10-Q 1 form10q.htm FORM 10-Q FIRST QUARTER 2008 form10q.htm


 
UNITED STATES
SECURITIES & EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________

FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 29, 2008

OR

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

For the transition period from _________________ to ________________

Commission File Number 1-9792
 
Cavalier Logo

Cavalier Homes, Inc.
(Exact name of registrant as specified in its charter)

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

32 Wilson Boulevard 100, Addison, Alabama 35540
(Address of principal executive offices) (Zip Code)

(256) 747-9800
(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer ¨
Accelerated Filer ¨
Non-Accelerated Filer ¨
Smaller Reporting Company x

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

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

Class
 
Outstanding at April 23, 2008
Common Stock, $0.10 Par Value
 
18,429,580 Shares
 
 


 
 

 

CAVALIER HOMES, INC.
FORM 10-Q


 
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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands, except per share amounts)

   
Quarter Ended
 
   
March 29, 2008
   
March 31, 2007
 
Revenue
  $ 49,516     $ 42,902  
Cost of sales
    41,216       36,922  
Gross profit
    8,300       5,980  
Selling, general and administrative expenses
    8,277       9,815  
Operating income (loss)
    23       (3,835 )
Other income (expense):
               
Interest expense
    (124 )     (164 )
Other, net
    185       (28 )
      61       (192 )
Income (loss) before income taxes and equity in earnings of equity-method investees
    84       (4,027 )
Income tax provision
    11       22  
Equity in earnings of equity-method investees
    45       158  
Net income (loss)
  $ 118     $ (3,891 )
                 
Net income (loss) per share:
               
Basic
  $ 0.01     $ (0.21 )
Diluted
  $ 0.01     $ (0.21 )
                 
Weighted average shares outstanding:
               
Basic
    18,387       18,368  
Diluted
    18,406       18,368  

 
The accompanying notes are an integral part of these condensed consolidated financial statements.


CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)

   
March 29, 2008
(unaudited)
   
December 31, 2007
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 19,211     $ 22,043  
Accounts receivable, less allowance for losses of $132 (2008) and $106 (2007)
    11,278       6,208  
Current portion of notes and installment contracts receivable, including held for resale of $5,768 (2008) and $5,688 (2007)
    5,887       5,761  
Inventories
    19,527       20,537  
Other current assets
    2,932       3,681  
Total current assets
    58,835       58,230  
Property, plant and equipment, net
    27,351       27,824  
Installment contracts receivable, less allowance for credit losses of $716 (2008) and $725 (2007)
    931       3,264  
Other assets
    1,889       2,059  
Total assets
  $ 89,006     $ 91,377  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Current portion of long-term debt and capital lease obligation
  $ 856     $ 834  
Note payable under retail floor plan agreement
    522       510  
Accounts payable
    6,298       4,720  
Amounts payable under dealer incentives
    3,003       3,619  
Estimated warranties
    11,784       11,720  
Accrued insurance
    5,432       5,158  
Accrued compensation and related withholdings
    2,693       2,846  
Reserve for repurchase commitments
    1,159       1,131  
Progress billings
    --       3,546  
Other accrued expenses
    3,339       3,384  
Total current liabilities
    35,086       37,468  
Long-term debt and capital lease obligation, less current portion
    3,524       3,678  
Other long-term liabilities
    249       247  
Total liabilities
    38,859       41,393  
Commitments and contingencies (Note 8)
               
Stockholders’ equity:
               
Series A Junior Participating Preferred stock, $0.01 par value; 200,000 shares authorized, none issued
    --       --  
Preferred stock, $0.01 par value; 300,000 shares authorized, none issued
    --       --  
Common stock, $0.10 par value; 50,000,000 shares authorized; 19,412,880 shares issued
    1,941       1,941  
Additional paid-in capital
    59,133       59,126  
Deferred compensation
    (147 )     (185 )
Retained deficit
    (6,998 )     (7,116 )
Treasury stock, at cost; 983,300 shares
    (3,782 )     (3,782 )
Total stockholders’ equity
    50,147       49,984  
Total liabilities and stockholders’ equity
  $ 89,006     $ 91,377  

 
The accompanying notes are an integral part of these condensed consolidated financial statements.


