# ** **

# **SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

** **

**(MarkOne)**

 

**ý****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended March 31, 2006**

 

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

 

**Commissionfile number 001-12085**

 

 

**NATIONAL R.V. HOLDINGS, INC.**

(Exact name of registrant asspecified in its charter)

 

| **Delaware**                                  | ** ** | **33-0371079**                        |
|-----------------------------------------------|------------|---------------------------------------|
| (State or  other jurisdiction of              |       | (I.R.S.  Employer Identification No.) |
| incorporation  or organization)               |       |                                  |
|                                          |       |                                  |
| **3411 N.  Perris Blvd., Perris, California** | ** ** | **92571**                             |
| (Address of principal executive  offices)     |       | (Zip Code)                            |

 

Registrant’s telephone number,including area code: **(951) 943-6007**

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bysection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

 

YES ý   NO o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer or a non-accelerated filer. See definition of “acceleratedfiler” or “large accelerated filer” in Rule 12b-2 of the Exchange Act.

 
| Large accelerated filer o |   | Accelerated filer ý |   | Non-accelerated filer o |
|--------------------------------|--------|-------------------------------|--------|------------------------------|

 

Indicate by check mark whether the registrantis a shell company (as defined in Exchange Act Rule 12b-2 of the ExchangeAct).

 

YES o  NO ý

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.

 
| **Class**                                | ** ** | **Outstanding at May 1, 2006** | ** ** |
|------------------------------------------|------------|----------------------------------------------------|------------|
| Common  stock, par value $0.01 per share |       | 10,339,484                                         |       |

 

 

----

 

 

**NATIONALR.V. HOLDINGS, INC.**

 

### **INDEX**

 
| ** ** | **PART I - FINANCIAL INFORMATION**                                                     |
|------------|---------------------------------------------------------------------------------------------|
|       |                                                                                        |
| Item 1.    | Consolidated Financial Statements (Unaudited)                                               |
|       | Consolidated Balance Sheets - March 31, 2006 and  December 31, 2005               |
|       | Consolidated Statements of Operations - Three Months Ended  March 31, 2006 and 2005    |
|       |                                                                                        |
|       | Consolidated Statements of  Cash Flows -Three Months Ended March 31, 2006 and 2005     |
|       |                                                                                        |
|       | Notes to Consolidated Financial  Statements                                                 |
|       |                                                                                        |
| Item 2.    | Management’s Discussion and Analysis of Financial Condition and  Results of Operations |
|       |                                                                                        |
| Item 3.    | Quantitative and Qualitative  Disclosures about Market Risk                                 |
|       |                                                                                        |
| Item 4.    | Controls and Procedures                                                                     |
|       |                                                                                        |
|       | **PART II - OTHER INFORMATION**                                                        |
|       |                                                                                        |
| Item  1A.  | Risk  Factors                                                                               |
|       |                                                                                        |
| Item 6.    | Exhibits                                                                                    |
|       |                                                                                        |
|       | Signature                                                                                   |

 

2

----

 

**Tableof Contents**

 

**PART I,ITEM 1**

**ConsolidatedFinancial Statements**

 

**NATIONALR.V. HOLDINGS, INC.**

**CONSOLIDATEDBALANCE SHEETS**

**(Inthousands, except share and per share amounts)**

 
| ** **                                                                                        | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                        | ** ** | **(Unaudited)**          | ** ** | ** **                  | ** ** |
|                                                                                              |       |                     |       |                        |       |
| ASSETS                                                                                            |       |                     |       |                        |       |
| Current  assets:                                                                                  |       |                     |       |                        |       |
| Cash and  cash equivalents                                                                        |       | $                        | 11         |                        | $          | 11 |   |
| Restricted  cash                                                                                  |       | 201                      |       | 201                         |       |
| Receivables,  less allowance for doubtful accounts of $436 and $392, respectively                 |       | 31,278                   |       | 21,533                      |       |
| Inventories                                                                                       |       | 63,868                   |       | 61,940                      |       |
| Prepaid  expenses                                                                                 |       | 2,044                    |       | 2,359                       |       |
| Deferred  income taxes                                                                            |       | 1,010                    |       | 1,281                       |       |
| Total  current assets                                                                             |       | 98,412                   |       | 87,325                      |       |
| Property,  plant and equipment, net                                                               |       | 38,628                   |       | 38,457                      |       |
| Other assets                                                                                      |       | 1,524                    |       | 1,608                       |       |
| Total assets                                                                                      |       | $                        | 138,564    |                        | $          | 127,390 |   |
|                                                                                              |       |                     |       |                        |       |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                        |       |                     |       |                        |       |
| Current  liabilities:                                                                             |       |                     |       |                        |       |
| Book  overdraft                                                                                   |       | $                        | 6,858      |                        | $          | 2,582 |   |
| Accounts  payable                                                                                 |       | 21,722                   |       | 19,769                      |       |
| Accrued  expenses                                                                                 |       | 25,828                   |       | 26,722                      |       |
| Current  portion of capital leases                                                                |       | 57                       |       | 57                          |       |
| Line of  credit                                                                                   |       | 19,947                   |       | 12,059                      |       |
| Total  current liabilities                                                                        |       | 74,412                   |       | 61,189                      |       |
| Long-term  portion of capital leases                                                              |       | 159                      |       | 169                         |       |
| Deferred  income taxes                                                                            |       | 1,010                    |       | 1,281                       |       |
| Long-term  accrued expenses                                                                       |       | 4,876                    |       | 5,089                       |       |
| Total  liabilities                                                                                |       | 80,457                   |       | 67,728                      |       |
|                                                                                              |       |                     |       |                        |       |
| Commitments  and contingent liabilities (Note 6)                                                  |       |                     |       |                        |       |
|                                                                                              |       |                     |       |                        |       |
| Stockholders’  equity:                                                                       |       |                     |       |                        |       |
| Preferred  stock - $0.01 par value; 5,000 shares authorized, 4,000 issued and  outstanding        |       | —                   |       | —                      |       |
| Common stock  - $0.01 par value; 25,000,000 shares authorized, 10,339,484 issued and  outstanding |       | 103                      |       | 103                         |       |
| Additional  paid-in capital                                                                       |       | 38,062                   |       | 37,563                      |       |
| Retained  earnings                                                                                |       | 19,942                   |       | 21,996                      |       |
| Total  stockholders’ equity                                                                  |       | 58,107                   |       | 59,662                      |       |
| Total  liabilities and stockholders’ equity                                                  |       | $                        | 138,564    |                        | $          | 127,390 |   |

 

The accompanying notes are anintegral part of the consolidated financial statements.

 

3

----

 

**Tableof Contents**

 

**NATIONALR.V. HOLDINGS, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Inthousands, except per share amounts)**

**(Unaudited)**

 
| ** **                           | ** ** | **Three-Months Ended  March 31,** | ** ** |
|--------------------------------------|------------|---------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
|                                 |       |                                        |       |   |   |
| Net sales                            |       | $                                           | 112,895    |   | $ | 125,625 |   |
| Cost of  goods sold                  |       | 107,568                                     |       | 120,010 |   |
| Gross profit                         |       | 5,327                                       |       | 5,615 |   |
| Selling  expenses                    |       | 3,254                                       |       | 3,639 |   |
| General and  administrative expenses |       | 3,745                                       |       | 3,252 |   |
| Operating  loss                      |       | (1,672                                      | )          | (1,276 | ) |
| Interest  expense                    |       | 424                                         |       | 277 |   |
| Other income                         |       | (61                                         | )          | (109 | ) |
| Loss before  income taxes            |       | (2,035                                      | )          | (1,444 | ) |
| Provision  for income taxes          |       | 19                                          |       | — |   |
| Net loss                             |       | $                                           | (2,054     | ) | $ | (1,444 | ) |
|                                 |       |                                        |       |   |   |
| Loss per  common share:              |       |                                        |       |   |   |
| Basic                                |       | $                                           | (0.20      | ) | $ | (0.14 | ) |
| Diluted                              |       | $                                           | (0.20      | ) | $ | (0.14 | ) |
|                                 |       |                                        |       |   |   |
| Weighted  average number of shares:  |       |                                        |       |   |   |
| Basic                                |       | 10,339                                      |       | 10,335 |   |
| Diluted                              |       | 10,339                                      |       | 10,335 |   |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

4

----

 

**Tableof Contents**

 

**NATIONAL R.V. HOLDINGS, INC.**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Inthousands)**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **Three-Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
|                                                                         |       |                                        |       |   |   |
| Cash flows  from operating activities:                                       |       |                                        |       |   |   |
| Net loss                                                                     |       | $                                           | (2,054     | ) | $ | (1,444 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities: |       |                                        |       |   |   |
| Bad debt  expense                                                            |       | 44                                          |       | 80 |   |
| Reserve and  write down of inventories                                       |       | 88                                          |       | 121 |   |
| Depreciation  and amortization                                               |       | 1,065                                       |       | 933 |   |
| Gain on  asset disposal                                                      |       | (6                                          | )          | (19 | ) |
| Stock-based  compensation                                                    |       | 499                                         |       | — |   |
| Changes in  assets and liabilities:                                          |       |                                        |       |   |   |
| Increase in  receivables                                                     |       | (9,789                                      | )          | (16,161 | ) |
| Increase in  inventories                                                     |       | (2,016                                      | )          | (8,169 | ) |
| Decrease in  prepaid expenses                                                |       | 315                                         |       | 209 |   |
| Increase in  accounts payable                                                |       | 1,953                                       |       | 12,039 |   |
| Increase  (decrease) in accrued expenses                                     |       | (1,107                                      | )     | 941 |   |
| Net cash  used in operating activities                                       |       | (11,008                                     | )          | (11,470 | ) |
|                                                                         |       |                                        |       |   |   |
| Cash flows  from investing activities:                                       |       |                                        |       |   |   |
| Decrease in restricted cash                                                  |       | —                                      |       | 226 |   |
| Repayments  on note receivable                                               |       | —                                      |       | 649 |   |
| Purchase of  property, plant and equipment                                   |       | (1,338                                      | )          | (1,342 | ) |
| Proceeds  from sale of assets                                                |       | 127                                         |       | 20 |   |
| Decrease (increase) in other assets                                          |       | 65                                          |       | (59 | ) |
| Net cash  used in investing activities                                       |       | (1,146                                      | )          | (506 | ) |
|                                                                         |       |                                        |       |   |   |
| Cash flows  from financing activities:                                       |       |                                        |       |   |   |
| Increase in  book overdraft                                                  |       | 4,276                                       |       | 8,944 |   |
| Principal  payments on capital leases                                        |       | (10                                         | )          | (6 | ) |
| Net advances  under line of credit                                           |       | 7,888                                       |       | 2,898 |   |
| Proceeds  from issuance of common stock                                      |       | —                                      |       | 140 |   |
| Net cash  provided by financing activities                                   |       | 12,154                                      |       | 11,976 |   |
| Net decrease  in cash and cash equivalents                                   |       | —                                      |       | — |   |
| Cash and  cash equivalents, beginning of the year                            |       | 11                                          |       | 11 |   |
| Cash and  cash equivalents, end of period                                    |       | $                                           | 11         |   | $ | 11 |   |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

5

----

 

**Tableof Contents**

 

**NATIONALR.V. HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

**NOTE 1 – BASIS OF PRESENTATION**

 

**General**

 

Theconsolidated financial statements include the financial statements of NationalRV Holdings, Inc. (the “Company”) and its wholly-owned subsidiariesNational RV, Inc. (“National RV”) and Country Coach, Inc. (“CountryCoach”).

