sponsoring Organizations of the Treadway Commission
      (COSO).





40




As
      described in Note 8 to the consolidated financial statements, effective January
      1, 2006 the Company adopted Statement of Financial Accounting Standards No.
      123(R), *Share-Based
      Payment* .




/s/
      CARR,
      RIGGS & INGRAM, LLC


Birmingham,
      Alabama


March
      8,
      2007




41


**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





To
      the
      Board of Directors and Stockholders of Cavalier Homes, Inc.:





We
      have
      audited the accompanying consolidated statements of operations, stockholders’
equity, and cash flows of Cavalier Homes, Inc. and subsidiaries (the “Company”)
      for the year ended December 31, 2004.  Our audit also included the
      financial statement schedule listed in the Index at Item 15a for the year ended
      December 31, 2004. These financial statements and financial statement schedule
      are the responsibility of the Company’s management. Our responsibility is to
      express an opinion on the financial statements and financial statement schedule
      based on our audit.





We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audit provides a
      reasonable basis for our opinion.





In
      our
      opinion, such consolidated financial statements present fairly, in all material
      respects, the results of operations and cash flows of Cavalier Homes, Inc.
      and
      subsidiaries for the year ended December 31, 2004, in conformity with accounting
      principles generally accepted in the United States of America. Also, in our
      opinion, such financial statement schedule, when considered in relation to
      the
      basic consolidated financial statements taken as a whole, presents fairly,
      in
      all material respects, the information set forth therein for the year ended
      December 31, 2004.




/s/
      DELOITTE & TOUCHE LLP


Birmingham,
      Alabama


March
      28,
      2005 (March 16, 2006 as to the 2004 effects of the


discontinued
      operations described in Note 2)





42




**CAVALIER
        HOMES, INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        BALANCE SHEETS**
 **DECEMBER
        31, 2006 AND 2005**
 *(dollars
        in thousands except per share amounts)*
 
 2006
              
              2005**ASSETS**Current
                  assets:Cash
                  and cash equivalents
              
              $
              25,967
              
              $
              14,379Accounts
                  receivable, less allowance for losses of $78 (2006) and $56 (2005)
              
              
              1,930
              
              
              39,453Current
                  portion of notes and installment contracts receivable, includingheld
                  for resale of $6,288 (2006) and $7,603 (2005)
              
              
              6,430
              
              
              7,703Inventories
              
              
              22,255
              
              
              27,303Other
                  current assets
              
              
              2,520
              
              
              2,723Total
                  current assets
              
              
              59,102
              
              
              91,561Property,
                  plant and equipment:Land
              
              
              3,781
              
              
              3,778Buildings
                  and improvements
              
              
              33,451
              
              
              34,668Machinery
                  and equipment
              
              
              28,612
              
              
              30,11865,844
              
              
              68,564Less
                  accumulated depreciation and amortization
              
              
              37,834
              
              
              38,988Property,
                  plant and equipment, net
              
              
              28,010
              
              
              29,576Installment
                  contracts receivable, less allowance for credit lossesof
                  $841 (2006) and $968 (2005)
              
              
              4,785
              
              
              6,396Other
                  assets
              
              
              4,809
              
              
              5,288$
              96,706
              
              $
              132,821**LIABILITIES
                  AND STOCKHOLDERS' EQUITY**Current
                  liabilities:Note
                  payable under revolving line of credit
              
              $
              —
              
              $
              17,750Current
                  portion of long-term debt
              
              
              1,226
              
              
              1,498Note
                  payable under retail floor plan agreement
              
              
              1,103
              
              
              1,990Accounts
                  payable
              
              
              3,748
              
              
              7,821Amounts
                  payable under dealer incentives
              
              
              3,041
              
              
              7,087Estimated
                  warranties
              
              
              11,900
              
              
              13,190Accrued
                  insurance
              
              
              5,394
              
              
              6,270Accrued
                  compensation and related withholdings
              
              
              2,691
              
              
              6,147Reserve
                  for repurchase commitments
              
              
              1,513
              
              
              1,270Other
                  accrued expenses
              
              
              3,178
              
              
              4,322Total
                  current liabilities
              
              
              33,794
              
              
              67,345Long-term
                  debt, less current portion above
              
              
              4,512
              
              
              7,631Total
                  liabilities
              
              
              38,306
              
              
              74,976Commitments
                  and contingencies (Note 11)Stockholders’ equity:Series
                  A Junior Participating Preferred stock, $0.01 par value; 200,000
                  sharesauthorized,
                  none issued
              
              
              —
              
              
              —Preferred
                  stock, $0.01 par value; 300,000 shares authorized, none issued
              
              
              —
              
              
              —Common
                  stock, $0.10 par value; 50,000,000 shares authorized,19,327,880
                  (2006) and 19,285,705 (2005) shares issued
              
              
              1,933
              
              
              1,929Additional
                  paid-in capital
              
              
              58,654
              
              
              58,275Retained
                  earnings
              
              
              1,595
              
              
              1,423Treasury
                  stock, at cost; 983,300 shares
              
              
              (3,782
              )
              
              (3,782
              )Total
                  stockholders’
                  equity
              
              
              58,400
              
              
              57,845$
              96,706
              
              $
              132,821
 See
        notes
        to consolidated financial statements.




43




**CAVALIER
        HOMES, INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENTS OF OPERATIONS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004**
 *(dollars
        in thousands except per share amounts)*
 
 
 
 2006
              
              2005
              
              2004Revenue
              
              $
              227,937
              
              $
              272,032
              
              $
              211,740Cost
                  of sales
              
              
              189,175
              
              
              219,435
              
              
              172,244Gross
                  profit
              
              
              38,762
              
              
              52,597
              
              
              39,496Selling,
                  general and administrative
              
              
              38,607
              
              
              40,284
              
              
              34,415Impairment
                  and other related charges
              
              
              —
              
              
              143
              
              
              —Operating
                  income
              
              
              155
              
              
              12,170
              
              
              5,081Other
                  income (expense):Interest
                  expense
              
              
              (1,110
              )
              
              (1,314
              )
              
              (1,075
              )Other,
                  net
              
              
              1,330
              
              
              851
              
              
              561220
              
              
              (463
              )
              
              (514
              )Income
                  from continuing operations before income taxes
              
              
              375
              
              
              11,707
              
              
              4,567Income
                  tax provision (benefit)
              
              
              1,049
              
              
              (32
              )
              
              75Equity
                  in earnings of equity-method investees
              
              
              805
              
              
              775
              
              
              980Income
                  from continuing operations
              
              
              131
              
              
              12,514
              
              
              5,472Income
                  (loss) from discontinued operations, including tax benefit
                of
                  $29 (2006) and gain on disposal of $439 (2005)
              
              
              41
              
              
              (1,599
              )
              
              (2,231
              )Net
                  income
              
              $
              172
              
              $
              10,915
              
              $
              3,241Income
                  (loss) per share:Basic:From
                  continuing operations
              
              $
              0.01
              
              $
              0.69
              
              $
              0.30From
                  discontinuing operations
              
              
              —
              
              
              (0.09
              )
              
              (0.12
              )Net
                  income
              
              $
              0.01
              
              $
              0.60
              
              $
              0.18Weighted
                  average shares outstanding
              
              
              18,335,377
              
              
              18,118,619
              
              
              17,879,939Diluted:From
                  continuing operations
              
              $
              0.01
              
              $
              0.68
              
              $
              0.30From
                  discontinuing operations
              
              
              —
              
              
              (0.09
              )
              
              (0.12
              )Net
                  income
              
              $
              0.01
              
              $
              0.59
              
              $
              0.18Weighted
                  average shares outstanding
              
              
              18,469,575
              
              
              18,356,795
              
              
              18,178,394
  See
        notes
        to consolidated financial statements.




44


**CAVALIER
          HOMES, INC. AND SUBSIDIARIES**
 **CONSOLIDATED
          STATEMENTS OF STOCKHOLDERS' EQUITY**
 **FOR
          THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004**
 *(dollars
          in thousands)*
 Additional
                        paid-in
                        capital
                      
                      Retained
                        earnings
                        (deficit)
                      
                      Treasury
                        stock
                      
                      TotalCommon
                          StockShares
                      
                      AmountBalance,
                          January 1, 2004
                      
                      
                      18,692,944
                      
                      $
                      1,869
                      
                      $
                      55,952
                      
                      $
                      (12,733
                      )
                      $
                      (4,101
                      )
                      $
                      40,987Stock
                          options exercised
                      
                      
                      299,630
                      
                      
                      30
                      
                      
                      909
                      
                      
                      —
                      
                      
                      —
                      
                      
                      939Net
                          income
                      
                      
                      —
                      
                      
                      —
                      
                      
                      —
                      
                      
                      3,241
                      
                      
                      —
                      
                      
                      3,241Balance,
                          December 31, 2004
                      
                      
                      18,992,574
                      
                      
                      1,899
                      
                      
                      56,861
                      
                      
                      (9,492
                      )
                      
                      (4,101
                      )
                      
                      45,167Stock
                          options exercised
                      
                      
                      293,131
                      
                      
                      30
                      
                      
                      760
                      
                      
                      —
                      
                      
                      319
                      
                      
                      1,109Income
                          tax benefit attributable toexercise
                          of stock options
                      
                      
                      —
                      
                      
                      —
                      
                      
                      654
                      
                      
                      —
                      
                      
                      —
                      
                      
                      654Net
                          income
                      
                      
                      —
                      
                      
                      —
                      
                      
                      —
                      
                      
                      10,915
                      
                      
                      —
                      
                      
                      10,915Balance,
                          December 31, 2005
                      
                      
                      19,285,705
                      
                      
                      1,929
                      
                      
                      58,275
                      
                      
                      1,423
                      
                      
                      (3,782
                      )
                      
                      57,845Stock
                          options exercised
                      
                      
                      42,175
                      
                      
                      4
                      
                      
                      144
                      
                      
                      —
                      
                      
                      —
                      
                      
                      148Stock-based
                          compensation
                      
                      
                      —
                      
                      
                      —
                      
                      
                      235
                      
                      
                      —
                      
                      
                      —
                      
                      
                      235Net
                          income
                      
                      
                      —
                      
                      
                      —
                      
                      
                      —
                      
                      
                      172
                      
                      
                      —
                      
                      
                      172Balance,
                          December 31, 2006
                      
                      
                      19,327,880
                      
                      $
                      1,933
                      
                      $
                      58,654
                      
                      $
                      1,595
                      
                      $
                      (3,782
                      )
                      $
                      58,400
  See
            notes
            to consolidated financial statements.


45




**CAVALIER
        HOMES, INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENTS OF CASH FLOWS**
 **FOR
        THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004**
 *(dollars
        in thousands)*
 
 2006
              
              2005
              
              2004**Operating
                  activities:**Net
                  income
              
              $
              172
              
              $
              10,915
              
              $
              3,241Adjustments
                  to reconcile net income to net cash provided by (used in)operating
                  activities:Depreciation
                  and amortization
              
              
              2,299
              
              
              2,477
              
              
              3,317Deferred
                  income taxes
              
              
              1,314
              
              
              (1,314
              )
              
              —Provision
                  for (recovery of) credit and accounts receivable losses
              
              
              114
              
              
              856
              
              
              (235
              )Stock-based
                  compensation
              
              
              235
              
              
              —
              
              
              —Gain
                  on sale of property, plant and equipment
              
              
              (293
              )
              
              (578
              )
              
              (10
              )Impairment
                  and other related charges
              
              
              —
              
              
              143
              
              
              209Other,
                  net
              
              
              (1,195
              )
              
              (196
              )
              
              (980
              )Installment
                  contracts purchased for resale
              
              
              (42,664
              )
              
              (41,442
              )
              
              (32,864
              )Sale
                  of installment contracts purchased for resale
              
              
              44,589
              
              
              34,625
              
              
              31,905Principal
                  collected on installment contracts purchased for resale
              
              
              221
              
              
              205
              
              
              2,066Changes
                  in assets and liabilities:Accounts
                  receivable
              
              
              37,554
              
              
              (35,173
              )
              
              (2,321
              )Inventories
              
              
              5,048
              
              
              (12,394
              )
              
              (3,945
              )Accounts
                  payable
              
              
              (4,073
              )
              
              3,526
              
              
              451Amounts
                  payable under dealer incentive programs
              
              
              (4,046
              )
              
              2,836
              
              
              (1,576
              )Accrued
                  compensation and related withholdings
              
              
              (3,456
              )
              
              2,394
              
              
              1,090Other
                  assets and liabilities
              
              
              (3,505
              )
              
              (1,958
              )
              