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)

   
Year-to-Date Ended
 
   
March 29, 2008
   
March 31, 2007
 
Operating activities:
           
Net income (loss)
  $ 118     $ (3,891 )
Adjustments to reconcile net income (loss) to net cash used in operating activities:
               
Depreciation
    543       530  
Stock-based compensation
    45       75  
Provision for credit and accounts receivable losses
    171       20  
Loss on sale of property, plant and equipment
    --       57  
Other, net
    (45 )     (158 )
Installment contracts purchased for resale
    (8,923 )     (11,780 )
Sale of installment contracts purchased for resale
    8,911       10,859  
Principal collected on installment contracts purchased for resale
    11       15  
Changes in assets and liabilities:
               
Accounts receivable, net
    (8,640 )     (9,242 )
Inventories
    1,010       (6,023 )
Accounts payable
    1,578       3,100  
Amounts payable under dealer incentives
    (616 )     (647 )
Accrued compensation and related withholdings
    (153 )     440  
Other assets and liabilities
    860       (622 )
Net cash used in operating activities
    (5,130 )     (17,267 )
Investing activities:
               
Proceeds from dispositions of property, plant and equipment
    --       12  
Capital expenditures
    (41 )     (606 )
Notes and installment contracts purchased for investment
    (80 )     (35 )
Sale of installment contracts purchased for investment
    2,320       --  
Principal collected on notes and installment contracts purchased for investment
    25       230  
Other investing activities
    223       332  
Net cash provided by (used in) investing activities
    2,447       (67 )
Financing activities:
               
Net borrowings on note payable under retail floor plan agreement
    12       690  
Payments on long-term debt and capital lease obligation
    (161 )     (335 )
Net cash provided by (used in) financing activities
    (149 )     355  
Net decrease in cash and cash equivalents
    (2,832 )     (16,979 )
Cash and cash equivalents at beginning of period
    22,043       25,967  
Cash and cash equivalents at end of period
  $ 19,211     $ 8,988  
                 
Supplemental disclosures:
               
Cash paid for (received from):
               
Interest
  $ 63     $ 174  
Income taxes
  $ (16 )   $ (206 )
Non-cash investing and financing activities:
               
Property, plant and equipment acquired through capital lease transaction
  $ 29     $ --  
Retail assets sold for assumption of note payable, net of note receivable of $447
  $ --     $ 1,793  

 
The accompanying notes are an integral part of these condensed consolidated financial statements.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited – dollars in thousands except per share amounts)

1.
BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

The condensed consolidated balance sheet as of December 31, 2007, which has been derived from audited financial statements, and the unaudited interim condensed consolidated financial statements have been prepared in compliance with standards for interim financial reporting and Form 10-Q instructions and thus do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, these statements contain all adjustments necessary to present fairly our financial position as of March 29, 2008, and the results of operations for the quarters ended March 29, 2008 and March 31, 2007, and the results of our cash flows for the year-to-date periods ended March 29, 2008 and March 31, 2007. All such adjustments are of a normal, recurring nature.

The results of operations for the quarter ended March 29, 2008 are not necessarily indicative of the results to be expected for the full year. The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis and financial statements and notes thereto included in our 2007 Annual Report on Form 10-K.

For a description of our significant accounting policies used in the preparation of our consolidated financial statements, see Note 1 of Notes to Consolidated Financial Statements in our 2007 Annual Report on Form 10-K.