 

Theaccompanying consolidated balance sheet as of December 31, 2005, which has beenderived from audited consolidated financial statements, and the unauditedinterim consolidated financial statements have been prepared pursuant to therules and regulations of the United States Securities and Exchange Commission (“SEC”).Certain information and note disclosures normally included in accordance withaccounting principles generally accepted in the United States of America havebeen condensed or omitted pursuant to those rules and regulations, although theCompany believes that the disclosures made are adequate to make the informationnot misleading. These consolidated financial statements should be read inconjunction with the audited consolidated financial statements for the yearended December 31, 2005 and notes thereto included in the Company’s AnnualReport on Form 10-K filed with the SEC on March 30, 2006.

 

Inthe opinion of management, the accompanying unaudited consolidated financialstatements contain all adjustments necessary, consisting of normal recurringadjustments, to state fairly the consolidated financial position, the resultsof operations and cash flows for all periods presented, including theelimination of significant intercompany accounts in consolidation. Certainreclassifications have been made to prior period amounts and classification inorder to conform to current period presentation.

 

***Seasonal Nature of BusinessActivities***

 

Resultsfor the interim period are not necessarily indicative of the results for anentire year. Seasonal factors, over which the Company has no control, have aneffect on the demand for the Company’s products. Demand in the recreationalvehicle (“RV”) industry characteristically declines over the winter season,while sales are generally highest during the spring and summer months.

 

***Use of Accounting Estimates***

 

Thepreparation of the consolidated financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and judgments that affect the reportedamount of assets and liabilities and disclosure of contingent assets andliabilities at the date of the consolidated financial statements and thereported amount of revenues and expenses for each period. On an on-going basis,management evaluates its estimates and judgments. Management bases itsestimates and judgments on historical experience and on various other factorsthat are believed to be reasonable under the circumstances, the results ofwhich form the basis for making judgments about the carrying value of assetsand liabilities that are not readily apparent from other sources. Actualresults may differ from these estimates under different assumptions orconditions.

 

***History of Recent Losses***

 

TheCompany experienced a net loss for the three months ended March 31, 2006 and2005 of $2.1 million and $1.4 million, respectively. The Company used cash inoperating activities for the three months ended March 31, 2006 and 2005 of$11.0 million and $11.5 million, respectively.The RV industry has been historicallycyclical and subject to downturns during periods of weak economic conditions.With the continued decline of RV industry wholesale shipments, rising interestrates, increased gas prices and continued economic uncertainty, the Companyexperienced continued net losses for the three months ended March 31, 2006.These conditions combined with recent historical losses led the Company toassess its short-term liquidity needs and plans to achieve profitability.

 

Management’sinitiatives to improve earnings and its working capital position by achievingoperational profitability include: (i) introducing new products and floor plansin 2006, (ii) adding new dealers to fill open market areas or replaceunder-performing dealers, (iii) decreasing overall sales incentives bytailoring programs that provide the maximum value to the Company, (iv) reducingmaterial and related obsolescence costs, (v) improving manufacturingefficiencies, (vi) further reducing manufacturing and other overhead costs, and(vii) decreasing the costs of warranty.

 

Inorder to fund on-going operations through at least March 31, 2007, the Companyremains dependent upon its ability to utilize outside financing throughborrowings on its line of credit until it achieves sustained operationalprofitability through a combination of increased sales, cost reductions andimproved product margins. After consideration of its available borrowingcapacity, the Company believes it has sufficient financial resources to fundits operations through at least March 31, 2007. However, the Company’s abilityto 

 

6

----

 

**Tableof Contents**

 

meetits obligations beyond March 2007 is dependent on its ability to generatepositive cash flows from operations and is dependent on continued borrowingsunder its line of credit. If management is unable to achieve its operationalprofitability plan or unforeseen events occur and its existing line of creditis insufficient to allow the Company to meet its obligations, the Company mayneed to implement alternative plans that could include long-term financingcollateralized by real estate (which is presently unencumbered) or additionaldebt financing, additional reductions in operating costs, deferral of capitalexpenditures, and further reductions in working capital. While the Companybelieves that it could successfully complete the alternative plans, ifnecessary, there can be no assurance that such alternatives would be availableon acceptable terms and conditions or that the Company would be successful inits implementation of such plans.

 

**NOTE 2 – INVENTORIES**

 

Inventories consist of the following (in thousands):

 
| ** **         | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------|------------|--------------------------|------------|-----------------------------|------------|
|               |       |                     |       |                        |       |
| Finished  goods    |       | $                        | 7,665      |                        | $          | 8,545 |   |
| Work-in-process    |       | 34,097                   |       | 30,870                      |       |
| Raw  materials     |       | 19,610                   |       | 19,289                      |       |
| Chassis            |       | 2,496                    |       | 3,236                       |       |
| Total  inventories |       | $                        | 63,868     |                        | $          | 61,940 |   |

 

Duringthe three months ended March 31, 2006, the Company recorded a write-down of$0.2 million related to stating inventory at the lower of cost or market. TheCompany did not incur a significant lower of cost or market adjustment for thethree months ended March 31, 2005.

 

**NOTE 3 – ACCRUED EXPENSES**

 

Accrued expenses consist of the following (in thousands):

 
| ** **                                         | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
|                                               |       |                     |       |                        |       |
| Current  accrued expenses:                         |       |                     |       |                        |       |
| Payroll and  other accrued expenses                |       | $                        | 8,600      |                        | $          | 8,679 |   |
| Accrued  sales incentives                          |       | 3,806                    |       | 4,129                       |       |
| Warranty  reserve                                  |       | 11,466                   |       | 11,705                      |       |
| Workers’  compensation self-insurance reserve |       | 1,956                    |       | 2,209                       |       |
| Total  current accrued expenses                    |       | $                        | 25,828     |                        | $          | 26,722 |   |
|                                               |       |                     |       |                        |       |
| Long-term  accrued expenses:                       |       |                     |       |                        |       |
| Warranty  reserve                                  |       | $                        | 144        |                        | $          | 130 |   |
| Workers’  compensation self-insurance reserve |       | 4,071                    |       | 4,280                       |       |
| Deferred  compensation                             |       | 661                      |       | 679                         |       |
| Total  long-term accrued expenses                  |       | $                        | 4,876      |                        | $          | 5,089 |   |

 

## **NOTE 4 – WARRANTY RESERVE**

 

The Company’s warrantyreserve, which is included in the consolidated financial statements under “Accruedexpenses” caption, is established based on its best estimate of the amountsnecessary to settle future and existing claims on products sold as of thebalance sheet date. The Company records an estimate for future warranty-relatedcosts based on recent actual warranty claims. Also, as part of the warrantyreserve the Company’s recall reserve is established, as necessary, based onmanagement’s estimate of the cost per unit to remedy a given problem and theestimated number of units that will ultimately be brought in for the repair.

 

The following table summarizes the activity related to the warrantyreserve for the three months ended March 31, 2006 and 2005, respectively (inthousands):

 

7

----

 

**Tableof Contents**

 
| ** **                                                             | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                             | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| Balance at January 1,                                                  |       | $                                           | 11,835     |   | $ | 8,505 |   |
| Accruals for current liabilities and  preexisting warranty adjustments |       | 4,170                                       |       | 4,480 |   |
| Payments in cash or in kind                                            |       | (4,395                                      | )          | (4,257 | ) |
| Balance at March 31,                                                   |       | $                                           | 11,610     |   | $ | 8,728 |   |

 

**NOTE 5 – CREDIT FACILITY**

 

At March 31, 2006, the Company had an asset-based revolving creditfacility with UPS Capital Corporation (“UPSC”) and Wells Fargo Bank for $30million, with the Company having the option, subject to certain conditions, ofincreasing the revolver in $5 million increments up to a total credit facilityof $40 million. The credit facility is collateralized by all of the Company’sassets other than real estate. Borrowing availability is based on eligibleaccounts receivable and inventory. The facility also includes a requirement tomaintain a blocked account arrangement, whereby remittances from the Company’scustomers reduce the debt outstanding. The credit facility contains, amongother provisions, certain financial covenants, including funded debt toEarnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) and afixed charge coverage ratio. If these financial covenants are not met, theCompany’s availability under the credit facility will be reduced. The Companydid not meet these financial covenants as of March 31, 2006, and currently doesnot expect to meet them until the fourth quarter of 2006. Until these covenantsare met, the Company’s borrowing availability under its $40 million facilitywill be limited to an amount between $24 million and $32 million, depending oneligible inventory and accounts receivable.

 

At March 31, 2006 and December 31, 2005, the Company had outstandingloans under the line of credit of $19.9 million and $12.1 million,respectively. Initial amounts borrowed under the revolving credit facility bearinterest at the prime rate listed in the Wall Street Journal plus 0.50percentage points and may be subsequently adjusted down based on a trailingtwelve month funded debt to EBITDA calculation. At March 31, 2006, the interestrate for the borrowings under the line of credit was 8.25%. The weightedaverage interest rate for the borrowing under the line of credit during thethree months ended March 31, 2006 and 2005 were 7.95% and 6.19%, respectively.

 

**NOTE 6 – COMMITMENTS AND CONTINGENCIES**

 

Litigation:

 

TheCompany is involved in legal proceedings in the ordinary course of business,including a variety of warranty, “lemon law,” product liability and othermiscellaneous litigation, all of which are typical in the recreation vehicleindustry. With respect to product liability claims, the Company’s insurancepolicies cover, in whole or in part, defense costs and liability costs forpersonal injury or property damage (excluding damage to Company motorhomes).While it is impossible to estimate with certainty the ultimate legal andfinancial liability with respect to this litigation, management is of theopinion that while the final resolution of any such litigation could have amaterial adverse effect on the Company’s financial position, results ofoperations or liquidity in a reporting period, an adequate reserve has beenestimated to account for such losses. However, actual results may significantlyvary from these estimates.

 

Recourse of Dealer Financing:

 

Mostof the Company’s motorhome sales are made on terms requiring payment within 15business days or less of the dealer’s receipt of the unit. Most dealers financeall, or substantially all, of the purchase price of their inventory under floorplan arrangements with banks or finance companies under which the lender paysthe Company directly. Dealers typically are not required to commence loanrepayments to such lenders for a period of at least six months. The loan iscollateralized by a lien on the motorhome. Consistent with industry practice,the Company has entered into repurchase agreements with these lenders. Ingeneral, the repurchase agreements require the Company to repurchase a unit ifthe dealer defaults on the financed unit. Upon a dealer default, the agreementsgenerally require the Company to repurchase RVs at the election of the lenderprovided certain conditions are met, such as repossession of the RV by thelender, the RV being new and unused and the time elapsed between invoice dateand demand for repurchase being no longer than a specified period which istypically 18 months or less. The Company’s maximum potential exposure underthese agreements approximated $176.1 million at March 31, 2006. The risk ofloss under the repurchase agreements is spread over a number of dealers andlenders and is reduced by the resale value of the RVs, which the Company wouldbe required to repurchase. Losses under these agreements have not been materialin the past and management does not believe that any future losses under suchagreements will have a material adverse effect on the Company’s consolidatedfinancial position, results of operations, or cash flows; consequently, noliability has been recognized in the consolidated financial statements.