              (1,278
              )Net
                  cash provided by (used in) operating activities
              
              
              32,314
              
              
              (35,078
              )
              
              (930
              )**Investing
                  activities:**Proceeds
                  from sale of property, plant and equipment
              
              
              1,555
              
              
              3,537
              
              
              2,320Capital
                  expenditures
              
              
              (1,995
              )
              
              (1,410
              )
              
              (786
              )Notes
                  and installment contracts purchased for investment
              
              
              (326
              )
              
              (831
              )
              
              (496
              )Principal
                  collected on notes and installment contracts purchased for investment
              
              
              845
              
              
              336
              
              
              474Other
                  investing activities
              
              
              1,075
              
              
              349
              
              
              120Net
                  cash provided by investing activities
              
              
              1,154
              
              
              1,981
              
              
              1,632**Financing
                  activities:**Net
                  borrowings (repayments) on note payable under revolving line of
                  credit
              
              
              (17,750
              )
              
              17,750
              
              
              —Net
                  borrowings (repayments) on note payable under retail floor plan
                  agreement
              
              
              (887
              )
              
              919
              
              
              1,071Payments
                  on long-term debt
              
              
              (3,391
              )
              
              (3,976
              )
              
              (3,431
              )Proceeds
                  from exercise of stock options
              
              
              148
              
              
              1,109
              
              
              939Net
                  cash provided by (used in) financing activities
              
              
              (21,880
              )
              
              15,802
              
              
              (1,421
              )Net
                  increase (decrease) in cash and cash equivalents
              
              
              11,588
              
              
              (17,295
              )
              
              (719
              )Cash
                  and cash equivalents, beginning of year
              
              
              14,379
              
              
              31,674
              
              
              32,393Cash
                  and cash equivalents, end of year
              
              $
              25,967
              
              $
              14,379
              
              $
              31,674Supplemental
                  cash flow disclosures:Cash
                  paid for:Interest
              
              $
              1,126
              
              $
              1,234
              
              $
              1,114Income
                  taxes
              
              $
              1,454
              
              $
              18
              
              $
              128
 
 See
        notes
        to consolidated financial statements.




46




**CAVALIER
      HOMES, INC. AND SUBSIDIARIES**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(DOLLARS
      IN THOUSANDS EXCEPT PER SHARE AMOUNTS)**


**FOR
      THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004**







**1.**
            **SUMMARY
                OF SIGNIFICANT ACCOUNTING
                POLICIES**




*Principles
      of Consolidation -* The
      consolidated financial statements include the accounts of Cavalier Homes, Inc.
      and its wholly-owned and majority-owned subsidiaries (collectively, Cavalier,
      the “Company”, “we”, “our” or “us”). Our minority ownership interests in various
      joint ventures are accounted for using the equity method and are included in
      other assets in the accompanying consolidated balance sheets (see Note 13).
      Intercompany transactions have been eliminated in consolidation. See Note 12
      for
      information related to our business segments.





*Nature
      of Operations*  *-* We
      design and produce manufactured homes which are sold to a network of dealers
      located primarily in the South Central and South Atlantic regions of the United
      States. In addition, through our financial services segment, we offer retail
      installment sale financing and related insurance products primarily for
      manufactured homes sold through our dealer network. Our retail segment operates
      retail sales locations which offer our homes, financing, and insurance products
      to retail customers.





*Accounting
      Estimates*  *-* Our
      consolidated financial statements are prepared in conformity with accounting
      principles generally accepted in the United States of America which require
      management to make estimates and assumptions that affect the reported amounts
      of
      assets and liabilities and disclosure of contingent assets and liabilities
      at
      the date of the consolidated financial statements and the reported amounts
      of
      revenues and expenses during the reporting period. Actual results could differ
      from those estimates.





*Fair
      Value of Financial Instruments -* The
      carrying value of our cash equivalents, accounts receivable, accounts payable
      and accrued expenses approximates fair value because of the short-term nature
      of
      these instruments. Additional information concerning the fair value of other
      financial instruments is disclosed in Notes 3 and 6.





*Cash
      Equivalents*  *-* We
      consider all highly liquid investments with original maturities of three months
      or less to be cash equivalents.





*Accounts
      Receivable -* Accounts
      receivable are carried at original invoice amount less an estimated allowance
      for doubtful accounts. Management determines the allowance for doubtful accounts
      by identifying troubled accounts and estimating expected losses using historical
      experience.





*Installment
      Contracts Receivable*  *-* Installment contracts receivable of CIS Financial Services, Inc. (“CIS”), a
      wholly-owned subsidiary, are reported at their outstanding unpaid principal
      balances reduced by any charge-off or specific valuation accounts. We purchase
      the majority of our contracts receivable with the intent to resell the loans,
      with limited recourse, to financial institutions under the terms of retail
      financing agreements. Recourse is applicable in the case of fraud or
      misrepresentation. CIS may also be required to repurchase the loan from certain
      third party financial institutions if any of the first four payments on a loan
      become 90 days delinquent. We have never been obligated to repurchase the loans
      under the limited recourse provisions of these contracts. Such sales are
      accounted for under the provisions of Statement of Financial Accounting
      Standards (“SFAS”) No. 140, *Accounting
      for Transfers and Servicing of Financial Assets and Extinguishments of
      Liabilities* .
      Loans
      purchased for resale are recorded in our balance sheet at the lower of cost
      or
      market and are classified as held for sale if we have the intent and believe
      that we have the ability to resell the loans within one year from acquisition
      based on the terms of retail financing agreements with various financial
      institutions. Loan origination and other fees, net of capitalized costs, are
      deferred and recognized over the life of the loan as an adjustment of
      yield.





*Allowance
      for Credit Losses on Installment Contracts -* We have
      provided an allowance for estimated future credit losses resulting from retail
      financing activities of CIS based on management’s periodic evaluation of our
      past loan loss experience, known and inherent risks in the portfolio, adverse
      situations that may affect the borrower’s ability to repay, the estimated value
      of any underlying collateral and current economic conditions. The allowance
      for
      credit losses is increased by charges to income and decreased by charge-offs
      (net of recoveries).





47




*Inventories
      -* Inventories are stated at the lower of cost (first-in, first-out method) or
      market. Work-in-process and finished goods inventories include an allocation
      for
      labor and overhead costs. Included in finished goods are repossessed inventories
      of CIS which are recorded at estimated net realizable value.





*Property,
      Plant and Equipment*  *-* Property, plant and equipment is stated at cost and depreciated over the
      estimated useful lives of the related assets primarily using the straight-line
      method. Maintenance and repairs are expensed as incurred.





*Impairment
      of Long-Lived Assets*  *-* In
      accordance with *SFAS
      No. 144, Accounting for the Impairment or Disposal of Long-Lived
      Assets* ,
      we
      evaluate the carrying value of long-lived assets to be held and used when events
      and circumstances warrant such a review. The carrying value of long-lived assets
      is considered impaired when the anticipated undiscounted cash flow from such
      assets is less than our carrying value. In that event, a loss is recognized
      based on the amount by which the carrying value exceeds the fair market value
      of
      the long-lived assets. Fair market value is determined primarily using the
      anticipated cash flows discounted at a rate commensurate with the risk involved.
      Losses on long-lived assets to be disposed of are determined in a similar
      manner, except that the fair market values are primarily based on independent
      appraisals and preliminary or definitive contractual arrangements less costs
      to
      dispose.





*Revenue
      Recognition* - ** Revenue
      for manufactured homes sold to independent dealers generally is recorded when
      all of the following conditions have been met: (a) an order for the home has
      been received from the dealer, (b) an agreement with respect to payment terms
      (usually in the form of a written or verbal approval for payment) has been
      received from the dealer’s flooring institution, and (c) the home has been
      shipped and risk of loss has passed to the dealer. All sales are final and
      without recourse except for the contingency described in Note 11. Estimated
      sales incentives, including rebates, payable to our independent retailers are
      accrued at the time of sale and are recorded as a reduction of revenue. Sales
      incentive levels are estimated based on the anticipated sales volume purchased
      by our independent retailers within the rebate period specified in the sales
      incentive agreements. For Company-owned retail locations, revenue is recorded
      when the home has been delivered and accepted by the retail customer, risk
of
      ownership has been transferred and funds have been received. Interest income
      on
      installment contracts receivable is recognized using a method which approximates
      the interest method. Accrual of interest income on installment contracts
      receivable is suspended when a loan is contractually delinquent for 90 days
      or
      more. The accrual is resumed when the loan becomes contractually current, and
      past-due interest income is recognized at that time.





*Product
      Warranties*  *-* We
      provide the retail home buyer a one-year limited warranty covering defects
      in
      material or workmanship in home structure, plumbing and electrical systems.
      We
      have provided a liability of $11,900 (2006) and $13,190 (2005) for estimated
      future warranty costs relating to homes sold, based upon management’s assessment
      of historical experience factors and current industry trends. Activity in the
      liability for product warranty was as follows:


**2006**
              
              **2005**
              
              **2004**Balance,
                  beginning of year
              
              $
              13,190
              
              $
              13,255
              
              $
              13,475Provision
                  for warranties issued in the current year
              
              
              12,407
              
              
              15,850
              
              
              15,016Adjustments
                  for warranties issued in prior years
              
              
              234
              
              
              (580
              )
              
              (593
              )Payments
              
              
              (13,931
              )
              
              (15,335
              )
              
              (14,643
              )Balance,
                  end of year
              
              $
              11,900
              
              $
              13,190
              
              $
              13,255





*Reserve
      for Repurchase Commitments* - We are
      contingently liable under terms of repurchase agreements with financial
      institutions providing inventory financing for retailers of our products. These
      arrangements, which are customary in the industry, provide for the repurchase
      of
      products sold to retailers in the event of default by the retailer. The risk
      of
      loss under these agreements is spread over numerous retailers. The price we
      are
      obligated to pay generally declines over the period of the agreement (generally
      18 - 24 months) and the risk of loss is further reduced by the sales value
      of
      repurchased homes. We apply FASB Interpretation (“FIN”) No. 45, *Guarantor’s
      Accounting and Disclosure Requirements for Guarantees, Including Indirect
      Guarantees of Indebtedness to Others, an interpretation of FASB Statements
      No.
      5, 57, and 107 and a rescission of FASB Interpretation No. 3* and SFAS
      No. 5, *Accounting for Contingencies* to
      account for our liability for repurchase commitments. Under the provisions
      of
      FIN 45, during the period in which a home is sold (inception of a repurchase
      commitment), we record the greater of the estimated fair value of the
      non-contingent obligation or a contingent liability under the provisions of
      SFAS
      No. 5 *,* based on
      historical information available at the time, as a reduction to revenue.
      Subsequent to the inception of the repurchase commitment, we evaluate the
      likelihood that we will be called on to perform under the inventory repurchase
      commitments. If it becomes probable that a dealer will default and a SFAS No.
      5
      loss reserve should be recorded, then such contingent liability is recorded
      equal to the estimated loss on repurchase. Based on identified changes in
      dealers’ financial conditions, we evaluate the probability of default for the
      group of dealers who are identified at an elevated risk of default and apply
      a
      probability of default to the group, based on historical default rates. Changes
      in the reserve are recorded as an adjustment to revenue. Following the inception
      of the commitment, the recorded reserve is reduced over the repurchase period
      and is eliminated once the dealer sells the home.




48




*Insurance*  *-* Our
      workers’ compensation (prior to February 1, 1999, and after April 1, 2001),
      product liability and general liability insurance coverages were provided under
      incurred loss, retrospectively rated premium plans. Under these plans, we incur
      insurance expense based upon various rates applied to current payroll costs
      and
      sales. Annually, such insurance expense is adjusted by the carrier for loss
      experience factors subject to minimum and maximum premium calculations. Refunds
      or additional premiums are estimated and recorded when sufficiently reliable
      data is available. Our workers’ compensation insurance coverage from February
      1999 through March 2001 was provided under a fully insured, large deductible
      policy, and during 2001, our product liability and general liability insurance
      coverages were converted to a fully insured, large deductible
      policy.





*Other
      Income (Expense): Other, net -* Other,
      net included in our consolidated statement of operations caption is comprised
      primarily of interest income (unrelated to financial services), dividends
      received from an unconsolidated investee accounted for under the cost method,
      and gain (loss) on the sale of the stock of the unconsolidated cost method
      investee.