We report two net income (loss) per share numbers, basic and diluted, which are computed by dividing net income (loss) by the weighted average shares outstanding (basic) or weighted average shares outstanding assuming dilution (diluted), as detailed below (shares shown in thousands):

   
Quarter Ended
 
   
March 29, 2008
   
March 31, 2007
 
Net income (loss)
  $ 118     $ (3,891 )
Weighted average shares outstanding:
               
Basic
    18,387       18,368  
Effect of potential common stock from the exercise of stock options
    19       --  
Diluted
    18,406       18,368  
Net income (loss) per share:
               
Basic
  $ 0.01     $ (0.21 )
Diluted
  $ 0.01     $ (0.21 )
Weighted average option shares excluded from computation of diluted loss per share because their effect is anti-dilutive
    634       1,007  

Restricted common stock outstanding issued to employees as of March 29, 2008 totaling 23,332 shares has been excluded from the computation of basic earnings (loss) per share since the shares are not vested and remain subject to forfeiture.

2.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS No. 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157. This FSP permits the delayed application of SFAS No. 157 for all non-recurring fair value measurements of non-financial assets and non-financial liabilities until fiscal years beginning after November 15, 2008. We adopted SFAS No. 157 in the first quarter of 2008 for all financial assets and financial liabilities with no material impact on our consolidated statements of operations or financial condition. For disclosure purposes, we estimated the fair value of our installment contracts receivable at $6,838 using Level 3 inputs as defined in SFAS No. 157. In general, these inputs were based on the actual sales prices we received from the sale of comparable installment contracts and the underlying collateral value on certain loans based on appraisals, when available, or industry price guides for used manufactured housing.


In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 allows companies to elect to follow fair value accounting for certain financial assets and liabilities in an effort to mitigate volatility in earnings without having to apply complex hedge accounting provisions. SFAS No. 159 is applicable only to certain financial instruments and is effective for fiscal years beginning after November 15, 2007. We elected to not adopt the provisions of SFAS No. 159.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51. SFAS No. 160 amends ARB No. 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It also amends certain of ARB No. 51’s consolidation procedures for consistency with the requirements of SFAS No. 141(R). This statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The statement shall be applied prospectively as of the beginning of the fiscal year in which the statement is initially adopted. We have not yet completed our assessment of the impact, if any, SFAS No. 160 will have on our financial condition, results of operations or cash flows.

3.
INVENTORIES

Inventories are stated at the lower of cost (first-in, first-out method) or market. Work-in-process and finished goods inventories include an allocation for labor and overhead costs. Inventories at March 29, 2008 and December 31, 2007 were as follows:

   
March 29, 2008
   
December 31, 2007
 
Raw materials
  $ 11,582     $ 11,967  
Work-in-process
    1,117       1,263  
Finished goods
    6,828       7,307  
Total inventories
  $ 19,527     $ 20,537  

4.
LONG-LIVED ASSETS

SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, provides that a long-lived asset or asset group that is to be sold shall be classified as “held for sale” if certain criteria are met, including the expectation supported by evidence that the sale will be completed within one year. We had idle assets of $6,555 and $6,873 at March 29, 2008 and December 31, 2007, respectively, recorded at the lower of carrying value or fair value. Idle assets are comprised primarily of closed home manufacturing facilities, which we are attempting to sell. Management does not have evidence at the balance sheet date that it is probable that the sale of these assets will occur within one year, and thus, in accordance with the requirements of SFAS No. 144, such assets are classified as “held and used” and depreciation has continued on these assets.

5.
INCOME TAXES

Since December 31, 2006, we have maintained a valuation allowance to fully reserve our deferred tax assets due to a number of factors, including among others, operating losses and uncertainty of future operating results. We did not record a federal income tax benefit in the quarters ended March 29, 2008 and March 31, 2007 because management believes it is not appropriate to record income tax benefits in excess of anticipated refunds and certain carryforward items under the provisions of SFAS No. 109, Accounting for Income Taxes. The income tax provision of $11 in the quarter ended March 29, 2008 includes $9 for state income taxes payable for certain subsidiaries and $2 of interest related to uncertain tax positions. The income tax provision of $22 in the quarter ended March 31, 2007 includes $19 for state income taxes payable for certain subsidiaries and $3 of interest related to uncertain tax positions. As of March 29, 2008, our valuation allowance against deferred tax assets totaled approximately $17,600. The valuation allowance may be reversed to income in future periods to the extent that the related deferred income tax assets are realized or the valuation allowance is otherwise no longer needed.