 

8

----

 

**Table of Contents**

 

Other Commitments:

 

In August 2004, the Company entered into an agreement to acquire,for $3 million, approximately 73 acres of land adjacent to its CountryCoach, Inc. facility in Junction City, Oregon. The Company paid a deposit of$0.1 million. The closing of the purchase is subject to customary closingconditions and is expected to occur in May 2006.

 

**NOTE 7 – STOCK BASED COMPENSATION**

 

#### **Stock Option Plans**

#### ** **

#### **Asof March 31, 2006, the Company had three service-based fixed option plans (the “Plans”):the 1996 Stock Option Plan, the 1997 Stock Option Plan and the 1999 StockOption Plan. The Plans are further described below:**

#### ** **

##### ***1996 Stock Option Plan***

##### ** **

InOctober 1996, the Company’s Board of Directors adopted and approved the 1996Stock Option Plan (the “1996 Option Plan”). The 1996 Option Plan is designed toserve as an incentive for retaining qualified and competent directors,employees and consultants. The 1996 Option Plan provides for the award ofoptions to purchase up to 675,000 shares of Common Stock. The 1996 Option Planis administered by the Compensation Committee of the Board of Directors. TheCompensation Committee has, subject to the provisions of the 1996 Option Plan,full authority to select Company individuals eligible to participate in suchplan, including officers, directors (whether or not employees) and consultants.The 1996 Option Plan provides for the awarding of incentive stock options (asdefined in Section 422 of the IRS Code) and non-incentive stock options.Options granted pursuant to the 1996 Option Plan will have such vestingschedules and expiration dates as the Compensation Committee shall establish foreach participant in the 1996 Option Plan, which terms shall be reflected in anoption agreement executed in connection with the granting of the option. Duringthe three months ended March 31, 2006, 145,000 options were granted under the1996 Option Plan.

 

##### ***1997 Stock Option Plan***

##### ** **

InJune 1997, the Company’s Board of Directors adopted and approved the 1997 StockOption Plan (the “1997 Option Plan”). The 1997 Option Plan is designed to serveas an incentive for retaining qualified and competent directors, employees andconsultants. The 1997 Option Plan provides for the award of options to purchaseup to 900,000 shares of Common Stock. The 1997 Option Plan is administered bythe Board of Directors or, at its option, a committee of the Board ofDirectors. The Board (or a designated committee) has, subject to the provisionsof the 1997 Option Plan, full authority to select Company individuals eligibleto participate in such plan, including officers, directors (whether or notemployees) and consultants. The 1997 Option Plan provides for the awarding ofincentive stock options (as defined in Section 422 of the IRS Code) and non-incentivestock options. Options granted pursuant to the 1997 Option Plan will have suchvesting schedules and expiration dates as the Board (or a designated committee)shall establish for each participant in the 1997 Option Plan, which terms shallbe reflected in an option agreement executed in connection with the granting ofthe option. During the three months ended March 31, 2006, no options weregranted under the 1997 Option Plan.

 

##### ***1999 Stock Option Plan***

##### ** **

The Company’s Board of Directors adopted and approved the 1999 StockOption Plan in April 1999, which was amended and restated in April 2000 andagain in April 2001 (together, the “1999 Option Plan”). The 1999 Option Plan isdesigned to serve as an incentive for retaining qualified and competent directors,employees and consultants. The 1999 Option Plan provides for the award ofoptions to purchase up to 1,150,000 shares of Common Stock. The 1999 OptionPlan is administered by the Compensation Committee. The Compensation Committeehas, subject to the provisions of the 1999 Option Plan, full authority toselect Company individuals eligible to participate in such plan, includingofficers, directors (whether or not employees) and consultants. The 1999 OptionPlan provides for the awarding of incentive stock options (as defined inSection 422 of the IRS Code) and non-incentive stock options. Options grantedpursuant to the 1999 Option Plan will have such vesting schedules andexpiration dates as the Compensation Committee shall establish for eachparticipant in the 1999 Option Plan, which terms shall be reflected in anoption agreement executed in connection with the granting of the option. Duringthe three months ended March 31, 2006, no options were granted under the 1999Option Plan.

 

Options granted to non-employee directors generally vest immediatelyupon grant and generally expire five to ten years from the date of grant.Options granted to employees, including employee directors, generally vest inthree equal installments and expire five to ten years from the date of grant.The price of options granted pursuant to these plans will not be less than 100percent of the market value of the shares on the date of grant. 

 

9

----

 

**Tableof Contents**

 

**Adoption of Statement of Financial AccountingStandards No. 123(R) “Share-Based Payment”**

 

Effective January 1, 2006, the Company adopted Statement of FinancialAccounting Standards (“SFAS”) No. 123(R), “Share-Based Payment”, (“SFAS No.123(R)”) and all related financial statement guidance and interpretations usingthe modified prospective application transition method. The modifiedprospective method applies the expense recognition requirements of SFAS No.123(R) to new awards and to awards outstanding at the effective date andsubsequently modified or canceled and does not restate prior periods forcomparative purposes. Previously, the Company had accounted for employee stockbased compensation using the intrinsic value method as proscribed underAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees” (“APB No. 25”) and related interpretations and the fair valuemethod for stock option grants that do not meet the requirements for use of theintrinsic value method as proscribed by Statement of Financial Accounting StandardsNo. 123 “Accounting for Stock-Based Compensation (“SFAS No. 123”). Due to thedifference in the valuation methods between APB No. 25 and SFAS No. 123(R), theadoption of SFAS No. 123(R) had a significant impact on the Company’s financialposition, results of operations and cash flows. For the three months endedMarch 31, 2006, the Company recognized compensation expenses and additionalpaid-in-capital of $0.5 million related to the stock-based compensationarrangements.

 

On November 10, 2005, the FASB issued FASB Staff Position (“FSP”) FASNo. 123(R)-3 “Transition Election Related to Accounting for Tax Effects ofShare-Based Payment Awards” (“FSP FAS No. 123(R)-3”). The alternativetransition method includes simplified methods to establish the beginningbalance of the additional paid-in-capital pool (“APIC pool”) related to the taxeffects of employee share-based compensation, and to determine the subsequentimpact on the APIC pool and consolidated statements of cash flows of the taxeffects of employee share-based compensation awards that are outstanding uponadoption of SFAS No. 123(R). An entity may make a one-time election to adoptthe transition method described in this guidance and may take up to one yearfrom the later of its initial adoption of SFAS No. 123(R) or the effective dateof this guidance, which was November 11, 2005. The Company is in the process ofdetermining whether to adopt the alternative transition method provided in FSPFAS No. 123(R)-3 for calculating the tax effects of share-based compensationpursuant to SFAS No. 123(R).

 

The fair value of service-based stock option awards is estimated on thedate of grant using the Black-Scholes-Merton (“Black-Scholes”) option-pricingmodel. The Black-Scholes model contains certain significant assumptions inorder to estimate the fair value of a stock option at the date of grant. Theexpected term is based on analyses of historical exercise patterns in order todetermine the average time in which an option is held before being exercised.The risk free interest rate is based on the U.S. Treasury yield curve for aperiod consistent with the expected term of the option in effect at the time ofgrant. The expected volatility is based on the historical volatility of theCompany’s common stock over the expected term and considerations regardingexpected future volatility of the common stock. The expected dividend is basedon the historical dividend rate paid by the Company.

 

Assumptions used in the Black-Scholes model for stock option grantsduring the three months ended March 31, 2006 are as follows:

 
| ** **                  | ** ** | **Three Months  Ended  March 31, 2006** | ** ** |
|-----------------------------|------------|--------------------------------------------------------|------------|
| Expected term (in years)    |       | 5.0                                                    |       |
| Risk-free interest rate     |       | 4.69                                                   | %          |
| Expected volatility         |       | 45.0                                                   | %          |
| Weighted average volatility |       | 45.0                                                   | %          |
| Expected dividend yield     |       | 0.0                                                    | %          |

 

Share based compensation expense recognized in the consolidatedstatement of operations for the three months ended March 31, 2006 is based onthe awards ultimately expected to vest and therefore has been reduced forestimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated atthe time of grant and revised, if necessary, in subsequent periods if actualforfeitures differ from those estimates. Pre-vesting forfeitures were estimatedbased on historical employee termination rates, which were estimated to beapproximately 1% for both officers and directors and 10% for employees at March31, 2006. The estimated fair value, less the estimated forfeitures areamortized to compensation expense using the straight-line attribution method.In the pro forma information required under SFAS No. 123 for the periods priorto January 1, 2006, the Company accounted for pre-vesting forfeitures in thepro-forma disclosure, required by SFAS No. 123, as incurred.

 

A summary of option activity under the Plans for the three months endedMarch 31, 2006 is presented below:

 
| **Options**                    | ** ** | **Shares  (in  thousands)** | ** ** | **Weighted-  Average Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term (years)** | ** ** |
|--------------------------------|------------|-----------------------------|------------|---------------------------------------------|------------|-------------------------------------------------------------------|------------|
| Outstanding at January 1, 2006 |       | 1,080                       |       | $                                           | 9.94       |                                                              |       |   |
| Granted                        |       | 145                         |       | 6.09                                        |       |                                                              |       |
| Exercised                      |       | —                      |       | —                                      |       |                                                              |       |
| Forfeited                      |       | (6                          | )          | 12.50                                       |       |                                                              |       |
| Canceled                       |       | (3                          | )          | 12.50                                       |       |                                                              |       |
| Outstanding at March 31, 2006  |       | 1,216                       |       | $                                           | 9.46       |                                                              | 4.4        |   |
| Exercisable at March 31, 2006  |       | 982                         |       | $                                           | 9.97       |                                                              | 3.2        |   |

 

10

----

 

**Tableof Contents**

 

The weighted-average grant date fair value of options granted duringthe three months ended March 31, 2006 was $2.79. Because the Plans establishedthat the exercise price will not be less than 100 percent of the market valueof the shares on the date of grant, there are no compensation costs related tothe intrinsic value of share-based compensation.

 

A summary of the status of the Company’s non-vested shares for thethree months ended March 31, 2006 is presented below:

 
| **Options**                   | ** ** | **Shares  (in thousands)** | ** ** | **Weighted-Average  Grant Date Fair  Value** | ** ** |
|-------------------------------|------------|---------------------------------|------------|--------------------------------------------------------|------------|
| Non-vested at January 1, 2006 |       | 310                             |       | $                                                      | 3.17       |   |
| Granted                       |       | —                          |       | —                                                 |       |
| Vested                        |       | (70                             | )          | 3.47                                                   |       |
| Forfeited                     |       | (6                              | )          | 4.56                                                   |       |
| Non-vested at March 31, 2006  |       | 234                             |       | $                                                      | 3.05       |   |

 

As of March 31, 2006, there was $0.6 million of total unrecognizedcompensation cost related to nonvested share-based compensation arrangementsgranted under the Plans that is expected to be recognized over aweighted-average period of 1.6 years. The total fair value of shares vestedduring the three months ended March 31, 2006 was $0.5 million. Since theCompany had net operating loss carryforwards (before valuation) as of March 31,2006, no excess tax benefit for the tax deductions related to stock-basedcompensation was recognized for the three months ended March 31, 2006.Additionally, no incremental tax benefits were recognized from stock optionsexercised for the three months ended March 31, 2006, which would have resultedin a reclassification to reduce net cash provided by operating activities withan offsetting increase in net cash provided by financing activities.