*Net
      Income (Loss) Per Share*  *-* We
      report two separate net income (loss) per share numbers, basic and diluted.
      Both
      are computed by dividing net income (loss) by the weighted average shares
      outstanding (basic) or weighted average shares outstanding assuming dilution
      (diluted) as detailed below:


**2006**
              
              **2005**
              
              **2004**Income
                  from continuing operations
              
              $
              131
              
              $
              12,514
              
              $
              5,472Income
                  (loss) from discontinued operations
              
              
              41
              
              
              (1,599
              )
              
              (2,231
              )Net
                  income
              
              $
              172
              
              $
              10,915
              
              $
              3,241Weighted
                  average shares outstanding:Basic
              
              
              18,335,377
              
              
              18,118,619
              
              
              17,879,939Effect
                    of potential common stock from the exercise of
                    stock options
              
              
              134,198
              
              
              238,176
              
              
              298,455Diluted
              
              
              18,469,575
              
              
              18,356,795
              
              
              18,178,394Income
                  (loss) per share:Basic:From
                  continuing operations
              
              $
              0.01
              
              $
              0.69
              
              $
              0.30From
                  discontinuing operations
              
              
              —
              
              
              (0.09
              )
              
              (0.12
              )Net
                  income
              
              $
              0.01
              
              $
              0.60
              
              $
              0.18Diluted:From
                  continuing operations
              
              $
              0.01
              
              $
              0.68
              
              $
              0.30From
                  discontinuing operations
              
              
              —
              
              
              (0.09
              )
              
              (0.12
              )Net
                  income
              
              $
              0.01
              
              $
              0.59
              
              $
              0.18





Options
      that were potentially dilutive to basic net income per share were not included
      in the computation of diluted net income per share because to do so would have
      been anti-dilutive. The maximum anti-dilutive options were 1,003,315, 1,339,897,
      and 1,371,420 for 2006, 2005, and 2004, respectively.





*Stock
      Based Compensation* - ** Effective
      January 1, 2006, we adopted the provisions of Statement of Financial Accounting
      Standards No. 123R, *Share-Based
      Payment* (“SFAS
      123R”) using the modified prospective method. SFAS 123R, which supersedes
      Accounting Principles Board Opinion 25, *Accounting
      for Stock Issued to Employees* (“APB
      25”), requires us to record compensation cost over the vesting period of awards
      of equity instruments based on the grant date fair value of the award and
      applies to new awards issued, awards modified, repurchased or cancelled and
      unvested awards after the effective date. SFAS 123R also requires the benefits
      of tax deductions in excess of recognized compensation cost be reported as
      a
      financing cash flow, rather than as an operating cash flow as required under
      previous literature.





49




Prior
      to
      the adoption of SFAS 123R, we used the intrinsic value method under APB 25. No
      compensation cost was recorded in 2005 since options were issued with exercise
      prices equal to the market prices of the underlying common stock on the dates
      of
      grant.





*Recently
      Issued Accounting Pronouncements* - ** In
      June
      2006, the Financial Accounting Standards Board (“FASB”) issued FASB
      Interpretation (“FIN”) No. 48, *Accounting
      for Uncertainty in Income Taxes,* an
      interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for
      uncertainty in income taxes recognized in a company’s financial statements in
      accordance with FASB Statement No. 109, *“Accounting
      for Income Taxes,”* by
      prescribing a recognition threshold and measurement attribute for the financial
      statement recognition and measurement of a tax position taken or expected to
      be
      taken in a tax return. Under FIN 48, the financial statement effect of a tax
      position should initially be recognized when it is more likely than not, based
      on the technical merits, that the position will be sustained upon examination.
      A
      tax position that meets the more-likely-than-not recognition threshold should
      initially and subsequently be measured as the largest amount of tax benefit
      that
      has a greater than fifty percent likelihood of being realized upon ultimate
      settlement with a taxing authority. This statement is effective for fiscal
      years
      beginning after December 15, 2006. The cumulative effect, if any of applying
      the
      provisions of FIN 48 will be reported as an adjustment to the opening balance
      of
      retained earnings in the period adopted. We are currently assessing the effects
      of the adoption of this statement on our consolidated financial
      statements.





In
      September 2006, the FASB issued SFAS No. 157, *Fair
      Value Measurements* ,
      which
      defines fair value, establishes guidelines for measuring fair value and expands
      disclosures regarding fair value measurements. SFAS No. 157 does not
      require any new fair value measurements but rather eliminates inconsistencies
      in
      guidance found in various prior accounting pronouncements.
      SFAS No. 157 is effective for fiscal years beginning after November
      15, 2007. Earlier adoption is permitted, provided the company has not yet issued
      financial statements, including for interim periods, for that fiscal year.
      We
      are currently evaluating the impact of SFAS No. 157, but do not expect
      the adoption of SFAS No. 157 to have a material impact on our
      consolidated financial statements.





*Reclassifications
      -* Certain
      amounts from the prior periods have been reclassified to conform to the 2006
      presentation.





**2.**
            **DISCONTINUED
                OPERATIONS**




In
      February 2005, we announced our decision to close an underperforming home
      manufacturing plant in Ft. Worth, Texas, which accounted for about 10% of total
      revenue and 11% of floor shipments in 2004 and had net property, plant and
      equipment of $2,403 at December 31, 2004. During 2004, we recorded impairment
      and other related charges of $209 ($209 after tax or $0.01 per diluted share)
      for write-downs for certain property, plant and equipment related to the
      closing. The Ft. Worth plant employed approximately 150 people, each of whom
      received a severance benefit paid at the date the employee ceased rendering
      service. During 2005, we recorded involuntary termination benefits of $878
      ($878
      after tax or $0.06 per diluted share). We sold the property, plant and equipment
      of the Ft. Worth facility in June 2005 realizing a gain of $439. These amounts
      are included in “Income (loss) from discontinued operations” in the accompanying
      statement of operations.





Summary
      operating results of the discontinued operations for the years ended December
      31, 2006, 2005, and 2004 were:


**2006**
              
              **2005**
              
              **2004**Revenue
              
              $
              —
              
              $
              3,124
              
              $
              22,421Income
                  (loss) from discontinued operations
              
              
              41
              
              
              (1,599
              )
              
              (2,231
              )




50


**3.**
            **INSTALLMENT
                CONTRACTS RECEIVABLE**




CIS
      finances retail sales through the purchase of installment contracts primarily
      from a portion of our dealer network and originates direct mortgage loans,
      at
      fixed interest rates, in the ordinary course of business, and resells a majority
      of the loans to financial institutions under the terms of retail finance
      agreements. CIS enters into agreements to sell, with limited recourse, contracts
      in our portfolio that meet specified credit criteria. Recourse is applicable
      in
      the case of fraud or misrepresentation. CIS may also be required to repurchase
      the loan from certain third party financial institutions if any of the first
      four payments on a loan become 90 days delinquent. We have never been obligated
      to repurchase the loans under the limited recourse provisions of these
      contracts. Under these agreements, CIS sold $44,589, $34,625 and $31,905 of
      contracts receivable and realized gains of $1,612, $1,310, and $940 for the
      years ended December 31, 2006, 2005, and 2004, respectively. Standard loan
      programs require minimum down payments or land equity, ranging from 5% to 20%
      of
      the purchase price of the home, on all installment contracts based on the
      creditworthiness of the borrower. CIS’s portfolio consists of fixed rate
      contracts with interest rates generally ranging from 7.5% to 14.0% and from
      8.0%
      to 14.0% at December 31, 2006 and 2005, respectively. The average original
      term
      of the portfolio was approximately 268 and 265 months at December 31, 2006
      and
      2005, respectively. For loans held in our portfolio, CIS requires the borrower
      to maintain adequate insurance on the home throughout the life of the contract.
      Contracts are secured by the home which is subject to repossession by CIS upon
      default by the borrower. At December 31, 2006, scheduled principal payments
      of
      installment contracts receivable including expected sales of installment
      contracts in 2007 are as follows (excludes deferred origination fees, points
      and
      capitalized costs of $209):


**Year
                    ending December 31,**2007
                
                $
                6,4302008
                
                
                1582009
                
                
                1922010
                
                
                1812011
                
                
                218Thereafter
                
                
                5,086Total
                
                $
                12,265


We
      maintain a reserve for loans based on historical experience, the estimated
      value
      of any underlying collateral, and specifically identified factors presenting
      uncertainty with respect to collectibility. Activity in the allowance for credit
      losses on installment contracts was as follows:


**2006**
                  ****
                  **2005**
                  ****
                  **2004**Balance,
                      beginning of year
                  
                  $
                  968
                  
                  $
                  953
                  
                  $
                  1,030Provision
                      for credit losses
                  
                  
                  145
                  
                  
                  857
                  
                  
                  75Charge
                      offs, net
                  
                  
                  (272
                  )
                  
                  (842
                  )
                  
                  (152
                  )Balance,
                      end of year
                  
                  $
                  841
                  
                  $
                  968
                  
                  $
                  953
  At
          December 31, 2006 and 2005, the estimated fair value of installment contracts
          receivable, excluding loans identified as presenting uncertainty with respect
          to
          collectibility, was $13,000 and $15,287 respectively. These fair values
          were
          estimated using discounted cash flows and interest rates offered by CIS
          on
          similar contracts at such times.





**4.**
            **INVENTORIES**




Inventories
      consisted of the following:


**2006**
                  
                  **2005**Raw
                      materials
                  
                  $
                  14,552
                  
                  $
                  17,611Work-in-process
                  
                  
                  1,424
                  
                  
                  1,305Finished
                      goods
                  
                  
                  6,279
                  
                  
                  8,387Total
                      inventory
                  
                  $
                  22,255
                  
                  $
                  27,303





During
      2006, 2005, and 2004, we purchased raw materials of approximately $14,698,
      $21,586, and $17,680, respectively, from joint ventures in which we own a
      minority interest.




**5.**
            **IMPAIRMENT
                AND OTHER RELATED CHARGES**




In
      accordance with SFAS No. 146, *Accounting
      for Costs Associated with Exit or Disposal Activities* ,
      we
      record the liability, measured at fair value, for costs associated with an
      exit
      or disposal activity when the liability is incurred. SFAS No. 144, *Accounting
      for the Impairment or Disposal of Long-Lived Assets* ,
      provides that a long-lived asset or asset group that is to be sold shall be
      classified as “held for sale” if certain criteria are met, including the
      expectation supported by evidence that the sale will be completed within one
      year. We had idle assets of $6,589 (2006) and $8,343 (2005) recorded at the
      lower of carrying value or fair value. Idle assets are comprised primarily
      of
      closed home manufacturing facilities which we are attempting to sell. Management
      does not have evidence at the balance sheet date that it is probable that the
      sale of these assets will occur within one year, and thus, in accordance with
      the requirements of SFAS No. 144, such assets are classified as “held and used”
and depreciation has continued on these assets.





51




During
      2005, we recorded impairment and other related charges of $143 ($143 after
      tax
      or $0.00 per diluted share) to write-down property, plant and equipment in
      connection with the valuation of a home manufacturing facility closed in a
      prior
      year. No impairment charges were incurred during 2006.





**6.**
            **CREDIT
                ARRANGEMENTS**




We
      maintain a credit facility (the “Credit Facility”) with our primary lender which
      includes (i) a revolving line of credit that provides for borrowings (including
      letters of credit) up to $25,000 and (ii) a real estate term loan with an
      initial term of 14 years of $10,000, which are cross-secured and
      cross-defaulted. During 2005, we entered into agreements as a subcontractor
      to
      provide 2,638 homes to FEMA as part of that agency’s hurricane relief efforts.
      In order to fund our short term cash needs required to fulfill the orders of
      FEMA homes, we amended our Credit Facility on December 6, 2005 to provide for
      an
      available revolving line of credit during the period from October 25, 2005
      through April 30, 2006 (the “first temporary advance period”) of $50,000 and
      during the period from May 1, 2006 through July 31, 2006 (the “second temporary
      advance period”) of $25,000, effectively waiving temporarily the tangible net
      worth requirement listed below. On May 23, 2006, the Credit Facility was further
      modified to allow for capital expenditures of $3,000 for the year ending
      December 31, 2006 and thereafter, and the collateral requirement was amended
      to
      exclude CIS loans receivable with origination dates less than 365 days old.
      On
      February 21, 2007 we further amended the terms of the Credit Facility, to,
      among
      other things, (i) extend the maturity date to April 15, 2008, (ii) reduce the
      interest rate on borrowings if TNW exceeds $62,000, (iii) increase the annual
      capital expenditure limit to $5,000 per year, (iv) increase the amount available
      under the revolving line of credit, and (v) revise certain financial covenants
      as noted below.





The
      amount available under the revolving line of credit as amended February 21,
      2007, up to $25,000, is equal to the lesser of an amount based on defined
      percentages of accounts and notes receivable and inventories or certain levels
      of tangible net worth plus all treasury stock purchases after December 31,
      2003,
      as noted in the following table.