We recognize potential accrued interest and penalties related to uncertain tax positions in income tax expense. To the extent interest and penalties are not assessed in the future with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision.

We file consolidated and separate income tax returns in the U.S. federal jurisdiction and in various state jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state or local income tax examinations by tax authorities in our major tax jurisdictions for years before 2003.


6.
ESTIMATED WARRANTIES

We provide retail home buyers a one-year limited warranty covering defects in material or workmanship in home structure, plumbing and electrical systems. A two-year limited warranty was provided for homes we shipped under the contract with the Mississippi Emergency Management Agency. We have provided a liability of $11,784 and $11,720 at March 29, 2008 and December 31, 2007, respectively, for estimated future warranty costs relating to homes sold, based upon management’s assessment of historical experience factors and current industry trends. Activity in the liability for estimated warranties was as follows:

   
Quarter Ended
 
   
March 29, 2008
   
March 31, 2007
 
Balance, beginning of period
  $ 11,720     $ 11,900  
Provision for warranties issued in the current period
    3,128       2,650  
Adjustments for warranties issued in prior periods
    69       490  
Payments
    (3,133 )     (3,390 )
Balance, end of period
  $ 11,784     $ 11,650  

We evaluate actual warranty costs on a quarterly basis in conjunction with the review of our liability for estimated warranties. Based on these evaluations, we recorded changes in the accounting estimates in the quarters ended March 28, 2008 and March 31, 2007 totaling $69 and $490, respectively, which increased the warranty provision.

7.
CREDIT ARRANGEMENTS

We have a credit agreement with our primary lender (the “Credit Facility”), which has been amended from time to time with a current maturity date of April 2009. The Credit Facility is comprised of (i) a revolving line of credit that provides for borrowings (including letters of credit) up to $17,500 and (ii) a real estate term loan with an initial term of 14 years, which are cross-secured and cross-defaulted. No amounts were outstanding under the revolving line of credit as of March 29, 2008 or December 31, 2007.

The amount available under the revolving line of credit is equal to the lesser of (i) $17,500 or (ii) an amount based on defined percentages of accounts and notes receivable and inventories reduced by the sum of $2,500 and any outstanding letters of credits. At March 29, 2008, $10,469 was available under the revolving line of credit after deducting letters of credit of $4,653.

The applicable interest rates under the revolving line of credit are based on certain levels of tangible net worth as noted in the following table.

Tangible Net Worth
 
Interest Rate
above $62,000
 
Prime less 0.50%
$62,000 $56,500
 
Prime
$56,500 $38,000
 
Prime plus 0.75%
below $38,000
 
Prime plus 1.25%

The bank’s prime rate was 5.25% and 7.25% at March 29, 2008 and December 31, 2007, respectively.

The real estate term loan agreement contained in the Credit Facility provided for initial borrowings of $10,000, of which $2,684 and $2,737 was outstanding on March 29, 2008 and December 31, 2007, respectively. Interest on the term note is fixed for a period of five years from issuance (September 2003) at 6.5% and may be adjusted at 5 and 10 years. Amounts outstanding under the real estate term loan are collateralized by certain plant facilities and equipment.