 

**Pro-formaInformation Required Under SFAS No. 123 for Periods Prior to Fiscal 2006**

 

Prior to adopting theprovisions of SFAS No. 123(R), the Company recorded estimated compensationexpense for employee stock options under the intrinsic value method promulgatedby APB No. 25 and provided pro-forma disclosure of the fair value method in itsinterim and annual consolidated financial statements as required by SFAS No.148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (“SFASNo. 148”) and SFAS No. 123.

 

For the purposes ofpro-forma disclosures required under SFAS No. 123 and SFAS No. 148 for thethree months ended March 31, 2005, the estimated value of the stock optionswere assumed to be amortized to expense over the stock options’ vestingperiods. The pro-forma effects of recognizing the compensation expense underthe fair value method on net loss and loss per common share for the threemonths ended March 31, 2005 were as follows (all amounts in thousands, exceptper share amounts):

 
| ** **                                                                                                                            | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                                            | ** ** | **2005**                                         | ** ** |
|                                                                                                                                  |       |                                             |       |
| Net loss                                                                                                                              |       | $(1,444                                          | )          |
| Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | 194                                              |       |
| Pro forma  net loss                                                                                                                   |       | $(1,638                                          | )          |
|                                                                                                                                  |       |                                             |       |
| Basic loss per share                                                                                                                  |       | $(0.14                                           | )          |
| Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | 0.02                                             |       |
| Basic loss  per share pro forma                                                                                                       |       | $(0.16                                           | )          |
|                                                                                                                                  |       |                                             |       |
| Diluted loss per share                                                                                                                |       | $(0.14                                           | )          |
| Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | 0.02                                             |       |
| Diluted loss  per share pro forma                                                                                                     |       | $(0.16                                           | )          |

 

11

----

 

**Tableof Contents**

 

Because the Plans established that the exercise price will not be lessthan 100 percent of the market value of the shares on the date of grant, therewere no compensation costs related to the intrinsic value of stock options. TheCompany did not grant stock options during the three months ended March 31,2005.

 

**NOTE 8 – INCOME TAXES**

 

Statement of Financial Accounting Standards No. 109 “Accounting forIncome Taxes” (“SFAS No. 109”) requires that a valuation allowance beestablished when it is more likely than not that a company’s deferred taxassets will not be realized. In determining whether a valuation allowance isrequired, the Company must take into account all positive and negative evidencewith regard to the utilization of deferred tax assets. SFAS No. 109 furtherstates that it is difficult to conclude that a valuation allowance is notneeded when there is negative evidence such as cumulative losses in recentyears. For the three months ended March 31, 2006 and 2005, the Company recordedrespective non-cash charges of $0.9 million and $0.6 million to fully reserveagainst the net deferred tax assets realized during those periods. Allocatingthe valuation allowance on a pro rata basis, in accordance with SFAS No. 109,resulted in current net deferred tax assets and long-term net deferred taxliabilities of $1.0 million at March 31, 2006 and $1.3 million at December 31,2005.

 

**NOTE 9 – LOSS PER SHARE**

 

Basic loss per share is computed by dividing net loss by the weightedaverage number of common shares outstanding for the period. Diluted loss pershare reflects the potential dilution that could occur if options wereexercised or converted into common stock. Shares attributable to the exerciseof outstanding options that are anti-dilutive are excluded from the calculationof diluted loss per share.

 

For the three months ended March 31, 2006 and 2005, excluded from the computation of diluted earnings per share were stock options to purchase 1,216,496 and 1,079,804 shares, respectively.

 

**NOTE 10 –RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS**

 

InNovember 2004, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) No. 151, “InventoryCosts-an Amendment of ARB No. 43, Chapter 4” (“SFAS No. 151”). SFASNo. 151 amends ARB No. 43, Chapter 4, to clarify that abnormal amounts of idlefacility expense, freight, handling costs, and wasted materials (spoilage)should be recognized as current-period charges. In addition, SFAS No. 151requires that allocation of fixed production overhead to the costs ofconversion be based on the normal capacity of the production facilities. This standard was effective for inventorycosts incurred during fiscal years beginning after June 15, 2005. Thisstandard was applied prospectively. While the adoption of this standard did nothave a material impact on the consolidated financial position, resultsof operations or cash flows of the Company for the three months ended March 31,2006, the requirements of SFAS No. 151 could potentially have a significantfuture impact based on certain economic factors and management’s judgments andestimates about what constitutes abnormal costs and normal capacity in whichactual results could significantly differ from theses estimates.

 

InDecember 2004, the FASB issued SFAS No. 153, “Exchanges of NonmonetaryAssets” (“SFAS No. 153”), which eliminates the exception for nonmonetaryexchanges of similar productive assets and replaces it with a general exceptionfor exchanges of nonmonetary assets that do not have commercial substance. SFAS No.153 was effective for nonmonetary asset exchanges occurring in fiscal periodsbeginning after June 15, 2005. Adoption of SFAS No. 153 did notsignificantly affect the financial condition, results of operations or cashflows of the Company.

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004),”Share-BasedPayment” (“SFAS No. 123(R)”), which replaces SFAS No. 123, “Accountingfor Stock-Based Compensation,” (“SFAS No. 123”) and supersedes APB OpinionNo. 25, “Accounting for Stock Issued to Employees.” SFAS No. 123(R)requires all share-based payments to employees, including grants of employeestock options, to be recognized in the consolidated financial statements basedon their fair values beginning with the first annual period after June 15,2005, with early adoption encouraged. The pro forma disclosures previouslypermitted under SFAS No. 123 no longer will be an alternative to consolidatedfinancial statement recognition. The Company was required to adopt SFAS No.123(R) in the first calendar quarter of 2006, beginning January 1, 2006. UnderSFAS No. 123(R), the Company must determine the appropriate fair valuemodel to be used for valuing share-based payments, the amortization method forcompensation cost and the transition method to be used at date of adoption. Thetransition methods include modified prospective and modified retrospectiveadoption options. Under the modified retrospective option, prior periods may berestated either as of the beginning of the year of adoption or for all periodspresented. The modified prospective method requires that compensation expensebe recorded for all unvested stock options and restricted stock at thebeginning of the first quarter of adoption of SFAS No. 123(R), while themodified retrospective method would record compensation expense for allunvested stock options and restricted stock beginning with the first periodrestated. After evaluating the requirements of SFAS No. 123(R), theCompany determined to adopt SFAS No. 123(R) using the modified prospectivemethod and use the Black-Scholes model to value service stock option plans thatare currently in effect. The adoption of SFAS No. 123(R) and all of its interpretationshad a material effect on the consolidated financial position, results ofoperations and cash flows of the Company. Note 7 to the consolidated financialstatements discusses the effects of the implementation of SFAS No. 123(R) 

 

12

----

 

**Tableof Contents**

 

and its related interpretations.

 

In March 2005, the SEC released Staff Accounting Bulletin No. 107, “Share-BasedPayment” (“SAB No. 107”), which provides interpretive guidance related to theinteraction between SFAS No. 123(R) and certain SEC rules and regulations. Italso provides the SEC staff’s views regarding valuation of share-based paymentarrangements. In April 2005, the SEC amended the compliance dates for SFAS No.123(R), to allow companies to implement the standard at the beginning of theirnext fiscal year, instead of the next reporting period beginning after June 15,2005. The adoption of SFAS No. 123(R) and all of its interpretations had amaterial effect on the consolidated financial position, results of operationsand cash flows of the Company. Note 7 to the consolidated financial statementsdiscusses the effects of the implementation of SFAS No. 123(R) and its relatedinterpretations.

 

InMarch 2005, the FASB issued FASB Interpretation No. 47, “Accounting forConditional Asset Retirement Obligations”  (“FIN No. 47”). FIN 47 providesguidance relating to the identification of and financial reporting for legalobligations to perform an asset retirement activity. The Interpretationrequires recognition of a liability for the fair value of a conditional assetretirement obligation when incurred if the liability’s fair value can bereasonably estimated. FIN No. 47 also defines when an entity would havesufficient information to reasonably estimate the fair value of an assetretirement obligation. The provision was effective no later than the end offiscal years ending after December 15, 2005. The adoption of FIN No. 47 did nothave a material impact on the consolidated financial position, results ofoperations or cash flows of the Company.

 

InJune 2005, the Emerging Issues Task Force, or EITF, reached a consensus onIssue 05-6, “Determining the Amortization Period for Leasehold Improvements”(“EITF 05-6”), which requires that leasehold improvements acquired in abusiness combination or purchased subsequent to the inception of a lease beamortized over the lesser of the useful life of the assets or a term thatincludes renewals that are reasonably assured at the date of the businesscombination or purchase. EITF 05-6 was effective for periods beginning afterJuly 1, 2005. The provisions of this consensus did not have a material impacton the consolidated financial position, results of operations or cash flows ofthe Company.

 

InJune 2005, the FASB issued SFAS No. 154, “Accounting Changes andError Corrections—a replacement of APB No. 20 and SFAS No. 3” (“SFASNo. 154”). SFAS No. 154 provides guidance on the accounting for and reportingof accounting changes and error corrections. It establishes, unlessimpracticable, retrospective application as the required method for reporting achange in accounting principle in the absence of explicit transitionrequirements specific to the newly adopted accounting principles. SFAS No. 154also provides guidance for determining whether retrospective application of achange in accounting principle is impracticable and for reporting a change whenretrospective application is impracticable. The correction of an error inpreviously issued consolidated financial statements is not an accountingchange. However, the reporting of a correction of an error involves adjustmentsto previously issued consolidated financial statements similar to thosegenerally applicable to reporting an accounting change retrospectively.Therefore, the reporting of a correction of an error by restating previouslyissued consolidated financial statements is also addressed by SFAS No. 154.SFAS No. 154 was required to be adopted in fiscal years beginning afterDecember 15, 2005. The adoption of this standard did not have amaterial impact on the consolidated financial position, results of operationsor cash flows of the Company.

 

In August 2005, the FASB issued FASB Staff Position (“FSP”) FSP FAS No.123-1, “Classification and Measurement of Freestanding Financial InstrumentsOriginally Issued in Exchange for Employee Services under FASB Statement No.123(R).” In this FSP, the FASB decided to defer the requirements in SFAS No.123(R), that make a freestanding financial instrument subject to therecognition and measurement requirements of other accounting principlesgenerally accepted in the United States of America when the rights conveyed bythe instrument are no longer dependent on the holder being an employee. Theguidance in this FSP should be applied upon initial adoption of SFAS No. 123(R).The adoption of SFAS No. 123(R) and all of its interpretations had a materialeffect on the consolidated financial position, results of operations and cashflows of the Company. Note 7 to the consolidated financial statements discussesthe effects of the implementation of SFAS No. 123(R) and its relatedinterpretations.