Tangible
                Net Worth (“TNW”)
            
            Credit
                Facility AvailableAbove
                $50,000
            
            35%
                of TNW$50,000
                - $38,000
            
            $15,000$38,000
                - $23,000
            
            $15,000
                to zero (dollar for dollar
                reduction)





At
      December 31, 2006, under the revolving line of credit, $10,059 (based on defined
      percentages of accounts and notes receivable and inventories) was available
      after deducting letters of credit of $5,204. During the fourth quarter of 2005,
      we borrowed $17,750 under the revolving line of credit, in order to fund our
      short term cash needs required to fulfill the outstanding FEMA order. During
      the
      first quarter of 2006, the line of credit balance was paid in full. We did
      not
      have any amounts outstanding under the revolving line of credit at December
      31,
      2006.





The
      applicable interest rates under the revolving line of credit are based on
      certain levels of tangible net worth as noted in the following table. The levels
      and rates as amended on February 21, 2007 are shown
      parenthetically.





Tangible
                Net Worth (“TNW”)
            
            Interest
                RateAbove
                $77,000
            (above
              $62,000)
            
            Prime
                less 0.50%
            (Prime less 1.00%)$77,000
                –$65,000
            ($62,000*-*$56,500)
            
            Prime
            (Prime)$65,000 –$58,000
            ($56,500
*-*$38,000)
            
            Prime
                plus 0.25%
            (Prime plus 0.50%)$58,000 –$38,000
            (below
              $38,000)
            
            Prime
                plus 1.00%
            (Prime plus 1.00%)Below
                $38,000
            (n/a)
            
            Prime
                plus 2.00%
            (n/a)





The
      bank’s prime rate at December 31, 2006 and 2005 was 8.25% and 7.25%,
      respectively. One of our directors served as president of the primary lender
      until August 31, 2004. We made payments to our lender in the amount $694 (2004)
      for interest, commitment fees, letter of credit and various bond related
      fees.





The
      real
      estate term loan agreement contained in the Credit Facility provided for
      borrowings of $10,000, of which $2,937 and $4,219 was outstanding at December
      31, 2006 and December 31, 2005, respectively. Interest on the term note is
      fixed
      for a period of five years from issuance at 6.5% and may be adjusted at 5 and
      10
      years. Amounts outstanding under the real estate term loan are collateralized
      by
      certain plant facilities and equipment.





The
      Credit Facility, as amended, contains certain restrictive and financial
      covenants which, among other things, limit our ability without the lender’s
      consent to (i) make dividend payments and purchases of treasury stock in an
      aggregate amount which exceeds 50% of consolidated net income for the two most
      recent years, (ii) mortgage or pledge assets which exceed in the aggregate
      $1,000, (iii) incur additional indebtedness, including lease obligations, which
      exceed in the aggregate $1,000, excluding floor plan notes payable which cannot
      exceed $3,000 and (iv) make annual capital expenditures of $3,000 for the year
      ended December 31, 2006 and $5,000, thereafter (as amended on February 21,
      2007). In addition, the Credit Facility contains certain financial covenants
      requiring us to maintain on a consolidated basis certain defined levels of
      debt
      to tangible net worth ratio (not to exceed 2.5 to 1) and cash flow to debt
      service ratio of not less than 1.5 to 1 for the year ending December 31, 2006
      and not less than 1.2 to 1 for the year ending December 31, 2007 (as amended
      February 21, 2007) and thereafter, and to maintain a current ratio, as defined,
      of at least 1.0 to 1 and consolidated tangible net worth of at least $23,000.
      The Credit Facility also requires CIS to comply with certain specified
      restrictions and financial covenants. At December 31, 2006, we were in
      compliance with our debt covenants.





52




We
      have
      amounts outstanding under four Industrial Development Revenue Bond issues
      (“Bonds”) which totaled $2,800 and $4,910 at December 31, 2006 and 2005,
      respectively. Three of the bond issues bear interest at variable rates ranging
      from 5.0% to 5.4% and mature at various dates through April 2009. One of the
      bond issues is payable in annual installments through 2013 with interest payable
      monthly at a variable rate currently at 4.31% as determined by a remarketing
      agent. The real estate term loan and the bonds are collateralized by
      substantially all of our plant facilities and equipment.





We
      have
      $1,103 and $1,990 of notes payable under a retail floor plan agreement at
      December 31, 2006 and December 31, 2005, respectively. The notes are
      collateralized by certain Company-owned retail stores’ new home inventories and
      bear interest rates ranging from prime to prime plus 2.5% but not less than
      6%
      based on the age of the home.





At
      December 31, 2006, principal repayment requirements on long-term debt are as
      follows:


**Year
                    ending December 31,**2007
                
                $
                1,2262008
                
                
                8342009
                
                
                8842010
                
                
                3602011
                
                
                381Thereafter
                
                
                2,053Total
                
                
                5,738Less
                    current portion
                
                
                1,226Long-term
                    debt
                
                $
                4,512


At
      December 31, 2006 and 2005, the estimated fair value of outstanding borrowings
      was $5,787 and $8,806, respectively. These estimates were determined using
      rates
      at which we believe we could have obtained similar borrowings at such
      times.





Cash
      paid
      for interest during the years ended December 31, 2006, 2005, and 2004 was
      $1,126, $1,234, and $1,114, respectively.





**7.**
            **STOCKHOLDERS’
                EQUITY**




The
      Stockholder Rights Plan set forth in a Rights Agreement dated October 23, 1996
      between us and our Rights Agent expired on November 2, 2006.





Pursuant
      to a common stock repurchase program approved by our Board of Directors, a
      total
      of 3,168,800 shares were purchased at a cost of $24,842 during the four year
      period ended December 31, 2001. We retired 2,151,500 of these shares at December
      31, 1999, with the remaining shares being recorded as treasury stock. During
      2005, we reissued 34,000 treasury shares upon exercise of stock options. At
      December 31, 2006, we have authority under the program to acquire up to 831,200
      additional shares.





**8.**
            **STOCK
                BASED COMPENSATION**




*Stock
      Incentive Plans*





At
      December 31, 2006, our stock incentive plans included the
      following:





·
            The
                2005 Incentive Compensation Plan (the “2005 Plan”) provides for both
                incentive stock options and non-qualified stock options to key employees.
                The 2005 Plan also provides for stock appreciation rights and awards
                of
                both restricted stock and performance shares. Awards are granted
                at prices
                and terms determined by the compensation committee of the Board of
                Directors. The term for awards granted under the 2005 Plan cannot
                exceed
                ten years from the date of grant. Upon adoption of the 2005 Plan,
                our 1996
                Key Employee Stock Incentive Plan (the “1996 Plan”) was terminated.
                However, the shares of common stock that remained available under
                the 1996
                Plan at the time of its termination were incorporated into the 2005
                Plan,
                along with any shares subject to options previously granted under
                the 1996
                Plan which lapse, terminate or are canceled up to a maximum of 1,500,000
                shares. Furthermore, the termination of the 1996 Plan did not affect
                any
                options which were outstanding and unexercised under that Plan. As of
                December 31, 2006, shares authorized for grant and available to be
                granted
                under the 2005 Plan totaled 1,255,177
                shares.




53






·
            The
                2005 Non-Employee Directors Stock Option Plan (the “2005 Directors Plan”)
                provides for the issuance of up to 500,000 shares of our common stock,
                which is reserved for grant to non-employee directors. Options are
                granted
                upon the director’s initial election and automatically on an annual basis
                thereafter at fair market value on the date of such grant. Stock
                option
                grants become exercisable at a rate of 1/12thof
                the shares subject to the stock option on each monthly anniversary
                of the
                date of grant. Except in the case of death, disability, or retirement,
                options granted under the 2005 Directors Plan expire ten years from
                the
                date of grant. We had a 1993 Non-employee Director Plan, (the “1993
                Plan”), but upon adoption of the 2005 Directors Plan, we did not make
                additional grants under the 1993 Plan and the 1993 Plan was terminated.
                However, the termination of the 1993 Plan did not affect any options
                which
                were outstanding and unexercised under that Plan. As of December
                31, 2006,
                shares available to be granted under the 2005 Directors Plan totaled
                470,000 shares.




The
      following table sets forth the summary of activity under our stock incentive
      plans for the years ended December 31, 2006, 2005, and 2004:




****
            **Shares****Available****for
                      Grant**
            ****
            **Options****Outstanding**
            ****
            **Weighted****Average****Exercise
                      Price**Balance,
                December 31, 2003
            
            
            981,403
            
            
            2,474,587
            
            $
            7.84Granted
                at fair value
            
            
            (25,000
            )
            
            25,000
            
            
            2.99Exercised
            
            
            —
            
            
            (299,630
            )
            
            3.14Cancelled
            
            
            115,571
            
            
            (115,571
            )
            
            8.97Balance,
                December 31, 2004
            
            
            1,071,974
            
            
            2,084,386
            
            
            8.39Approved
                (2005 Directors Plan)
            
            
            500,000
            
            
            —
            
            
            —Plan
                shares expired
            
            
            (71,723
            )
            
            —
            
            
            —Granted
                at fair value
            
            
            (25,000
            )
            
            25,000
            
            
            5.51Exercised
                - increase in common shares
            
            
            —
            
            
            (293,131
            )
            
            3.39Exercised
                - treasury shares reissued
            
            
            —
            
            
            (34,000
            )
            
            3.40Cancelled
            
            
            43,583
            
            
            (43,583
            )
            
            9.72Balance,
                December 31, 2005
            
            
            1,518,834
            
            
            1,738,672
            
            
            9.26Plan
                shares expired
            
            
            (46,341
            )
            
            —
            
            
            —Granted
                at fair value
            
            
            (35,000
            )
            
            35,000
            
            
            6.45Stock
                awards
            
            
            (70,000
            )
            
            —
            
            
            —Exercised
            
            
            —
            
            
            (42,175
            )
            
            3.53Cancelled
            
            
            357,684
            
            
            (357,684
            )
            
            13.30Balance,
                December 31, 2006
            
            
            1,725,177
            
            
            1,373,813
            
            $
            8.32Options
                exercisable at December 31, 2006
            
            
            
            
            
            1,371,311
            
            $
            8.32Options
                exercisable at December 31, 2005
            
            
            
            
            
            1,738,672
            
            $
            9.26Options
                exercisable at December 31, 2004
            
            
            
            
            
            2,084,386
            
            $
            8.39




The
      weighted average fair values of options granted during 2006, 2005, and 2004
      were
      $3.53, $3.05, and $1.67, respectively. The total intrinsic value of options
      exercised during 2006, 2005 and 2004 were $128, $1,040, and $716, respectively.
      The aggregate intrinsic value of options outstanding and options exercisable
      as
      of December 31, 2006 was $297. The intrinsic value is calculated as the
      difference between the market value on the date of exercise and the exercise
      price of the shares.





54




The
      following table summarizes information concerning stock options outstanding
      at
      December 31, 2006:


****
              ****
              **Options
                  Outstanding**
              ****
              **Options
                  Exercisable**
              ********
              **Range
                  of**
                **Exercise
                  Prices**
              ****
              **Number**
                **Outstanding**
              ****
              **Weighted**
                **Average**
                **Remaining**
                **Contractual**
                **Life**
              ****
              **Weighted**
                **Average**
                **Exercise**
                **Price**
              ****
              **Number**
                **Exercisable**
              ****
              **Weighted**
                **Average**
                **Exercise**
                **Price**$1.69
                  - $4.00
              
              
              370,498
              
              
              4.64
              
              $
              3.36
              
              
              370,498
              
              $
              3.36$4.01
                  - $9.66
              
              
              140,900
              
              
              4.12
              
              
              8.37
              
              
              138,398
              
              
              8.41$9.67
                  - $10.22
              
              
              355,350
              
              
              1.01
              
              
              10.15
              
              
              355,350
              
              
              10.15$10.23
                  - $11.00
              
              
              507,065
              
              
              0.11
              
              
              10.64
              
              
              507,065
              
              
              10.64$1.69
                  - $11.00
              
              
              1,373,813
              
              
              1.98
              
              $
              8.32
              
              
              1,371,311
              
              $
              8.32  *Stock
        Based Compensation*





Effective
      January 1, 2006, we adopted SFAS 123R. See Note 1 for a description of our
      adoption of SFAS 123R. We use the Black-Scholes option pricing model to
      determine the fair value of stock option shares granted. The determination
      of
      the fair value of stock-based payment awards on the date of grant using an
      option-pricing model is affected by our stock price as well as other
      assumptions, including our expected stock price volatility over the term of
      the
      awards, actual and projected employee stock option exercise behaviors, risk-free
      interest rate and expected dividends. We estimate the expected term of options
      granted by calculating the average term from our historical stock option
      exercise experience. We estimate the volatility of our common stock by using
      the
      historical volatility in our common stock over a period similar to the expected
      term on the options. We base the risk-free interest rate that we use in the
      option valuation model on U.S. Treasury zero-coupon issues with remaining terms
      similar to the expected term on the options. We do not anticipate paying any
      cash dividends in the foreseeable future and therefore use an expected dividend
      yield of zero in the option valuation model. We are required to estimate
      forfeitures at the time of grant and revise those estimates in subsequent
      periods if actual forfeitures differ from those estimates. Based on historical
      data, we assumed zero forfeitures in our 2006 calculation of stock-based
      compensation expense. All stock-based payment awards are amortized on a
      straight-line basis over the requisite service periods of the awards, which
      are
      generally the vesting periods.