 

In October 2005, the FASB issued FSP FAS No. 123(R)-2, “PracticalAccommodation to the Application of Grant Date As Defined in FASB Statement No.123(R)*.”* In this FSP, the FASB isproviding companies with a “practical accommodation” when determining the grantdate of an award that is subject to the accounting provisions in SFAS No.123(R)*.* Specifically, assuming acompany meets all of the other criteria in the definition of grant date in SFASNo. 123(R), a mutual understanding (between the company and the recipient) ofthe key terms and conditions of an award is presumed to exist at the date theaward is approved (in accordance with the company’s normal corporate governancepolicy) if (1) the award is a unilateral grant meaning that the recipient doesnot have the ability to negotiate the key terms and conditions of the award,and (2) the key terms and conditions of the award are expected to becommunicated to the recipient within a relatively short period of time (asdefined in the FSP) after the grant was approved. The guidance in this FSPshall be applied upon initial adoption of SFAS No. 123(R). The adoption of SFASNo. 123(R) and all of its interpretations had a material effect on theconsolidated financial position, results of operations and cash flows of theCompany. Note 7 to the consolidated financial statements discusses the effectsof the implementation of SFAS No. 123(R) and its related interpretations.

 

In November 2005, the FASB issued FSP FAS No. 123(R)-3, “TransitionElection Related to Accounting for the Tax Effects of 

 

13

----

 

**Tableof Contents**

 

Share-Based Payment Awards.” This FSP provides a practical exceptionwhen a company transitions to the accounting requirements in SFAS No. 123(R).SFAS No. 123(R) requires a company to calculate the pool of excess tax benefitsavailable to absorb tax deficiencies recognized subsequent to adopting SFAS No.123(R) (termed the “APIC Pool”), assuming the company had been following therecognition provisions prescribed by SFAS No. 123. The FASB learned thatseveral companies do not have the necessary historical information to calculatethe APIC pool as envisioned by SFAS No. 123(R) and accordingly, the FASBdecided to allow a practical exception as documented in this FSP. The guidancein this FSP was effective after the date the FSP was posted to the FASBwebsite. The adoption of SFAS No. 123(R) and all of its interpretations had amaterial effect on the consolidated financial position, results of operationsand cash flows of the Company. Note 7 to the consolidated financial statementsdiscusses the effects of the implementation of SFAS No. 123(R) and its relatedinterpretations.

 

In February 2006,the FASB issued FSP FAS No. 123(R)-4, “Classification of Options and SimilarInstruments Issued As Employee Compensation That Allow for Cash Settlement uponthe Occurrence of a Contingent Event.” The guidance in this FSP amends certainparagraphs in SFAS No. 123(R),**andaddresses situations when a company has option plans that require the companyto settle outstanding options in cash upon the occurrence of certain contingentevents. For example, some plans require a company to cash settle an option upona change in control of the company, or death or disability of the holder. ThisFSP amends SFAS No. 123(R) to address such situations and concludes that aprobability notion be applied. The guidance in this FSP was effective as acompany adopted SFAS No. 123(R). If a company had already adopted SFAS No.123(R), the FASB required retrospective application if a company applied thestandard inconsistent with the conclusions in this FSP. The guidance in thisFSP was applied upon initial adoption of SFAS No. 123(R). The adoption of SFASNo. 123(R) and all of its interpretations had a material effect on theconsolidated financial position, results of operations and cash flows of theCompany. Note 7 to the consolidated financial statements discusses the effectsof the implementation of SFAS No. 123(R) and its related interpretations.

 

14

----

 

**Table of Contents**

 

**NATIONALR.V. HOLDINGS, INC.**

**PART I, ITEM 2 - MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

** **

**Disclosure Regarding Forward Looking Statements**

 

*This report contains information that mayconstitute “forward-looking statements.” Generally, the words “believe,” “expect,”“intend,” “estimate,” “anticipate,” “project,” “will” and similar expressionsidentify forward-looking statements, which generally are not historical innature. All statements that address operating performance, events ordevelopments that the Company expects or anticipate will occur in thefuture—including statements relating to volume growth, share of sales andearnings per share growth, and statements expressing general optimism aboutfuture operating results—are forward-looking statements. As and when made,management believes that these forward-looking statements are reasonable.However, caution should be taken not to place undue reliance on any suchforward-looking statements because such statements speak only as of the datewhen made. The Company undertakes no obligation to publicly update or reviseany forward-looking statements, whether as a result of new information, futureevents or otherwise. In addition, forward-looking statements are subject to certainrisks and uncertainties that could cause actual results to differ materiallyfrom the Company’s historical experience and its present expectations orprojections. These risks and uncertainties include, but are not limited to,those described in this report, in Part II, “Item 1A. Risk Factors” andelsewhere in the Annual Report on Form 10-K for the year ended December 31,2005, and those described from time to time in future reports filed with theSecurities and Exchange Commission.*

 

**Executive Overview**

 

The following management’s discussion and analysis (“MD & A”) isintended to help the reader understand the results of operations of National RVHoldings, Inc. This MD & A is provided as a supplement to, and should beread in conjunction with, the Company’s consolidated financial statements andthe accompanying notes to the consolidated financial statements containedwithin this quarterly Form 10-Q filing.

 

National R.V. Holdings, Inc. (the “Company”) through its twowholly-owned subsidiaries National RV, Inc. (“NRV”) and Country Coach, Inc. (“CCI”),is one of the nation’s leading producers of motorized recreational vehicles,often referred to as RVs or motorhomes. From its Perris, California facility,NRV designs, manufactures, and markets Class A gas and diesel motorhomes underthe *Dolphin*, *Islander*, *SeaBreeze*, *Surfside*,*Tradewinds*and *Tropical* brand names. From its Junction City, Oregonfacility, CCI designs, manufactures and markets high-end (Highline) Class Adiesel motorhomes under the brand names *Affinity*,*Allure*, *Inspire*, *Intrigue*,*Magna* and bus conversions underthe *Country Coach Prevost*brand.

 

For the three monthsended March 31, 2006, the Company incurred a net loss of $2.1 million or $0.20per share as compared to a net loss of $1.4 million or $0.14 per share for thethree months ended March 31, 2005. Despite its losses, the Company increasedmarket share by 11.0% as reported by Statistical Surveys, Inc for the twomonths ended February 28, 2006 (the most recent period available) as comparedto 2005, even though the Class A motorhome industry experienced a 20.2% declinein wholesale shipments as reported by the Recreation Vehicle IndustryAssociation (“RVIA”) for the three months ended March 31, 2006 as compared to2005. While sales decreased by 10.1%, the Company was able to increase itsgross profit percentage through decreased sales incentives and better costcontainment. However, the Company incurred additional general andadministrative costs, primarily share-based compensation expense recognizedunder SFAS No. 123(R), which more than offset the increase in the gross profitpercentage.

 

Effective January 1,2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”)No. 123(R), “Share-Based Payment”, and all related financial statement guidanceand interpretations using the modified prospective application transitionmethod. The modified prospective method applies the expense recognitionrequirements of SFAS No. 123(R) to new awards and to awards outstanding at theeffective date and subsequently modified or canceled and does not restate priorperiods for comparative purposes. Previously, the Company had accounted foremployee stock-based compensation using the intrinsic value method asproscribed under Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees” (“APB No. 25”) and related interpretations andthe fair value method for stock option grants that do not meet the requirementsfor use of the intrinsic value method as proscribed by SFAS No. 123. Due to thedifference in the valuation methods between APB No. 25 and SFAS No. 123(R), theadoption of SFAS No. 123(R) had a significant impact on the Company’s financialposition, results of operations and cash flows. For the three months endedMarch 31, 2006, the Company recognized compensation expenses and additionalpaid-in-capital of $0.5 million related to the stock-based compensationarrangements. Because the Company’s stock option plans established that theexercise price will not be less than 100 percent of the market value of theshares on the date of grant, no compensation costs related to the intrinsicvalue of stock options were recognized in periods prior to January 1, 2006.

 

Share-based compensation expense recognized in the consolidated statementof operations for the three months ended March 31, 2006 is based on the awardsultimately expected to vest and therefore has been reduced for estimatedforfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the timeof grant and revised, if necessary, in subsequent periods if actual forfeituresdiffer from those 

 

15

----

 

**Tableof Contents**

 

estimates. Pre-vesting forfeitures were estimated based on historicalemployee termination rates, which were estimated to be approximately 1% forboth officers and directors and 10% for employees at March 31, 2006. Theestimated fair value, less the estimated forfeitures are amortized tocompensation expense using the straight-line attribution method. In the proforma information required under SFAS No. 123 for the periods prior to January1, 2006, the Company accounted for pre-vesting forfeitures in the pro-formadisclosure required by SFAS No. 123 as incurred.

 

As of March 31, 2006,there was $0.6 million of total unrecognized compensation cost related tononvested share-based compensation arrangements granted under the Plans that isexpected to be recognized over a weighted-average period of 1.6 years. Thetotal fair value of shares vested during the three months ended March 31, 2006was $0.5 million. Since the Company had net operating loss carryforwards(before valuation) as of March 31, 2006, no excess tax benefit for the taxdeductions related to stock-based compensation was recognized for the threemonths ended March 31, 2006. Additionally, no incremental tax benefits wererecognized from stock options exercised for the three months ended March 31,2006 which would have resulted in a reclassification to reduce net cashprovided by operating activities with an offsetting increase in net cashprovided by financing activities.

 

**LookingForward**

 

TheCompany continues to focus on growth and profitability. At CCI, the focus is onimproving margins through continued investment in manufacturing engineering,while continuing its aggressive product development to maintain its marketposition of building “The World’s Finest Motor Coaches.” At NRV the focusremains on growth and cost containment. In addition, the Company continues tofocus on increasing its dealer body in open markets.

 

TheCompany’s continuous re-design and introduction of new product offerings at NRVand CCI are aimed at continuing to increase in the Company’s market shareduring 2006. The introductions of additional new products are planned at bothdivisions later in the year. NRV is rolling out its new Pacifica dieselmotorhome in second quarter of 2006, while CCI will introduce its new Tributeand Rhapsody lines in the second half of the year.

 

Costcontainment remains a high priority, specifically in the manufacturing cost,warranty and workers’ compensation areas. The Company continues to focus onimproving the quality of its motorhomes. Also, the Company has instituted anumber of safety programs, which have resulted in measurably reduced workers’compensation costs. Both NRV and CCI have recently staffed full-timemanufacturing engineers to assist in driving efficiency gains.

 

TheCompany is continually striving to increase its customer support by improvingclub support, telephone support for owners and dealers, and parts fulfillment.The Company utilizes various techniques such as surveys and focus groups toensure that it is improving in the area of customer satisfaction. A continuedfocus on dealer acquisition and enhanced training programs, such asfactory-training programs provide the Company’s customers a basis forself-diagnostics and a better understanding of the equipment they areoperating.

 

TheRVIA’s market expansion campaign, GO RVing is fostering greater awareness andgarnering media attention. Though RVIA expects substantial growth for theindustry in the long-term or decade ahead, RVIA expects a continued decline inthe industry during 2006.

 

**Critical Accounting Policies**

 

Thepreparation of the consolidated financial statements and related disclosures inconformity with accounting principles generally accepted in the United Statesof America requires management to make judgments, assumptions and estimatesthat affect the amounts reported. See the discussion of critical accountingpolicies below and in the Annual Report on Form 10-K for the year endedDecember 31, 2005. Besides the adoption of SFAS No. 123(R), there were nounusual uncertainties of a material nature involved in the application of theseprinciples nor any unusual, material variation in estimates related to theseprinciples for the three months ended March 31, 2006.

 

**Stock-Based Compensation**

 

Effective January 1, 2006, the Company adopted Statement of FinancialAccounting Standards (“SFAS”) No. 123(R), “Share-Based Payment”, and allrelated financial statement guidance and interpretations using the modifiedprospective application transition method. Under the provisions of SFAS No.123(R), the fair value of the stock options are estimated using the BlackScholes option pricing model. The assumptions used in the Black-Scholes optionpricing model requires managements to make estimates about the term in whichthe option holder will exercise, the risk free interest rate, volatility of thestock, future dividend yield and pre-vesting forfeiture rates. These estimatesare based on historical experience and on various other judgments thatmanagement believes to be reasonable under the circumstances. Actual resultscould significantly differ from theses estimates, and the results of operationscould be materially impacted.

 

16

----

 

**Tableof Contents**

 

Effective January 1, 2006 the Company adopted Statement of FinancialAccounting Standards (“SFAS”) No. 151, “Inventory Costs-an Amendment ofARB No. 43, Chapter 4 (“SFAS No. 151”). SFAS No. 151 amends ARB No.43, Chapter 4, to clarify that abnormal amounts of idle facility expense,freight, handling costs, and wasted materials (spoilage) should be recognizedas current-period charges. In addition, SFAS No. 151 requires that allocationof fixed production overheads to the costs of conversion be based on the normalcapacity of the production facilities. Compliance with SFAS No. 151 requiressignificant judgments and estimates as to what constitutes abnormal amounts ofidle facility, freight, handling costs, and wasted materials (spoilage) as wellas the threshold of “normal capacity” of a production facility. Therequirements of SFAS No. 151 could potentially have a future impact on theCompany’s financial position, results of operations and cash flow of theCompany based on certain economic factors and management’s judgments andestimates about what constitutes abnormal costs and normal capacity in whichactual results could significantly differ from theses estimates.

 

**Results of Operations**

 

Comparison of the Results of Operations for the three months endedMarch 31, 2006 to the three months ended March 31, 2005:

 

(Amounts in tables are in thousands, except percentages)

 

**Net sales**

 
| ** **                | ** ** | **2006**   | ** ** | **Three Months Ended  March 31,  Percent Change** | ** ** | **2005**   | ** ** |
|---------------------------|------------|------------|------------|-----------------------------------------------------------------------|------------|------------|------------|
| ** **                | ** ** | ** ** | ** ** | ** **                                                            | ** ** | ** ** | ** ** |
| Net sales                 |       | $          | 112,895    |                                                                  | (10.1      | )%         | $          | 125,625 |   |
| as a percent of net sales |       | 100.0      | %          |                                                                  |       | 100.0      | %          |
|                           |            |            |            |                                                                       |            |            |            |  |  |

 

Net sales decreased $12.7million or 10.1% for the three months ended March 31, 2006 as compared to thethree months ended March 31, 2005. Wholesale unit shipments of dieselmotorhomes for the three months ended March 31, 2006 were 352, down 13.3%from 406 units for the three months ended March 31, 2005. Shipments of gasmotorhomes for the three months ended March 31, 2006 were 368, down 8.2%from 401 units for the three months ended March 31, 2005. The decrease innet sales is due to the overall decrease in wholesale shipments in the Class Amarket, which were down 20.2% for the three months ended March 31, 2006compared to 2005.

 

**Grossprofit margin**

 
| ** **          | ** ** | **2006**   | ** ** | **Three Months Ended  March 31,  Percent Change** | ** ** | **2005**   | ** ** |
|---------------------|------------|------------|------------|-----------------------------------------------------------------------|------------|------------|------------|
| ** **          | ** ** | ** ** | ** ** | ** **                                                            | ** ** | ** ** | ** ** |
| Gross profit        |       | $          | 5,327      |                                                                  | (5.1       | )%         | $          | 5,615 |   |
| Gross profit margin |       | 4.7        | %          |                                                                  |       | 4.5        | %          |
|                     |            |            |            |                                                                       |            |            |            |  |  |

 

The gross profit marginfor the three months ended March 31, 2006 was 4.7% compared to a 4.5% grossprofit margin for the three months ended March 31, 2005. The primary factorsthat led to the increase in gross margins were reduced sales incentives andimproved production efficiencies.

 

**Sellingexpenses**

 
| ** **                 | ** ** | **2006** | ** ** | **Three Months Ended  March 31,  Percent Change** | ** ** | **2005** | ** ** |
|----------------------------|------------|----------|------------|-----------------------------------------------------------------------|------------|----------|------------|
|                       |       |     |       |                                                                  |       |     |       |
| Selling  expenses          |       | $        | 3,254      |                                                                  | (10.6      | )%       | $          | 3,639 |   |
| as a percent  of net sales |       | 2.9      | %          |                                                                  |       | 2.9      | %          |
|                            |            |          |            |                                                                       |            |          |            |  |  |

 

Selling expensesdecreased $0.4 million or 10.6% for the three months ended March 31, 2006compared to the three months ended March 31, 2005. Selling expenses decreaseddue to decreased sales commissions, resulting from a decrease in sales, and areduction in dealer sales incentives, and the decrease was partially offset byincreased marketing costs.

 

17

----

 

**Table of Contents**

 

**Generaland administrative expenses**

 
| ** **                           | ** ** | **2006** | ** ** | **Three Months Ended  March 31,  Percent Change** | ** ** | **2005** | ** ** |
|--------------------------------------|------------|----------|------------|-----------------------------------------------------------------------|------------|----------|------------|
|                                 |       |     |       |                                                                  |       |     |       |
| General and  administrative expenses |       | $        | 3,745      |                                                                  | 15.2       | %        | $          | 3,252 |   |
| as a percent  of net sales           |       | 3.3      | %          |                                                                  |       | 2.6      | %          |
|                                      |            |          |            |                                                                       |            |          |            |  |  |

 

General andadministrative expenses totaling $3.7 million for the three months endedMarch 31, 2006 were up $0.5 million, or 15.2%, compared to the threemonths ended March 31, 2005. The increase is primarily due to the recognition,for the three months ended March 31, 2006, of share-based payments using themodified prospective application method of SFAS No. 123(R). Share-basedcompensation was not recognized for the three months ended March 31, 2005, buthas been included in the pro-forma information in the Note 7 to consolidatedfinancial statements for comparative purposes.

 

**Interestexpense**

 
| ** **                 | ** ** | **2006** | ** ** | **Three Months Ended  March 31,  Percent Change** | ** ** | **2005** | ** ** |
|----------------------------|------------|----------|------------|-----------------------------------------------------------------------|------------|----------|------------|
|                       |       |     |       |                                                                  |       |     |       |
| Interest  expense          |       | $        | 424        |                                                                  | 53.1       | %        | $          | 277 |   |
| as a percent  of net sales |       | 0.4      | %          |                                                                  |       | 0.2      | %          |
|                            |            |          |            |                                                                       |            |          |            |  |  |

 

Interest expense for thethree months ended March 31, 2006 and 2005 was $0.4 million and $0.3 million,respectively. The increase in interest expense is a result of increasedborrowing on the line of credit as well as rising interest rates directlyrelated to the increases in the prime interest rate by the Federal Reserve.

 

**Liquidity and Capital Resources**

 

The Company incurred net losses of $2.1 million and $1.4 million forthe three months ended March 31, 2006 and March 31, 2005, respectively.The Company used $11.0 million and $11.5 million in operating activities forthe three months ended March 31, 2006 and 2005, respectively. The RV industryhistorically has been cyclical and subject to down turns during periods of weakeconomic conditions. Swings in consumer confidence, rising interest rates,increased gas prices and continued economic uncertainty have led to an overalldecline in the RV industry; consequently, the Company experienced continuedlosses.

 

During the three months ended March 31, 2006, the Company financed itsoperations primarily through its existing working capital and line of creditwith UPSC and Wells Fargo Bank. At March 31, 2006, the Company had $0.01million in cash and cash equivalents (excluding restricted cash totaling $0.2million required to secure a letter of credit in connection with one of theCompany’s insurance policies.) The Company had net working capital of $24.0million and $26.1 million at March 31, 2006 and December 31, 2005,respectively. The decrease in working capital at March 31, 2006 compared to December31, 2005 was primarily due to an increase in the line of credit of $7.9 millionand an increase in book overdraft of $4.3 million, significantly offset by anincrease in receivables of $9.7 million.

 

During the three monthsended March 31, 2006, the Company used $11.0 million of cash in its operations,which was primarily due to a net loss of $2.1 million, increases in receivablesand inventories of $9.8 million and $2.0 million, respectively, and a decreasein accrued expenses of $1.1 million, partially offset by a $2.0 millionincrease in accounts payable. During the three months ended March 31, 2005, theCompany used $11.5 million of cash in its operations, which was primarily dueto a net loss of $1.4 million, $16.2 million and $8.2 million increases inreceivables and inventories, respectively, significantly offset by a $12.0million increase in accounts payable. For the three months ended March 31,2006, net cash used in investing activities was $1.1 million, which wasprimarily attributable to purchases of property, plant and equipment. During thethree months ended March 31, 2005, net cash used in investing activities was$0.5 million, consisting primarily of $1.3 million in capital expenditures,partially offset by repayments on the note receivable of $0.6 million. Net cashprovided by financing activities for the three months ended March 31, 2006 was$12.2 million, primarily due to net advances under the line of credit of $7.9million and an increase in the book overdraft of $4.3 million. Net cashprovided by financing activities for the three months ended March 31, 2005 was$12.0 million, primarily due to an increase in the book overdraft of $8.9million and net advances under the line of credit of $2.9 million.

 

At March 31, 2006, the Company had an asset-based revolving creditfacility with UPSC and Wells Fargo Bank for $30 million, with the Companyhaving the option, subject to certain conditions, of increasing the revolver in$5 million increments up to a total credit facility of $40 million. The creditfacility is collateralized by all of the Company’s assets other than realestate. Borrowing availability 

 

18

----

 

**Tableof Contents**

 

is based on eligible accounts receivable and inventory. The facilityalso includes a requirement to maintain a blocked account arrangement, wherebyremittances from the Company’s customers reduce the debt outstanding. Thecredit facility contains, among other provisions, certain financial covenants,including funded debt to Earnings Before Interest, Taxes, Depreciation andAmortization (“EBITDA”) and a fixed charge coverage ratio. If these financialcovenants are not met, the Company’s availability under the credit facilitywill be reduced. The Company did not meet these financial covenants as of March31, 2006, and currently does not expect to meet them until the fourth quarterof 2006. Until these covenants are met, the Company’s borrowing availabilityunder its $40 million facility will be limited to an amount between $24 millionand $32 million, depending on eligible inventory and accounts receivable.

 

At March 31, 2006 and December 31, 2005, the Company had outstandingloans under the line of credit of $19.9 million and $12.1 million,respectively. Initial amounts borrowed under the revolving credit facility bearinterest at the prime rate listed in the Wall Street Journal plus 0.50percentage points and may be subsequently adjusted down based on a trailingtwelve month funded debt to EBITDA calculation. At March 31, 2006, the interestrate for the borrowings under the line of credit was 8.25%. The weightedaverage interest rate for the borrowing under the line of credit during thethree months ended March 31, 2006 and 2005 were 7.95% and 6.19%, respectively.

 

Management’splan to achieve operational profitability includes continuing or starting avariety of initiatives to improve its earnings and working capital position,including: (i) introducing new products and floor plans in 2006, (ii) addingnew dealers to fill open market areas or replace under-performing dealers,(iii) decreasing overall sales incentives by tailoring programs that providethe maximum value to the Company, (iv) reducing material and relatedobsolescence costs, (v) improving manufacturing efficiencies, (vi) furtherreducing manufacturing and other overhead costs, and (vii) decreasing the costsof warranty.