The
      assumptions used to value stock option grants are as follows:


**2006**
                  ****
                  **2005**
                  ****
                  **2004**Dividend
                      yield
                  
                  
                  0.00
                  %
                  
                  0.00
                  %
                  
                  0.00
                  %Expected
                      volatility
                  
                  
                  60.80
                  %
                  
                  61.77
                  %
                  
                  62.51
                  %Risk
                      free interest rate
                  
                  
                  5.04
                  %
                  
                  3.71
                  %
                  
                  3.52
                  %Expected
                      lives
                  
                  
                  4.6
                      years
                  
                  
                  5.0
                      years
                  
                  
                  5.0
                      years


The
      fair
      value of restricted stock awards granted in 2006 was $463 based on the closing
      market price of $6.61 on the date of the award. We recognize the estimated
      compensation cost of restricted stock awards, defined as the fair value of
      our
      common stock on the date of grant, on a straight line basis over the three
      year
      vesting period. At December 31, 2006, none of the outstanding 70,000 restricted
      stock awards were vested.




55


Stock
        based compensation recorded in 2006 totaled $235 and is included in selling,
        general and administrative expense in our statement of operations. Future
        compensation cost on unvested stock-based awards as of December 31, 2006
        is
        estimated to be $340, which will be charged to expense in 2007 and 2008.
        The
        application of SFAS No. 123R had the following effect for the year ended
        December 31, 2006 on the amounts reported relative to amounts that would
        have
        been reported using the intrinsic value method under previous
        accounting:


**Using**
                **Intrinsic
                  Value**
                **Method**
              ****
              **SFAS
                  123R**
                **Adjustments**
              ****
              **As**
                **Reported**Operating
                  income
              
              $
              390
              
              $
              (235
              )
              $
              155Income
                  from continuing operations before income taxes
              
              
              610
              
              
              (235
              )
              
              375Net
                  income
              
              
              407
              
              
              (235
              )
              
              172Income
                  per share:Basic
              
              
              0.02
              
              
              (0.01
              )
              
              0.01Diluted
              
              
              0.02
              
              
              (0.01
              )
              
              0.01Cash
                  flow from operations
              
              
              32,314
              
              
              —
              
              
              32,314Cash
                  flow from financing activities
              
              
              (21,880
              )
              
              —
              
              
              (21,880
              )  The
            following table provides the pro forma amounts of net income and net
            income per
            share for the years ended December 31, 2005 and 2004 that would have
            resulted if
            we had accounted for our stock incentive plans under the fair value recognition
            provisions of SFAS No. 123R:


**2005**
              ****
              **2004**Net
                  income, as reported
              
              $
              10,915
              
              $
              3,241Less:
                  Total stock-based employee compensation expense determined under
                  fair
                  value based method for all awards, net of related tax
                  effects
              
              
              76
              
              
              42Pro
                  forma
              
              $
              10,839
              
              $
              3,199Income
                  per share:Basic:As
                  reported
              
              $
              0.60
              
              $
              0.18Pro
                  forma
              
              $
              0.60
              
              $
              0.18Diluted:As
                  reported
              
              $
              0.59
              
              $
              0.18Pro
                  forma
              
              $
              0.59
              
              $
              0.18  Prior
        to
        the adoption of SFAS No. 123R, we presented all tax benefits for deductions
        resulting from the exercise of stock options as operating cash flows on our
        consolidated statement of cash flows. SFAS No. 123R requires the benefits
        of tax
        deductions in excess of recognized compensation expense to be reported as
        a
        financing cash flow, rather than as an operating cash flow. This requirement
        will reduce net operating cash flows and increase net financing cash flows
        in
        periods after adoption. Total cash flow will remain unchanged from what would
        have been reported under prior accounting rules.





**9.**
            **INCOME
                TAXES**




Provision
      (benefit) for income taxes consists of:


**2006**
              
              **2005**
              
              **2004**Continuing
                  operations:Current:Federal
              
              $
              (362
              )
              $
              3,350
              
              $
              —State
              
              
              97
              
              
              589
              
              
              75Reduction
                  of current expense by net operating loss carryforward
              
              
              —
              
              
              (2,657
              )
              
              —(265
              )
              
              1,282
              
              
              75Deferred:Federal
              
              
              562
              
              
              4,299
              
              
              1,113State
              
              
              (175
              )
              
              212
              
              
              (197
              )Change
                  in valuation allowance
              
              
              927
              
              
              (5,825
              )
              
              (916
              )1,314
              
              
              (1,314
              )
              
              —Provision
                  (benefit) for income taxes, continuing operations
              
              
              1,049
              
              
              (32
              )
              
              75Discontinued
                  operations, federal current
              
              
              (29
              )
              
              —
              
              
              —Provision
                  (benefit) for income taxes
              
              $
              1,020
              
              $
              (32
              )
              $
              75


56




The
      income tax provision for 2006 includes (1) federal income tax benefit totaling
      $351 for carry back of the 2006 net operating loss to 2005, (2) state income
      taxes currently payable of $71, (3) additional state income tax payable of
      $225
      related to a state audit that occurred in 2006, reduced by $153 accrued in
      a
      prior year, (4) an increase in the valuation allowance for deferred tax assets
      of $927, and (5) a deferred income tax provision of $387 for normal operating
      activities, including adjustments to state tax net operating loss carryforwards
      (“NOL”) (i) in one state to increase the NOL as a result of the completion of
      that state’s audit and (ii) in another state to reduce the NOL as a result of
      discussions we had during the year with that state with regard to an NOL that
      had expired at the end of 2005. In 2005, our income tax benefit of $32 included
      a current provision of $1,282 offset by the reversal of a portion of the
      deferred tax asset valuation allowance that provided a $1,314 tax
      benefit.





The
      exercise of stock options resulted in a tax benefit and has been reflected
      as a
      reduction of income taxes payable and an increase to additional paid-in capital.
      Such benefits recorded were $0, $654 and $0 for the years ended December 31,
      2006, 2005 and 2004, respectively.





Total
      provision for income tax (benefit) differs from the amount of income tax
      determined by applying the applicable U.S statutory federal income tax rate
      to
      income before taxes as a result of the following differences:


**2006**
                
                **2005**
                
                **2004**Income
                    tax provision at expected federal income tax rate
                
                $
                417
                
                $
                3,813
                
                $
                1,160State
                    income tax provision (benefit), net of federal tax effect
                
                
                17
                
                
                1,213
                
                
                (148
                )Change
                    in valuation allowance
                
                
                927
                
                
                (5,825
                )
                
                (916
                )Non-deductible
                    operating expenses
                
                
                117
                
                
                107
                
                
                124Expiration
                    of carryforward items
                
                
                —
                
                
                489
                
                
                —Return
                    to provision adjustments
                
                
                (291
                )
                
                357
                
                
                —Adjustments
                    to prior year’s
                    tax
                    provisions
                
                
                —
                
                
                —
                
                
                106Change
                    in liability for tax contingencies
                
                
                (174
                )
                
                —
                
                
                —Other
                
                
                7
                
                
                (186
                )
                
                (251
                )Total
                
                $
                1,020
                
                $
                (32
                )
                $
                75  We
          assess
          the need for a valuation allowance against our deferred tax assets in accordance
          with SFAS No. 109, *Accounting
          for Income Taxes.* Realization
          of deferred tax assets (net of recorded valuation allowances) is largely
          dependent upon future profitable operations and future reversals of existing
          taxable temporary differences. In assessing the need for a valuation allowance,
          we consider all positive and negative evidence, including anticipated operating
          results, scheduled reversals of deferred tax liabilities, and tax planning
          strategies.





In
      2006,
      our need for a valuation allowance considered the following factors: (1) our
      2006 operating performance, which was significantly below previous projections,
      (2) a 44 year industry low in 2006 for shipments of manufactured housing with
      each quarter’s shipments lower than the previous quarter, (3) projected
      shipments for 2007 that could be relatively flat compared to 2006 shipments,
      and
      (4) our lack of visibility with respect to our 2007 results. Due to these
      factors, we recorded an adjustment to our valuation allowance to fully reserve
      our deferred tax assets, which totaled $14,709 as of December 31,
      2006.





In
      2005,
      as a result of continuing improvements in operating performance and projected
      income and tax liability for 2006, we reversed a portion of the deferred tax
      asset valuation allowance and realized $1,314 in deferred tax benefits. Because
      we believed challenging industry conditions would persist in 2006, we further
      believed that under the standards of SFAS No. 109 it was not appropriate to
      record income tax benefits in excess of the benefit projected to be realized
      in
      2006. As of December 31, 2005, we maintained a valuation allowance of
      $13,782.





The
      valuation allowance may be reversed to income in future periods to the extent
      that the related deferred income tax assets are realized or the valuation
      allowances are otherwise no longer required.




57




Deferred
      tax assets and liabilities are based on the expected future tax consequences
      of
      temporary differences between the book and tax bases of assets and liabilities.
      Deferred tax assets and liabilities are comprised of the following as of
      December 31, 2006 and 2005:


**2006**
              
              **2005**Current
                  differences:Warranty
                  expense
              
              $
              4,336
              
              $
              4,834Inventory
                  capitalization
              
              
              1,142
              
              
              998Allowance
                  for losses on receivables
              
              
              590
              
              
              382Accrued
                  expenses
              
              
              2,600
              
              
              2,792Repurchase
                  commitments
              
              
              342
              
              
              4919,010
              
              
              9,497Less
                  valuation allowance
              
              
              9,010
              
              
              8,577Totals
              
              $
              —
              
              $
              920Non-current
                  differences:Depreciation
                  and basis differential of acquired assets
              
              $
              1,137
              
              $
              1,340Net
                  operating loss and other carryforwards
              
              
              4,169
              
              
              3,971Goodwill
              
              
              216
              
              
              251Other
              
              
              177
              
              
              375,699
              
              
              5,599Less
                  valuation allowance
              
              
              5,699
              
              
              5,205Totals
              
              $
              —
              
              $
              394  In
            2005,
            we utilized federal net operating loss carry forwards of $6,843 and state
            net
            operating loss carryforwards of $4,208 to reduce taxes otherwise payable.
            At
            December 31, 2006, we had federal and state net operating loss carryforwards
            of
            $745 and $61,423, respectively. The net operating loss carry forwards
            will
            expire as follows:


**Year
                  ending December 31,:**
              
              **Federal**
              
              **State**2007
              
              $
              —
              
              $
              3,4642008
              
              
              —
              
              
              5572009
              
              
              —
              
              
              1052010
              
              
              745
              
              
              —2011
              
              
              —
              
              
              2492019
              
              
              —
              
              
              982020
              
              
              —
              
              
              20,8232021
              
              
              —
              
              
              7,6882022
              
              
              —
              
              
              12,2692023
              
              
              —
              
              
              9,6562024
              
              
              —
              
              
              3,0702025
              
              
              —
              
              
              1032026
              
              
              —
              
              
              3,341
 We
        have
        recorded a liability for tax contingencies where it is likely that certain
        tax
        return positions will be challenged and our position may not prevail. The
        liability for tax contingencies is calculated using historical financial
        information, multiplied by the effective tax rate and includes an applicable
        interest accrual applied where appropriate. The liability for tax contingencies
        is adjusted when circumstances warrant, including the progression of authority
        audits, emerging case law and legislation. Open tax years for which we are
        subject to audit vary by tax jurisdiction. We estimate the maximum liability
        for
        tax contingencies to be $244 and have recorded a liability for tax contingencies
        of $94 (2006) and $268 (2005).





Net
      cash
      paid for income taxes for the years ended December 31, 2006, 2005, and 2004
      were
      $1,454, $18, and $128, respectively.