 

Inorder to fund on-going operations through at least March 31, 2007, the Companyremains dependent upon its ability to utilize outside financing throughborrowings on its line of credit until it achieves sustained operationalprofitability through a combination of increased sales, cost reductions andimproved product margins. After consideration of the restrictions of theborrowing capacity noted above, the Company believes it has sufficientfinancial resources to fund its operations through at least March 31, 2007.However, the Company’s ability to meet its obligations beyond March 2007 isdependent on its ability to generate positive cash flows from operations and isdependent on continued borrowings under its line of credit. If management isunable to achieve its operational profitability plan or unforeseen events occurand its existing line of credit is insufficient to allow the Company to meetits obligations, the Company may need to implement alternative plans that couldinclude long-term financing collateralized by real estate (which is presentlyunencumbered) or additional debt financing, additional reductions in operatingcosts, deferral of capital expenditures, and further reductions in workingcapital. While the Company believes that it could successfully complete thealternative plans, if necessary, there can be no assurance that suchalternatives would be available on acceptable terms and conditions or that theCompany would be successful in its implementation of such plans.

 

Mostof the Company’s motorhome sales are made on terms requiring payment within 15business days or less of the dealer’s receipt of the unit. Most dealers financeall, or substantially all, of the purchase price of their inventory under floorplan arrangements with banks or finance companies under which the lender paysthe Company directly. Dealers typically are not required to commence loanrepayments to such lenders for a period of at least six months. The loan iscollateralized by a lien on the motorhome. Consistent with industry practice,the Company has entered into repurchase agreements with these lenders. Ingeneral, the repurchase agreements require the Company to repurchase a unit ifthe dealer defaults on the financed unit. Upon a dealer default, the agreementsgenerally require the Company to repurchase RVs at the election of the lenderprovided certain conditions are met, such as repossession of the RV by thelender, the RV being new and unused and the time elapsed between invoice dateand demand for repurchase being no longer than a specified period which istypically 18 months or less. The Company’s maximum potential exposure underthese agreements approximated $176.1 million at March 31, 2006. The risk ofloss under the repurchase agreements is spread over a number of dealers andlenders and is reduced by the resale value of the RVs, which the Company wouldbe required to repurchase. Losses under these agreements have not been materialin the past and management does not believe that any future losses under suchagreements will have a material adverse effect on the Company’s consolidatedfinancial position, results of operations, or cash flows; consequently, noliability has been recognized in the consolidated financial statements.

 

InAugust 2004, the Company entered into an agreement to acquire, for $3 million,approximately 73 acres of land adjacent to its Country Coach, Inc. facility inJunction City, Oregon. The Company paid a deposit of $0.1 million. The closingof the purchase is subject to customary closing conditions and is expected tooccur in May 2006. The Company believes the combination of internally generatedfunds and unused borrowing availability will be sufficient to meet thisobligation.

 

**Recent Accounting Pronouncements**

 

InNovember 2004, the FASB issued Statement of Financial Accounting Standards(“SFAS”) No. 151, “Inventory Costs-an Amendment of ARB No. 43,Chapter 4.” SFAS No. 151 amends ARB No. 43, Chapter 4, to clarify thatabnormal amounts of idle facility expense, freight, handling costs, and wastedmaterials (spoilage) should be recognized as current-period charges. Inaddition, SFAS No. 151 requires that allocation of fixed production overhead tothe costs of conversion be based on 

 

19

----

 

**Tableof Contents**

 

the normal capacity of the production facilities. This standard waseffective for inventory costs incurred during fiscal years beginning afterJune 15, 2005. This standard was applied prospectively. While the adoptionof this standard did not have a material impact on the consolidatedfinancial position, results of operations or cash flows of the Company for thethree months ended March 31, 2006, the requirements of SFAS No. 151 couldpotentially have a significant future impact based on certain economic factorsand management’s judgments and estimates about what constitutes abnormal costsand normal capacity in which actual results could significantly differ fromtheses estimates.

 

InDecember 2004, the FASB issued SFAS No. 153, “Exchanges of NonmonetaryAssets”, which eliminates the exception for nonmonetary exchanges of similar productiveassets and replaces it with a general exception for exchanges of nonmonetaryassets that do not have commercial substance. SFAS No. 153 was effectivefor nonmonetary asset exchanges occurring in fiscal periods beginning afterJune 15, 2005. Adoption of SFAS No. 153 did not significantly affectthe financial condition, results of operations or cash flows of the Company.

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004),”Share-BasedPayment” (“SFAS No. 123(R)”), which replaces SFAS No. 123, “Accountingfor Stock-Based Compensation,” (“SFAS No. 123”) and supersedes APB OpinionNo. 25, “Accounting for Stock Issued to Employees.” SFAS No. 123(R)requires all share-based payments to employees, including grants of employeestock options, to be recognized in the consolidated financial statements basedon their fair values beginning with the first annual period after June 15,2005, with early adoption encouraged. The pro forma disclosures previouslypermitted under SFAS No. 123 no longer will be an alternative to consolidatedfinancial statement recognition. The Company was required to adopt SFAS No.123(R) in the first calendar quarter of 2006, beginning January 1, 2006. UnderSFAS No. 123(R), the Company must determine the appropriate fair valuemodel to be used for valuing share-based payments, the amortization method forcompensation cost and the transition method to be used at date of adoption. Thetransition methods include modified prospective and modified retrospectiveadoption options. Under the modified retrospective option, prior periods may berestated either as of the beginning of the year of adoption or for all periodspresented. The modified prospective method requires that compensation expensebe recorded for all unvested stock options and restricted stock at thebeginning of the first quarter of adoption of SFAS No. 123(R), while themodified retrospective method would record compensation expense for allunvested stock options and restricted stock beginning with the first period restated.After evaluating the requirements of SFAS No. 123(R), the Companydetermined to adopt SFAS No. 123(R) using the modified prospective method anduse the Black-Scholes model to value service stock option plans that arecurrently in effect. The adoption of SFAS No. 123(R) and all of itsinterpretations had a material effect on the consolidated financial position,results of operations and cash flows of the Company. Note 7 to the consolidatedfinancial statements discusses the effects of the implementation of SFAS No.123(R) and its related interpretations.

 

In March 2005, the SEC released Staff Accounting Bulletin No. 107, “Share-BasedPayment” (“SAB No. 107”), which provides interpretive guidance related to theinteraction between SFAS No. 123(R) and certain SEC rules and regulations. Italso provides the SEC staff’s views regarding valuation of share-based paymentarrangements. In April 2005, the SEC amended the compliance dates for SFAS No.123(R), to allow companies to implement the standard at the beginning of theirnext fiscal year, instead of the next reporting period beginning after June 15,2005. The adoption of SFAS No. 123(R) and all of its interpretations had amaterial effect on the consolidated financial position, results of operationsand cash flows of the Company. Note 7 to the consolidated financial statementsdiscusses the effects of the implementation of SFAS No. 123(R) and its relatedinterpretations.

 

InMarch 2005, the FASB issued FASB Interpretation No. 47, “Accounting forConditional Asset Retirement Obligations”  (“FIN No. 47”). FIN 47 providesguidance relating to the identification of and financial reporting for legalobligations to perform an asset retirement activity. The Interpretationrequires recognition of a liability for the fair value of a conditional assetretirement obligation when incurred if the liability’s fair value can bereasonably estimated. FIN No. 47 also defines when an entity would havesufficient information to reasonably estimate the fair value of an asset retirementobligation. The provision was effective no later than the end of fiscal yearsending after December 15, 2005. The adoption of FIN No. 47 did not have amaterial impact on the consolidated financial position, results of operationsor cash flows of the Company.

 

InJune 2005, the Emerging Issues Task Force, or EITF, reached a consensus onIssue 05-6, “Determining the Amortization Period for Leasehold Improvements,”which requires that leasehold improvements acquired in a business combinationor purchased subsequent to the inception of a lease be amortized over thelesser of the useful life of the assets or a term that includes renewals thatare reasonably assured at the date of the business combination or purchase.EITF 05-6 is effective for periods beginning after July 1, 2005. The provisionsof this consensus did not have a material impact on the consolidated financialposition, results of operations or cash flows of the Company.

 

InJune 2005, the FASB issued SFAS No. 154, “Accounting Changes and ErrorCorrections—a replacement of APB No. 20 and SFAS No. 3” (“SFAS No.154”). SFAS No. 154 provides guidance on the accounting for and reporting ofaccounting changes and error corrections. It establishes, unless impracticable,retrospective application as the required method for reporting a change inaccounting principle in the absence of explicit transition requirementsspecific to the newly adopted accounting principles. SFAS No. 154 also providesguidance for determining whether retrospective application of a change inaccounting principle is impracticable and for 

 

20

----

 

**Tableof Contents**

 

reportinga change when retrospective application is impracticable. The correction of anerror in previously issued consolidated financial statements is not anaccounting change. However, the reporting of a correction of an error involvesadjustments to previously issued consolidated financial statements similar tothose generally applicable to reporting an accounting change retrospectively.Therefore, the reporting of a correction of an error by restating previouslyissued consolidated financial statements is also addressed by SFAS No. 154.SFAS No. 154 was required to be adopted in fiscal years beginning afterDecember 15, 2005. The adoption of this standard did not have amaterial impact on the consolidated financial position, results of operationsor cash flows of the Company.

 

In August 2005, the FASB issued FSP FAS No. 123-1, “Classification andMeasurement of Freestanding Financial Instruments Originally Issued in Exchangefor Employee Services under FASB Statement No. 123(R).” In this FSP, the FASBdecided to defer the requirements in SFAS No. 123(R), that make a freestandingfinancial instrument subject to the recognition and measurement requirements ofother accounting principles generally accepted in the United States of Americawhen the rights conveyed by the instrument are no longer dependent on theholder being an employee. The guidance in this FSP should be applied uponinitial adoption of SFAS No. 123(R). The adoption of SFAS No. 123(R) and all ofits interpretations had a material effect on the consolidated financialposition, results of operations and cash flows of the Company. Note 7 to theconsolidated financial statements discusses the effects of the implementationof SFAS No. 123(R) and its related interpretations.

 

In October 2005, the FASB issued FSP FAS No. 123(R)-2, “PracticalAccommodation to the Application of Grant Date As Defined in FASB Statement No.123(R)*.”* In this FSP, the FASB isproviding companies with a “practical accommodation” when determining the grantdate of an award that is subject to the accounting provisions in SFAS No.123(R), “Share-Based Payment”*.*Specifically, assuming a company meets all of the other criteria in thedefinition of grant date in SFAS No. 123(R), a mutual understanding (betweenthe company and the recipient) of the key terms and conditions of an award ispresumed to exist at the date the award is approved (in accordance with thecompany’s normal corporate governance policy) if (1) the award is a unilateralgrant meaning that the recipient does not have the ability to negotiate the keyterms and conditions of the award, and (2) the key terms and conditions of theaward are expected to be communicated to the recipient within a relativelyshort period of time (as defined in the FSP) after the grant was approved. Theguidance in this FSP shall be applied upon initial adoption of SFAS No. 123(R).The adoption of SFAS No. 123(R) and all of its interpretations had a materialeffect on the consolidated financial position, results of operations and cashflows of the Company. Note 7 to the consolidated financial statements discussesthe effects of the implementation of SFAS No. 123(R) and its relatedinterpretations.

 

In November 2005, the FASB issued FSP FAS No. 123(R)-3, “TransitionElection Related to Accounting for the Tax Effects of Share-Based PaymentAwards.” This FSP provides a practical exception when a company transitions tothe accounting requirements in SFAS No. 123(R). SFAS No. 123(R) requires acompany to calculate the pool of excess tax benefits available to absorb taxdeficiencies recognized subsequent to adopting SFAS No. 123(R) (termed the “APICPool”), assuming the company had been following the recognition provisionsprescribed by SFAS No. 123. The FASB learned that several companies do not havethe necessary historical information to calculate the APIC pool as envisionedby SFAS No. 123(R) and accordingly, the FASB decided to allow a practicalexception as documented in this FSP. The guidance in this FSP was effectiveafter the date the FSP was posted to the FASB website. The adoption of SFAS No.123(R) and all of its interpretations had a material effect on the consolidatedfinancial position, results of operations and cash flows of the Company. Note 7to the consolidated financial statements discusses the effects of theimplementation of SFAS No. 123(R) and its related interpretations.

 

In February 2006, the FASB issued FSP FAS No. 123(R)-4, “Classificationof Options and Similar Instruments Issued As Employee Compensation That Allowfor Cash Settlement upon the Occurrence of a Contingent Event.” The guidance inthis FSP amends certain paragraphs in SFAS No. 123(R)**and addresses situations when a company has option plansthat require the company to settle outstanding options in cash upon theoccurrence of certain contingent events. For example, some plans require acompany to cash settle an option upon a change in control of the company, ordeath or disability of the holder. This FSP amends SFAS No. 123(R) to addresssuch situations and concludes that a probability notion be applied. Theguidance in this FSP was effective as a company adopted SFAS No. 123(R). If acompany had already adopted SFAS No. 123(R), the FASB required retrospectiveapplication if a company applied the standard inconsistent with the conclusionsin this FSP. The guidance in this FSP was applied upon initial adoption of SFASNo. 123(R). The adoption of SFAS No. 123(R) and all of its interpretations hada material effect on the consolidated financial position, results of operationsand cash flows of the Company. Note 7 to the consolidated financial statementsdiscusses the effects of the implementation of SFAS No. 123(R) and its relatedinterpretations.

 

21

----

 

**Tableof Contents**

 

**NATIONALR.V. HOLDINGS, INC.PART I, ITEM 3 - Quantitative and Qualitative Disclosures about MarketRisk**

 

Market risk representsthe risk of loss that may impact the Company’s financial position, results ofoperations or cash flows due to adverse changes in market prices, includinginterest rate risk and other relevant market rate or price risks. The Companydoes not have any significant risks related to derivative financial instrumentsor foreign currency translation. However, the Company is exposed to interestrate changes related primarily to cash borrowings on the Company’s creditfacility. The weighted average interest rate for the borrowings on the creditfacility during the three months ended March 31, 2006 and 2005 were 7.95%and 6.19%, respectively. For every 0.25% increase in interest rates, theCompany would expect a quarterly increase in interest expense of approximately$0.6 thousand for each $1.0 million borrowed.

 

22

----

 

**Tableof Contents**

 

**NATIONAL R.V. HOLDINGS, INC.**

**PART I, ITEM 4 – CONTROLS AND PROCEDURES**

 

The Company maintainsdisclosure controls and procedures that are designed to ensure that informationrequired to be disclosed in the Company’s reports under the Securities ExchangeAct of 1934, as amended (the “Exchange Act”), is recorded, processed,summarized and reported within the time periods specified in the SEC’s rulesand forms, and that such information is accumulated and communicated tomanagement, including the Company’s Chief Executive Officer (“CEO”) and ChiefFinancial Officer (“CFO”), as appropriate, to allow timely decisions regardingrequired disclosure. In designing and evaluating the disclosure controls andprocedures, management recognized that any controls and procedures, no matterhow well designed and operated, can provide only reasonable assurance ofachieving the desired control objectives, as they are designed to do, andmanagement necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

 

In connection with the preparation of this Quarterly Report on Form10-Q, as of March 31, 2006, an evaluation was performed under the supervisionand with the participation of the Company’s management, including the CEO andCFO, of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures (as defined in Rule 13a-15(e) under theExchange Act). In light of the material weakness referenced below which theCompany first identified in connection with the assessment required by Section404 of the Sarbanes-Oxley Act of 2002 and disclosed in its Form 10-K for theyear ended December 31, 2005 and which continued to exist as of the end of theperiod covered by this report, the Company’s CEO and CFO concluded that, as ofthe end of the period covered by this report, the disclosure controls andprocedures were not effective at a reasonable assurance level as of March 31,2006.

 

A material weakness is a control deficiency, or a combination ofcontrol deficiencies that results in more than a remote likelihood that amaterial misstatement of the annual or interim consolidated financialstatements will not be prevented or detected. The Company identified the followingmaterial weakness in the Company’s internal control over financial reporting:

 

*Insufficient personnel resources, supervision and trainingwithin its accounting function -*The Company did not maintain effective controls over the financialreporting process at its CCI division and the related corporate oversightbecause of insufficient personnel resources, supervision and training withinthe accounting function. This material weakness resulted in the restatement ofthe consolidated financial statements to correct an error related to theamortization of leasehold improvements. In addition, this material weaknessresulted in audit adjustments to the 2005 annual consolidated financialstatements affecting inventory, accounts payable, accrued liabilities, accumulateddepreciation and amortization, and the related income statement accounts,primarily cost of goods sold, selling, general and administrative expenses.Additionally, this control deficiency could result in misstatements in theaforementioned accounts that would result in a material misstatement to theannual or interim consolidated financial statements that would not be preventedor detected.

 

#### **Remediation of the Material Weakness**

#### ** **

Duringthe 2006 fiscal year, management has taken a number of steps that it believeswill impact the effectiveness of internal control over financial reportingincluding the following:

 

**1.****              ****Insufficientpersonnel resources, supervision and training within its accounting function**

 

Managementhas assessed the supervision, training and corporate oversight within itsaccounting function. The Company has undertaken remedial actions that include strengthenedcontrols for the accounting close process, additional divisional staffing andthe implementation of procedures to improve the supervision of the divisionalaccounting staffs. Remedial actions also include additional procedures atcorporate to strengthen ongoing reviews of divisional accounting activitiesthrough the utilization of its corporate and internal audit staffs.

 

The Company believes that it will be able to improve its internalcontrol procedures and remedy the material weakness and additional controldeficiencies identified as part of its 2005 year-end assessment process.Notwithstanding the Company’s remediation efforts, because of the inherentlimitations in a cost-effective control system, misstatements due to error orfraud may occur and not be detected.

 

#### **Changes in Internal Control over Financial Reporting**

#### ** **

Except as disclosedabove, there have been no changes in the Company’s internal control overfinancial reporting for the three months ended March 31, 2006 that hasmaterially affected, or is reasonably likely to materially affect, the Company’sinternal control over financial reporting.

 

23

----

 

**Tableof Contents**

 

**NATIONAL R.V. HOLDINGS, INC.**

 

**PART II - OTHERINFORMATION**

** **

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

 

In addition to the other information set forth in this report, youshould carefully consider the factors discussed in Part I, “Item 1A. RiskFactors” in the Annual Report on Form 10-K for the year ended December 31,2005, which could materially affect the Company’s business, financial conditionor future results. The risks described in the Company’s Annual Report on Form10-K are not the only risks facing the Company. Additional risks anduncertainties not currently known to the Company or that the Company currentlydeems to be immaterial also may materially adversely affect the Company’sbusiness, financial condition and/or operating results. Other than with respectto the risk factor below, there have been no material changes from the riskfactors disclosed in the “Risk Factors” section of the Company’s Annual Reporton Form 10-K for the year ended December 31, 2005. The risk factor below wasdisclosed on the Form 10-K and has been updated in connection with this Form10-Q filing.

 

**For some of our components, we depend on asmall group of suppliers, and the loss or business interruption of any of thesesuppliers could affect our ability to obtain components at competitive prices,which would decrease our margins. Further, any defects in the third-partycomponents or raw materials we incorporate into our motorhomes could negativelyaffect our sales and financial results.**

 

Most recreation vehicle and bus components are readily available from avariety of sources. However, a few components are produced by only a smallgroup of quality suppliers that have the capacity to supply large quantities ona national basis. Our NRV subsidiary purchases gasoline-powered chassis fromFord Motor Company and Workhorse Custom Chassis and rear engine diesel-poweredchassis from Freightliner Custom Chassis Corporation and Spartan MotorCorporation. Our CCI subsidiary manufactures its own chassis, the DynoMax,which is used as the base upon which all CCI motorhomes are built, except forthe Country Coach Prevost bus conversions, which utilize a Prevost bus shell.We generally maintain a one to two month production supply of a chassis ininventory. Historically, in the event of an industry-wide restriction ofsupply, chassis manufacturers have allocated chassis among our competitors andus based on the volume of chassis previously purchased. If Ford Motor Company,Workhorse Custom Chassis, Freightliner Custom Chassis Corporation or SpartanMotor Corporation were to discontinue the manufacturing of motor home chassis,or if as a group all of our chassis suppliers significantly reduced theavailability of chassis to the industry, our business could be adverselyeffected. Similarly, shortages, production delays or work stoppages by theemployees of these chassis manufacturers or other chassis suppliers could havea material adverse effect on us. Finally, as is standard in the industry,arrangements with chassis suppliers are terminable at any time by either thechassis supplier or us. If we cannot obtain an adequate chassis supply, thiscould result in a material adverse affect on our financial condition and resultsof operations.

 

In addition to chassis, we incorporate a variety of components and rawmaterials from third parties into our recreational vehicles. Any defects inthese components or raw materials could cause us to incur significant expensein repairing, replacing or finding alternatives to the components or rawmaterials, could negatively impact the sales of affected motorhomes and couldcause a material adverse effect on our financial results and financialcondition. In this regard, in April 2006, we identified an issue relating to asupply of defective fiberglass affecting about 50 of our motorhomes in ourCalifornia work-in-process inventory. Although the supplier has acknowledgedthe defective product, we are not certain whether the supplier will voluntarilyreimburse us to the full extent of our costs in the absence of our seekinglegal recourse. Failure on the part of the supplier to indemnify us for ourcosts resulting from their defective product could negatively affect ourfinancial position, results of operations and cash flows for the second quarterof 2006.

 

**ITEM 6.****EXHIBITS**

 

Exhibits

 

31.1                                       Certificationof Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the ExchangeAct.

 

31.2                                       Certificationof Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the ExchangeAct.

 

32.1                                       Certificationpursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 ofthe Sarbanes-Oxley Act of 2002.

 

24

----

 

**Tableof Contents**

 

**SIGNATURE**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|              | **NATIONAL  R.V. HOLDINGS, INC.** |                       |
|-------------------|-----------------------------------|----------------------------|
|              | (Registrant)                      |                       |
|              |                              |                       |
| Date: May 4, 2006 | By                                | /s/ Thomas J. Martini |   |
|              |                              |                       |   |
|              | Thomas J. Martini                 |                       |
|              | Chief Financial Officer           |                       |
|              |  (Principal Accounting and   |                       |
|              | Financial  Officer)               |                       |

 

25

----