**10.**
            **EMPLOYEE
                BENEFIT PLANS**




We
      have
      self-funded group medical plans which are administered by third party
      administrators. The medical plans have reinsurance coverage limiting liability
      for any individual employee loss to a maximum of $100, with an aggregate limit
      of losses in any one year based on the number of covered employees. Incurred
      claims identified under our incident reporting system and incurred but not
      reported claims are funded or accrued based on estimates that incorporate our
      past experience, as well as other considerations such as the nature of each
      claim or incident, relevant trend factors and advice from consulting actuaries.
      We have established self-insurance trust funds for payment of claims and make
      deposits to the trust funds in amounts determined by consulting actuaries.
      The
      cost of these plans to us was $3,138, $1,579, and $1,809 for years ended
      December 31, 2006, 2005, and 2004, respectively.





58






We
      sponsor a 401(k) retirement plan covering all employees who meet participation
      requirements. Employee contributions are limited to a percentage of compensation
      as defined in the plan. The amount of our matching contribution is discretionary
      as determined by the Board of Directors. Our matching contributions totaled
      $481, $423, and $413 for the years ended December 31, 2006, 2005, and 2004,
      respectively.





**11.**
            **COMMITMENTS
                AND CONTINGENCIES**




*Operating
      Leases*





We
      are
      obligated under various operating lease agreements with varying monthly payments
      and expiration dates through July 2008. Total rent expense under operating
      leases was $533, $238, and $205 for the years ended December 31, 2006, 2005,
      and
      2004, respectively.





Future
      minimum rents payable under operating leases that have initial or remaining
      noncancelable lease terms in excess of one year at December 31, 2006 are as
      follows:




**Year
                ending December 31,:**
            
            **Operating**
              **Leases**2007
            
            $
            1122008
            
            
            532009
            
            
            4Total
            
            $
            169  *Contingent
        Liabilities and Other:*





a.
            Under
                the repurchase agreements described in Note 1, we were contingently
                liable
                at December 31, 2006, to financial institutions providing inventory
                financing for retailers of our products up to a maximum of approximately
                $62,000 in the event we must perform under the repurchase commitments.
                We
                recorded an estimated liability of $1,513 at December 31, 2006 and
                $1,270
                at December 31, 2005 related to these commitments. Activity in the
                reserve
                for repurchase commitments was as
                follows:


2006
                  
                  2005
                  
                  2004Balance,
                      beginning of year
                  
                  $
                  1,270
                  
                  $
                  2,052
                  
                  $
                  3,070Reduction
                      for payments made on inventory repurchases
                  
                  
                  (197
                  )
                  
                  (86
                  )
                  
                  (717
                  )Recoveries
                      for payments made on inventory repurchases
                  
                  
                  10
                  
                  
                  —
                  
                  
                  —Accruals
                      for guarantees issued during the period
                  
                  
                  2,173
                  
                  
                  2,059
                  
                  
                  2,337Reduction
                      to pre-existing guarantees due to decliningobligation
                      or expired guarantees
                  
                  
                  (2,045
                  )
                  
                  (2,415
                  )
                  
                  (2,258
                  )Changes
                      to the accrual for pre-existing guarantees for thosedealers
                      deemed to be probable of default
                  
                  
                  302
                  
                  
                  (340
                  )
                  
                  (380
                  )Balance,
                      end of year
                  
                  $
                  1,513
                  
                  $
                  1,270
                  
                  $
                  2,052


In
      conjunction with the review of our critical accounting estimates, we evaluated
      our historical loss factors applied to the reserve for repurchase commitments,
      including changes in dealers’ circumstances and industry conditions, for those
      dealers deemed to be probable of default. Based on our review of dealers’
circumstances, we recorded a change in accounting estimate that resulted in
      a
      reduction in revenue in 2006 of $302, but increases in revenue of $340 and
      $380
      for the years ended December 31, 2005 and 2004, respectively.





b.
            Under
                the insurance plans described in Note 1, we were contingently liable
                at
                December 31, 2006 for future retrospective premium adjustments. We
                recorded an estimated liability of $4,816 at December 31, 2006 and
                $5,002
                at December 31, 2005 related to these contingent
                claims.





c.
            Litigation
                is subject to uncertainties and we cannot predict the probable outcome
                or
                the amount of liability of individual litigation matters with any
                level of
                assurance. We are engaged in various legal proceedings that are incidental
                to and arise in the course of our business. Certain of the cases
                filed
                against us and other companies engaged in businesses similar to ours
                allege, among other things, breach of contract and warranty, product
                liability, personal injury and fraudulent, deceptive or collusive
                practices in connection with their businesses. These kinds of suits
                are
                typical of suits that have been filed in recent years, and they sometimes
                seek certification as class actions, the imposition of large amounts
                of
                compensatory and punitive damages and trials by jury. Our liability
                under
                some of this litigation is covered in whole or in part by insurance.
                Anticipated legal fees and other losses, in excess of insurance coverage,
                associated with these lawsuits are accrued at the time such cases
                are
                identified or when additional information is available such that
                losses
                are probable and reasonably estimable. In our opinion, the ultimate
                liability, if any, with respect to the proceedings in which we are
                currently involved is not presently expected to have a material adverse
                effect on our results of operations, financial position or liquidity.
                We
                used the services of a law firm in which a partner is also one of
                our
                directors. We paid legal fees to this firm of $292 (2006), $414 (2005),
                and $346 (2004). In addition, the law firm received, from the proceeds
                of
                the settlement of one of our claims, an indirect legal fee payment
                of $74
                in 2005.




59




d.
            We
                and certain of our equity partners have guaranteed certain debt for
                one
                company in which we own a one-third interest. The guarantees are
                limited
                to 40% of the outstanding debt. At December 31, 2006, $1,715 of debt
                was
                outstanding under the guarantees, of which we had guaranteed $686.
                Subsequent to December 31, 2006, this company sold the last of its
                properties and repaid all of the debt. Therefore, our guarantee related
                to
                this debt has expired.





e.
            We
                have provided letters of credit totaling $5,204 as of December 31,
                2006 to
                providers of certain of our surety bonds and insurance policies.
                While the
                current letters of credit have a finite life, they are subject to
                renewal
                at different amounts based on the requirements of the insurance carriers.
                We have recorded insurance expense based on anticipated losses related
                to
                these policies.





**12.**
            **SEGMENT
                INFORMATION**




Our
      reportable segments are organized around products and services. The Home
      manufacturing segment is comprised of our four manufacturing divisions (seven
      plants), which are aggregated for reporting purposes, and our supply companies
      who sell their products primarily to the manufacturing divisions. Through our
      Home manufacturing segment, we design and manufacture homes, which are sold
      in
      the United States to a network of dealers, which includes Company-owned retail
      locations. Through our Financial services segment, we primarily offer retail
      installment sale financing and related insurance products for manufactured
      homes
      sold through our dealer network. Our Retail segment is comprised of
      Company-owned retail lots that derive their revenues from home sales to
      individuals. The accounting policies of the segments are the same as those
      described in the summary of significant accounting policies except that
      intercompany profits, transactions and balances have not been eliminated. Our
      determination of segment operating profit does not reflect other income
      (expense), equity in earnings of equity-method investees, or income tax
      provision (benefit).


**2006**
                  ****
                  **2005**
                  ****
                  **2004**Gross
                      revenue:Home
                      manufacturing
                  
                  $
                  222,773
                  
                  $
                  267,500
                  
                  $
                  207,997Financial
                      services
                  
                  
                  3,335
                  
                  
                  3,002
                  
                  
                  2,444Retail
                  
                  
                  9,416
                  
                  
                  9,498
                  
                  
                  7,938Gross
                      revenue
                  
                  $
                  235,524
                  
                  $
                  280,000
                  
                  $
                  218,379Intersegment
                      revenue:Home
                      manufacturing
                  
                  $
                  7,587
                  
                  $
                  7,968
                  
                  $
                  6,639Financial
                      services
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —Retail
                  
                  
                  —
                  
                  
                  —
                  
                  
                  —Intersegment
                      revenue
                  
                  $
                  7,587
                  
                  $
                  7,968
                  
                  $
                  6,639Revenue
                      from external customers:Home
                      manufacturing
                  
                  $
                  215,186
                  
                  $
                  259,532
                  
                  $
                  201,358Financial
                      services
                  
                  
                  3,335
                  
                  
                  3,002
                  
                  
                  2,444Retail
                  
                  
                  9,416
                  
                  
                  9,498
                  
                  
                  7,938Total
                      revenue
                  
                  $
                  227,937
                  
                  $
                  272,032
                  
                  $
                  211,740




60


2006
              
              2005
              
              2004Operating
                  income (loss):Home
                  manufacturing
              
              $
              4,282
              
              $
              18,121
              
              $
              10,235Financial
                  services
              
              
              929
              
              
              34
              
              
              539Retail
              
              
              (267
              )
              
              (1
              )
              
              (113
              )Elimination
              
              
              (250
              )
              
              (258
              )
              
              (108
              )Segment
                  operating income (loss)
              
              
              4,694
              
              
              17,896
              
              
              10,553General
                  corporate
              
              
              (4,539
              )
              
              (5,726
              )
              
              (5,472
              )Operating
                  income (loss)
              
              $
              155
              
              $
              12,170
              
              $
              5,081Depreciation
                  and amortization:Home
                  manufacturing
              
              $
              2,054
              
              $
              2,254
              
              $
              2,590Financial
                  services
              
              
              28
              
              
              25
              
              
              29Retail
              
              
              24
              
              
              21
              
              
              17Segment
                  depreciation and amortization
              
              
              2,106
              
              
              2,300
              
              
              2,636General
                  corporate
              
              
              193
              
              
              177
              
              
              681Total
                  depreciation and amortization
              
              $
              2,299
              
              $
              2,477
              
              $
              3,317Capital
                  expenditures:Home
                  manufacturing
              
              $
              1,712
              
              $
              1,295
              
              $
              599Financial
                  services
              
              
              14
              
              
              17
              
              
              30Retail
              
              
              3
              
              
              10
              
              
              40Segment
                  capital expenditures
              
              
              1,729
              
              
              1,322
              
              
              669General
                  corporate
              
              
              266
              
              
              88
              
              
              117Total
                  capital expenditures
              
              $
              1,995
              
              $
              1,410
              
              $
              786Identifiable
                  assets:Home
                  manufacturing
              
              $
              57,042
              
              $
              96,901
              
              $
              60,297Financial
                  services
              
              
              13,608
              
              
              15,423
              
              
              13,755Retail
              
              
              5,118
              
              
              3,713
              
              
              3,296Segment
                  assets
              
              
              75,768
              
              
              116,037
              
              
              77,348General
                  corporate
              
              
              20,938
              
              
              16,784
              
              
              20,882Total
                  assets
              
              $
              96,706
              
              $
              132,821
              
              $
              98,230


The
      Financial services segment’s operating profit includes net interest income of
      $1,052, $1,107, and $1,010, and gains from the sale of installment contracts
      of
      $1,612, $1,310, and $940, for the years ended December 31, 2006, 2005, and
      2004,
      respectively.





The
      decrease in identifiable assets of the home manufacturing segment primarily
      relates to decreases in accounts receivable and inventory in conjunction with
      the FEMA related sales agreements which were completed in January 2006.
      Identifiable assets for the General corporate category include $3,943, $3,728,
      and $3,449 of investment in equity-method investees at December 31, 2006, 2005,
      and 2004, respectively.




61




**13.**
            **EQUITY
                METHOD INVESTEES**




Our
      minority ownership interests in four joint ventures (of which we own various
      interest percentages) are accounted for using the equity method and are included
      in other assets in the accompanying consolidated balance sheets in the amount
      of
      $3,943 (2006) and $3,728 (2005). We recorded equity in earnings of equity-method
      investees of $805, $775, and $980 for the years ended December 31, 2006, 2005,
      and 2004, respectively. Dividends received from investees accounted for by
      the
      equity method were $622, $367, and $209 for the years ended December 31, 2006,
      2005, and 2004, respectively. In 2006 and 2004, our only significant minority
      ownership interest in an individual joint venture was in WoodPerfect, Ltd.,
      of
      which we own a 35.42% interest. At December 31, 2005, none of our equity method
      investees were defined as significant. We completed the significance test in
      2006 using average income for the last five fiscal years since income from
      continuing operations in 2006 was at least 10% lower than the average income
      for
      the five year period (excluding losses). Summarized information related to
      the
      combined group of equity investees and for WoodPerfect, Ltd., individually,
      is
      as follows:


**2006**
              
              **2005**
              
              **2004**Combined
                  group:Balance
                  Sheet:Current
                  assets
              
              $
              12,418
              
              $
              13,171
              
              $
              18,304Non-current
                  assets
              
              
              6,479
              
              
              9,217
              
              
              9,988Current
                  liabilities
              
              
              2,030
              
              
              3,769
              
              
              8,834Non-current
                  liabilities
              
              
              2,974
              
              
              3,236
              
              
              3,964Income
                  Statement:Net
                  sales
              
              
              75,537
              
              
              94,625
              
              
              92,656Gross
                  profit
              
              
              11,285
              
              
              12,417
              
              
              10,482Income
                  from continuing operations
              
              
              1,259
              
              
              3,505
              
              
              3,773Net
                  income
              
              
              1,259
              
              
              3,505
              
              
              3,581WoodPerfect,
                  Ltd.:Balance
                  Sheet:Current
                  assets
              
              $
              7,033
              
              $
              8,037
              
              $
              8,080Non-current
                  assets
              
              
              3,232
              
              
              3,388
              
              
              3,253Current
                  liabilities
              
              
              1,480
              
              
              3,096
              
              
              4,001Non-current
                  liabilities
              
              
              156
              
              
              110
              
              
              149Income
                  Statement:Net
                  sales
              
              
              47,553
              
              
              61,084
              
              
              47,001Gross
                  profit
              
              
              5,954
              
              
              6,854
              
              
              3,206Income
                  from continuing operations
              
              
              1,463
              
              
              1,953
              
              
              1,794Net
                  income
              
              
              1,463
              
              
              1,953
              
              
              1,794




**14.**
            **CONCENTRATION
                OF CREDIT RISK**




We
      design
      and produce manufactured homes which are sold to a network of dealers located
      primarily in the South Central and South Atlantic regions of the United States
      and under agreements, which may be terminated at any time by either party,
      with
      or without cause, after a short notice period. We are not dependent on any
      single dealer, and the largest independent dealer accounted for approximately
      7%
      of sales in 2006, excluding FEMA-related sales.





Additionally,
      in 2005, we entered into agreements with two companies to build homes for
      delivery to FEMA as part of that agency’s disaster relief for the Gulf Coast
      states hit by hurricanes. Under the agreements, we built 2,219 single-section
      homes, which generated revenue of approximately $68,000 and accounted for
      approximately 25.6% of sales in 2005. As of December 31, 2005, we had
      outstanding accounts receivable related to these sales of $35,365.





CIS
      finances retail sales through the purchase of installment contracts primarily
      from retail customers of a portion of our dealer network and resells a majority
      of the loans to financial institutions under the terms of retail finance
      agreements. For loans held in its portfolio, CIS requires the borrower to
      maintain adequate insurance on the home throughout the life of the contract.
      Contracts are secured by the home which is subject to repossession by CIS upon
      default by the borrower.





**15.**
            **SUBSEQUENT
                EVENTS**




As
      discussed in Note 6, we amended the terms of the Credit Facility in February
      2007, to, among other things, (i) extend the maturity date to April 15, 2008,
      (ii) reduce the interest rate on borrowings if TNW exceeds $62,000, (iii)
      increase the annual capital expenditure limit to $5,000 per year, (iv) increase
      the amount available under the revolving line of credit, and (v) revise certain
      financial covenants.





Subsequent
      to the end of the year, debt of an equity method investee guaranteed by us
      and
      certain of our equity partners was repaid. Therefore, our guarantee related
      to
      this debt has expired. See Note 11 above.





62
 **CAVALIER
        HOMES INC. AND SUBSIDIARIES**


**SCHEDULE
        II - VALUATION AND QUALIFYING ACCOUNTS**
 **For
        the Years Ended December 31, 2006, 2005, and 2004**
 ***(dollars
        in thousands)***




**Balance
                at Beginning of Year**
            
            **Additions
                Charged to Costs and Expenses**
            
            **Deductions**
            
            **Balance
                at End of Year**Allowance
                for losses on accounts receivable:Year
                Ended December 31, 2006
            
            $
            56
            
            $
            22
            
            $
            —
            
            $
            78Year
                Ended December 31, 2005
            
            $
            85
            
            $
            (1
            )
            $
            (28
            )
            $
            56Year
                Ended December 31, 2004
            
            $
            102
            
            $
            (17
            )
            $
            —
            
            $
            85Deferred
                tax asset valuation allowance:Year
                Ended December 31, 2006
            
            $
            13,782
            
            $
            927
            
            $
            —
            
            $
            14,709Year
                Ended December 31, 2005
            
            $
            19,607
            
            $
            —
            
            $
            (5,825
            )
            $
            13,782Year
                Ended December 31, 2004
            
            $
            20,523
            
            $
            —
            
            $
            (916
            )
            $
            19,607


**ITEM
              9.**
            **CHANGES
                IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
                DISCLOSURE**




None.





**ITEM
              9A.**
            **CONTROLS
                AND PROCEDURES**




**Evaluation
      of Disclosure Controls and Procedures**





Under
      the
      supervision and with the participation of our chief executive officer and chief
      financial officer, management has evaluated the effectiveness of the design
      and
      operation of our disclosure controls and procedures (as defined in Rule
      13a-15(e) and 15d-15(e) of the Securities Exchange act of 1934) as of December
      31, 2006. Based on that evaluation, our chief executive officer and our chief
      financial officer have concluded that our disclosure controls and procedures
      were effective as of December 31, 2006.





**Management’s
      Report on Internal Control Over Financial Reporting**





Management’s
      Report on Internal Control Over Financial Reporting is included on page 39
      of
      this report.





**Changes
      in Internal Control Over Financial Reporting**





The
      Company experienced turnover related to a key position in the Financial Close
      and Reporting process during the third quarter of 2006. The Corporate Controller
      - External Reporting and Tax position was vacated during the quarter. The
      position was filled in early October 2006, prior to completing and filing the
      third quarter Form 10-Q. Based on testing of internal controls over financial
      reporting performed during the fourth quarter 2006 and during the preparation
      of
      this 10-K, management has concluded that this change did not result in a
      deficiency in internal controls over financial reporting, and therefore has
      concluded the internal control structure of the Company to be effective as
      of
      December 31, 2006.





There
      were no other changes in the company’s internal control over financial reporting
      during the Company’s most recent fiscal quarter that have materially affected,
      or are reasonably likely to materially affect, the Company’s internal control
      over financial reporting.





**ITEM
              9B.**
            **OTHER
                INFORMATION**





None.




63




**PART
      III**





**ITEM
              10.**
            **DIRECTORS,
                EXECUTIVE OFFICERS AND CORPORATE
                GOVERNANCE**





The
      information required by this item will be included in our Proxy Statement for
      the Annual Meeting of Stockholders to be held on May 22, 2007, which is
      incorporated herein by reference.





**ITEM
              11.**
            **EXECUTIVE
                COMPENSATION**





The
      information required by this item will be included in our Proxy Statement for
      the Annual Meeting of Stockholders to be held on May 22, 2007, which is
      incorporated herein by reference.





**ITEM
              12.**
            **SECURITY
                OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
                STOCKHOLDER MATTERS**





The
      information required by this item will be included in our Proxy Statement for
      the Annual Meeting of Stockholders to be held on May 22, 2007, which is
      incorporated herein by reference.





**ITEM
              13.**
            **CERTAIN
                RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
                INDEPENDENCE**





The
      information required by this item will be included in our Proxy Statement for
      the Annual Meeting of Stockholders to be held on May 22, 2007, which is
      incorporated herein by reference.





**ITEM
              14.**
            **PRINCIPAL
                ACCOUNTANTS FEES AND
                SERVICES**





The
      information required by this item will be included in our Proxy Statement for
      the Annual Meeting of Stockholders to be held on May 22, 2007, which is
      incorporated herein by reference.





**PART
      IV**





**ITEM
              15.**
            **EXHIBITS
                AND FINANCIAL STATEMENT SCHEDULES**





(a)
            1.The
                financial statements contained in this report and the page on which
                they
                may be found are as follows:




**Financial
                  Statement Description**
              
              **Page**Reports
                  of Independent Registered Public Accounting Firms
              
              40Consolidated
                  Balance Sheets as of December 31, 2006 and 2005
              
              43Consolidated
                  Statements of Operations for the years ended December 31, 2006,
                  2005, and
                  2004
              
              44Consolidated
                  Statements of Stockholders’ Equity for the years ended December 31, 2006,
                  2005, and 2004
              
              45Consolidated
                  Statements of Cash Flows for the years ended December 31, 2006,
                  2005, and
                  2004
              
              46Notes
                  to Consolidated Financial Statements
              
              47
  2.The
                        financial statement schedule required to be filed with this
                        report and the
                        page on which it may be found is as
                        follows:
 
 **No.**
              
              **Schedule
                  Description**
              
              **Page**II
              
              Valuation
                  and Qualifying Accounts
              
              63
  3. The
                            exhibits required to be filed with this report are listed
                            below. We will
                            furnish upon request any of the exhibits listed upon
                            the receipt of $15.00
                            per exhibit, plus $.50 per page, to cover the cost to
                            us of providing the
                            exhibit.




64




(3) Articles
      of Incorporation and By-laws.





*
      (a) Our
      Composite Amended and Restated Certificate of Incorporation, filed as Exhibit
      3(a) to our Annual Report on Form 10-K for the year ended December 31, 1998.





*
      (b) The
      Certificate of Designation of Series A Junior Participating Preferred Stock
      of
      Cavalier Homes, Inc. as filed with the Office of the Delaware Secretary of
      State
      on October 24, 1996 and filed as Exhibit A to Exhibit 4 to our Registration
      Statement on form 8-A filed on October 30, 1996.





*
      (c) Our
      Amended and Restated By-laws, filed as Exhibit 3(b) to our registration of
      securities on Form 8A/A filed on March 3, 2004.





(4) Instruments
      Defining the Rights of Security Holders, Including Indentures.





*
      (a) Articles
      four, six, seven, eight and nine of our Amended and Restated Certificate of
      Incorporation, as amended, included in Exhibit 3(a) above.





*
      (b) Article
      II, Sections 2.1 through 2.18; Article III, Sections 3.1 and 3.2; Article IV,
      Sections 4.1 and 4.3; Article VI, Sections 6.1 through 6.5; Article VIII,
      Sections 8.1 and 8.2; and Article IX of our Amended and Restated By-laws,
      included in Exhibit 3(c) above.





(10) Material
      contracts.





*
      (a) Lease
      Agreement dated March 1, 1997, between the City of Winfield and Buccaneer Homes,
      a division of Cavalier Manufacturing, Inc., filed as Exhibit 10(aa) to our
      Annual Report on Form 10-K for the year ended December 31, 1996.





*
      (b) Assignment
      and Assumption Agreement by and among the Estate of Jerry F. Wilson, Robert
      Lowell Burdick, John W Lowe, Cavalier Manufacturing, Inc. and Cavalier Real
      Estate Co., Inc., dated January 13, 1999, regarding the lease of the
      manufacturing facility located in Addison, Alabama, filed as Exhibit 10(g)
      to
      our Annual Report on Form 10-K for the year ended December 31, 1999.





*
      (c) Lease
      Agreement between the Industrial Development Board of the Town of Addison and
      the Winston County Industrial Development Association, dated as of February
      1,
      1994, regarding the lease of the manufacturing facility located in Addison,
      Alabama, filed as Exhibit 10(h) to our Annual Report on Form 10-K for the year
      ended December 31, 1999.





*
      (d) Assignment
      and Assumption Agreement by and among Winston County Industrial Development
      Association, Cavalier Manufacturing, Inc. and Cavalier Real Estate Co., Inc.
      dated January 13, 1999, regarding the lease of the manufacturing facility
      located in Addison Alabama, filed as Exhibit 10(a) to our Quarterly Report
      on
      Form 10-Q for the quarter ended March 31, 2000.





*
      (e) Lease
      Agreement between The Industrial Development Board of the Town of Addison and
      Cavalier Homes of Alabama, a division of Cavalier Manufacturing, Inc., dated
      November 1, 1997, filed as Exhibit 10(yy) to our Annual Report on Form 10-K
      for
      the year ended December 31, 1997.





*
      (f) Lease
      Agreement dated April 1, 1999, between Crisp County-Cordele Industrial
      Development Authority and Cavalier Industries, Inc. regarding the lease of
      the
      manufacturing facility located in Cordele, Georgia, filed as Exhibit 10(j)
      to
      our Annual Report on Form 10-K for the year ended December 31,
      1999.




*
      (g) Lease
      Agreement dated March 1, 2001, between the Industrial Development Board of
      the
      City of Hamilton and Quality Housing Supply, LLC regarding the lease of the
      component manufacturing facility located in Hamilton, Alabama, filed as Exhibit
      10(a) to our Quarterly Report on Form 10-Q for the quarter ended March 31,
      2001.





*
      (h) Amended
      and Restated Revolving and Term Loan Agreement, dated as of March 31, 2000,
      by
      and among the Company, First Commercial Bank and certain subsidiaries of the
      Company, filed as Exhibit 10(b) to our Quarterly Report on Form 10-Q for the
      quarter ended March 31, 2000.





65


*
          (i) First
          Amendment to Amended and Restated Revolving and Term Loan Agreement, dated
          as of
          September 29, 2000, between us and First Commercial Bank, filed as Exhibit
          10(a)
          to our Quarterly Report on Form 10-Q for the quarter ended September 30,
          2000.





*
      (j) Second
      Amendment to Amended and Restated Revolving and Term Loan Agreement, dated
      as of
      May 4, 2001, between us and First Commercial Bank, filed as Exhibit 10(c) to
      our
      Quarterly Report on Form 10-Q for the quarter ended March 31, 2001.





*
      (k) Second
      Modification to Amended and Restated Revolving Note, dated as of June 21, 2002,
      between us and First Commercial Bank, filed as Exhibit 10(a) to our Quarterly
      Report on Form 10-Q for the quarter ended June 29, 2002.





*
      (l) Third
      Amendment to Amended and Restated Revolving and Term Loan Agreement, dated
      as of
      June 21, 2002, between us and First Commercial Bank, filed as Exhibit 10(b)
      to
      our Quarterly Report on Form 10-Q for the quarter ended June 29,
      2002.





*
      (m) Third
      Modification to Amended and Restated Revolving Note, dated as of October 25,
      2002, between us and First Commercial Bank, filed as Exhibit 10(c) to our
      Quarterly Report on Form 10-Q for the quarter ended September 28,
      2002.





*
      (n) Fourth
      Amendment to Amended and Restated Revolving and Term Loan Agreement, dated
      as of
      October 25, 2002, between us and First Commercial Bank, filed as Exhibit 10(d)
      to our Quarterly Report on Form 10-Q for the quarter ended September 28,
      2002.





*
      (o) Fourth
      Modification to Amended and Restated Revolving Note, dated as of August 6,
      2003,
      between us and First Commercial Bank, filed as Exhibit 10(a) to our Quarterly
      Report on Form 10-Q for the quarter ended June 28, 2003.





*
      (p) Fifth
      Amendment to Amended and Restated Revolving and Term Loan Agreement, dated
      as of
      August 6, 2003, between us and First Commercial Bank, filed as Exhibit 10(b)
      to
      our Quarterly Report on Form 10-Q for the quarter ended June 28,
      2003.




*
      (q) Sixth
      Amendment to Amended and Restated Revolving and Term Loan Agreement, dated
      as of
      October 26, 2004, between us and First Commercial Bank, filed as Exhibit 10(c)
      to our Quarterly Report on Form 10-Q for the quarter ended September 25,
      2004.





*
      (r) Seventh
      Amendment to Amended and Restated Revolving and Term Loan Agreement, dated
      as of
      October 25, 2005, between us and First Commercial Bank, filed as Exhibit 99.1
      to
      our Report on Form 8-K filed on October 31, 2005.





*
      (s) Eighth
      Amendment to Amended and Restated Revolving and Term Loan Agreement, dated
      as of
      December 6, 2005, between us and First Commercial Bank, filed as Exhibit 99.1
      to
      our Report on Form 8-K filed on December 7, 2005.





*
      (t) Ninth
      Amendment to Amended and Restated Revolving and Term Loan Agreement, dated
      as of
      May 23, 2006, between us and First Commercial Bank, filed as Exhibit 99.1 to
      our
      Report on Form 8-K filed on May 25, 2006.





*
      (u) Tenth
      Amendment to Amended and Restated Revolving and Term Loan Agreement, dated
      as of
      February 21, 2007, between us and First Commercial Bank, filed as Exhibit 99.1
      to our Report on Form 8-K filed on February 21, 2007.





*
      (v) Real
      Estate Note, dated as of August 6, 2003, between us and First Commercial Bank,
      filed as Exhibit 10(c) to our Quarterly Report on Form 10-Q for the quarter
      ended June 28, 2003.





*
      (w) Revolving
      Note, under the Amended and Restated Revolving and Term Loan Agreement, dated
      as
      of December 6, 2005, between us and First Commercial Bank, filed as Exhibit
      10(y) to our Annual Report on Form 10-K for the year ended December 31,
      2005.




66




*
      (x) Guaranty
      Agreement, dated as of August 6, 2003, between us and First Commercial Bank,
      filed as Exhibit 10(d) to our Quarterly Report on Form 10-Q for the quarter
      ended June 28, 2003.





*
      (y) Amended
      and Restated Real Estate Note, dated as of September 26, 2003, between us and
      First Commercial Bank, filed as Exhibit 10(a) to our Quarterly Report on Form
      10-Q for the quarter ended September 27, 2003.





*
      (z) Continuing
      Guaranty Agreement between First Commercial Bank and Cavalier Homes, Inc.,
      dated
      March 31, 2000, relating to guaranty of payments of Cavalier Acceptance
      Corporation, filed as Exhibit 10(c) to our Quarterly Report on Form 10-Q for
      the
      quarter ended March 31, 2000.





*
      (aa) Release
      of Guarantor and Amendment to Guaranty Agreements among First Commercial Bank,
      Patriot Homes, Inc., Cavalier Homes, Inc., Southern Energy Homes, Inc. and
      Lee
      Roy Jordan, dated as of December 31, 1999, filed as Exhibit 10(hh) to our Annual
      Report on Form 10-K for the year ended December 31, 1999.





*
                ** (bb) Cavalier Homes, Inc. 1996 Key Employee Stock Incentive Plan,
                filed
                as an Appendix to our definitive Proxy Statement for the Annual Meeting
                of
                Stockholders held May 15, 1996.





*
                ** (cc) Amendment to Cavalier Homes, Inc. 1996 Key Employee Stock
                Incentive Plan, filed as Exhibit 10(i) to our Quarterly Report on
                Form
                10-Q for the quarter ended March 28, 1997.





*
                ** (dd) Amendment to Cavalier Homes, Inc. 1996 Key Employee Stock
                Incentive Plan, effective December 30, 1997, filed as Exhibit 10(j)
                to our
                Annual Report on Form 10-K for the year ended December 31, 1997.





*
                ** (ee) Amendment to Cavalier Homes, Inc. 1996 Key Employee Stock
                Incentive Plan, effective January 23, 1998, filed as Exhibit 10(k)
                to our
                Annual Report on Form 10-K for the year ended December 31, 1997.





*
                ** (ff) Amendment to Cavalier Homes, Inc. Key 1996 Employee Stock
                Incentive Plan, effective October 20, 1998, filed as Exhibit 10(l)
                to our
                Annual Report on Form 10-K for the year ended December 31, 1998.





*
                ** (gg) Cavalier Homes, Inc. 1993 Amended and Restated Nonemployee
                Directors Stock Option Plan, filed as an Appendix to our definitive
                Proxy
                Statement for the Annual Meeting of Stockholders held May 15, 1996.





*
                ** (hh) Amendment to Cavalier Homes, Inc. 1993 Amended and Restated
                Nonemployee Directors Plan filed as Exhibit 10(i) to our Annual Report
                on
                Form 10-K for the year ended December 31, 1996.





*
                ** (ii) Amendment to Cavalier Homes, Inc. 1993 Amended and Restated
                Nonemployee Directors Plan, filed as Exhibit 10(n) to our Annual
                Report on
                Form 10-K for the year ended December 31, 1997.





*
      ** (jj)
      Cavalier Homes, Inc. 2005 Incentive Compensation Plan, filed as an Appendix
      to
      our definitive Proxy Statement for the Annual Meeting of Stockholders held
      May
      24, 2005.





*
      ** (kk)
      Cavalier Homes, Inc. 2005 Non-Employee Directors Stock Option Plan, filed as
      an
      Appendix to our definitive Proxy Statement for the Annual Meeting of
      Stockholders held May 24, 2005.





*
                ** (ll) Form of Stock Option Agreement between us and Thomas A. Broughton,
                III, dated January 29, 2002, filed as Exhibit 4(e) to our Registration
                Statement on Form S-8, Registration No.
                333-90652.





*
      (mm)
      Form of Indemnification Agreement between Belmont Homes, Inc. and the Directors
      and Executive Officers of Belmont Homes, Inc., filed as Exhibit 10.2 to Belmont
      Homes, Inc. Current Report on Form 8-K filed on September 8, 1997.





*
                (nn) Form of Indemnification Agreement by and between Cavalier Homes,
                Inc.
                and each member of our Board of Directors, filed as Exhibit 10(a)
                to our
                Quarterly Report on Form 10-Q for the quarter ended September 25,
                1998.





*
                (oo) Inventory Security Agreement and Power of Attorney, dated as
                of July
                13, 2004, between us and 21stMortgage Company, filed as Exhibit 10(a) to our Quarterly Report
                on Form
                10-Q for the quarter ended September 25,
                2004.





67




(21)
            Subsidiaries
                of the Registrant.





(23)
            Consents
                of Independent Registered Public Accounting
                Firms


(a)
            Carr,
                Riggs & Ingram, LLC


(b)
            Deloitte
                & Touche LLP





(31)
            Rule
                13a-15(e) or 15d-15(e)
                Certifications


(a)
            Certification
                of principal executive officer pursuant to Exchange Act Rule 13a-15(e)
                or
                15d-15(e).


(b)
            Certification
                of principal financial officer pursuant to Exchange Act Rule 13a-15(e)
                or
                15d-15(e).





(32)
            Section
                1350 Certifications


(a)
                Certification
                    of CEO pursuant to 18 U.S.C. Section 1350, as adopted pursuant
                    to Section
                    906 of the Sarbanes-Oxley Act of 2002.


(b)
                Certification
                    of CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant
                    to Section
                    906 of the Sarbanes-Oxley Act of
                    2002.







*
            Incorporated
                by reference herein.


**
            Management
                contract or compensatory plan or
                arrangement.





68




**SIGNATURES**




Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, the registrant has duly caused this report to be signed on its behalf
      by
      the undersigned, thereunto duly authorized.




**CAVALIER
                  HOMES, INC.**
                RegistrantBy:
              /s/
                  DAVID A. ROBERSONDavid
                  A. Roberson
                Its
                  President and Chief Executive OfficerDate:
                  March 8, 2007




Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed below by the following persons on behalf of the Registrant and in the
      capacity and on the dates indicated.




**Signature**
              
              **Title**
              
              **Date**/s/
                  DAVID A. ROBERSON
              
              Director
                  and Principal Executive Officer
              
              March
                  8, 2007David
                  A. Roberson/s/
                  MICHAEL R. MURPHY
              
              Chief
                  Financial Officer and Principal Accounting Officer
              
              March
                  8, 2007Michael
                  R. Murphy/s/
                  BARRY DONNELL
              
              Chairman
                  of the Board and Director
              
              March
                  8, 2007Barry
                  Donnell/s/
                  THOMAS A. BROUGHTON, III
              
              Director
              
              March
                  8, 2007Thomas
                  A. Broughton, III/s/
                  JOHN W. LOWE
              
              Director
              
              March
                  8, 2007John
                  W. Lowe/s/
                  LEE ROY JORDAN
              
              Director
              
              March
                  8, 2007Lee
                  Roy Jordan/s/
                  J. DON WILLIAMS
              
              Director
              
              March
                  8, 2007J.
                  Don Williams/s/
                  BOBBY TESNEY
              
              Director
              
              March
                  8, 2007Bobby
                  Tesney




69


**INDEX**




Exhibit


Number





(21)
              Subsidiaries
                  of the Registrant





(23)
              Consents
                  of Independent Registered Public Accounting
                  Firms




(a)
            Carr,
                Riggs & Ingram, LLC


(b)
            Deloitte
                & Touche LLP





(31)
            Exhibits


(a)
            Certification
                of principal executive officer pursuant to Exchange Act Rule 13a-15(e)
                or
                15d-15(e).


(b)
            Certification
                of principal financial officer pursuant to Exchange Act Rule 13a-15(e)
                or
                15d-15(e).





(32)
            Exhibits


(a)
            Certification
                of CEO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
                Section
                906 of the Sarbanes-Oxley Act of 2002.


(b)
            Certification
                of CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
                Section
                906 of the Sarbanes-Oxley Act of
                2002.




70