The Credit Facility contains certain restrictive and financial covenants which, among other things, limit our ability without the lender’s consent to (i) make dividend payments and purchases of treasury stock in an aggregate amount which exceeds 50% of consolidated net income for the two most recent years, (ii) mortgage or pledge assets which exceed in the aggregate $1,000, (iii) incur additional indebtedness, including lease obligations, which exceed in the aggregate $1,000, excluding floor plan notes payable which cannot exceed $3,000 and (iv) make annual capital expenditures of $5,000. In addition, the Credit Facility contains certain financial covenants requiring us (i) to maintain on a consolidated basis certain defined levels of liabilities to tangible net worth ratio (not to exceed 1.5 to 1), (ii) to maintain a current ratio, as defined, of at least 1.1 to 1,


(iii) maintain minimum cash and cash equivalents of $5,000, (iv) achieve an annual cash flow to debt service ratio of not less than 1.35 to 1 for the year ending December 31, 2008, and (v) achieve an annual minimum profitability of $100. The Credit Facility also requires CIS to comply with certain specified restrictions and financial covenants. At March 29, 2008, we were in compliance with our debt covenants.

We have amounts outstanding under Industrial Development Revenue Bond issues (“Bonds”) which totaled $1,670 and $1,775 at March 29, 2008 and December 31, 2007, respectively. One bond issue bearing interest at variable rates ranging from 5.15% to 5.25% will mature at various dates through April 2009; and a second bond issue is payable in annual installments through 2013 with interest payable monthly at a variable rate currently at 2.41% as determined by a remarketing agent. The real estate term loan and the Bonds are collateralized by substantially all of our plant facilities and equipment.

We had $522 and $510 of notes payable under a retail floor plan agreement at March 29, 2008 and December 31, 2007, respectively. The notes are collateralized by certain retail new home inventories and bear interest rates ranging from prime to prime plus 2.5% but not less than 6% based on the age of the home.

We entered into a capital lease transaction during the first quarter of 2008 related to machinery and equipment we acquired with an initial cost of $29. At March 29, 2008, $26 was outstanding under the capital lease obligation.

At March 29, 2008 and December 31, 2007, the estimated fair value of outstanding borrowings other than notes payable under a retail floor plan agreement was $4,436 and $4,551, respectively. These estimates were determined using rates we believe we could have obtained on similar borrowings at such times.

8.
COMMITMENTS AND CONTINGENCIES

We are contingently liable under terms of repurchase agreements with financial institutions providing inventory financing for retailers of our products. These arrangements, which are customary in the industry, provide for the repurchase of products sold to retailers in the event of default by the retailer. The risk of loss under these agreements is spread over numerous retailers. The price we are obligated to pay generally declines over the period of the agreement (generally 9 – 24 months) and the risk of loss is further reduced by the sales value of repurchased homes. We applied FASB Interpretation (“FIN”) No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57, and 107 and a rescission of FASB Interpretation No. 34 and SFAS No. 5, Accounting for Contingencies to account for our liability for repurchase commitments. Under the provisions of FIN 45, during the period in which a home is sold (inception of a repurchase commitment), we record the greater of the estimated fair value of the non-contingent obligation or a contingent liability under the provisions of SFAS No. 5, based on historical information available at the time, as a reduction to revenue. Additionally, subsequent to the inception of the repurchase commitment, we evaluate the likelihood that we will be called on to perform under the inventory repurchase commitments. If it becomes probable that a dealer will default and a SFAS No. 5 loss reserve should be recorded, then such contingent liability is recorded equal to the estimated loss on repurchase. Based on identified changes in dealers’ financial conditions, we evaluate the probability of default for the group of dealers who are identified at an elevated risk of default and apply a probability of default to the group based on historical default rates. Changes in the reserve are recorded as an adjustment to revenue. Following the inception of the commitment, the recorded reserve is reduced over the repurchase period and is eliminated once the dealer sells the home. Under the repurchase agreements, we were contingently liable at March 29, 2008, to financial institutions providing inventory financing for retailers of our products up to a maximum of approximately $61,000 in the event we must perform under the repurchase commitments. We recorded an estimated liability of $1,159 at March 29, 2008 and $1,131 at December 31, 2007 related to these commitments. Activity in the reserve for repurchase commitments was as follows:

   
Quarter Ended
 
   
March 29, 2008
   
March 31, 2007
 
Balance, beginning of period
  $ 1,131     $ 1,513  
Reduction for payments made on inventory purchases
    --       (86 )
Recoveries for inventory repurchases
    4       18  
Accrual for guarantees issued during the period
    308       296  
Reduction to pre-existing guarantees due to declining obligations or expired guarantees
    (317 )     (477 )
Changes to the accrual for pre-existing guarantees for those dealers deemed to be probable of default
    33       (65 )
Balance, end of period
  $ 1,159     $ 1,199  



In conjunction with the quarterly review of our critical accounting estimates, we evaluate our historical loss factors applied to the reserve for repurchase commitments, including changes in dealers’ circumstances and industry conditions, for those dealers deemed to be probable of default.

Our workers’ compensation, product liability and general liability insurance is provided by fully-insured, large deductible policies. The current deductibles under these programs are $250 for workers’ compensation and $100 for product liability and general liability. Under these plans, we incur insurance expense based upon various rates applied to current payroll costs and sales. Refunds or additional premiums are estimated and recorded when sufficiently reliable data is available. We recorded an estimated liability of $4,158 at March 29, 2008 and $4,274 at December 31, 2007 related to these contingent claims.

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

We provided letters of credit totaling $4,653 as of March 29, 2008. These letters of credit are to providers of surety bonds ($2,607) and insurance policies ($2,046). While the current letters of credit have a finite life, they are subject to renewal at different amounts based on the requirements of the insurance carriers. We recorded insurance expense based on anticipated losses related to these policies.

9.
SEGMENT INFORMATION

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

   
Quarter Ended
 
   
March 29, 2008
   
March 31, 2007
 
Revenue from external customers:
           
Home manufacturing
  $ 48,681     $ 42,045  
Financial services
    835       857  
Revenue from external customers
  $ 49,516     $ 42,902  
                 
Operating income (loss):
               
Home manufacturing
  $ 904     $ (2,983 )
Financial services
    107       217  
Segment operating income (loss)
    1,011       (2,766 )
General corporate
    (988 )     (1,069 )
Operating income (loss)
  $ 23     $ (3,835 )
                 


10



   
March 29, 2008
   
December 31, 2007
 
Identifiable assets:
           
Home manufacturing
  $ 67,563     $ 62,809  
Financial services
    14,555       14,587  
Segment assets
    82,118       77,396  
General corporate
    6,888       13,981  
Total assets
  $ 89,006     $ 91,377  

10.
EQUITY-METHOD INVESTEES

We recorded equity in earnings of equity-method investees of $45 and $158 for the quarters ended March 29, 2008 and March 31, 2007, respectively. As we disclosed in our 2007 consolidated financial statements, we sold our ownership interest in one partnership to a joint venture partner and we acquired that partner’s interest in another of our joint ventures, which resulted in only one remaining active equity-method investee. In 2007, none of our equity-method investees were defined as significant. Summarized information related to the equity-method investees is shown below.

   
Quarter Ended
 
   
March 29, 2008
   
March 31, 2007
 
Net sales
  $ 4,670     $ 13,744  
Gross profit
    1,147       2,612  
Income from continuing operations
    196       679  
Net income
    196       679  

11.           STOCK-BASED COMPENSATION

Stock Incentive Plans

At March 29, 2008, our stock incentive plans included the following:

a.
The 2005 Incentive Compensation Plan (the “2005 Plan”) provides for both incentive stock options and non-qualified stock options to key employees. The 2005 Plan also provides for stock appreciation rights and awards of both restricted stock and performance shares. Awards are granted at prices and terms determined by the compensation committee of the Board of Directors. The term for awards granted under the 2005 Plan cannot exceed ten years from the date of grant. Upon adoption of the 2005 Plan, our 1996 Key Employee Stock Incentive Plan (the “1996 Plan”) was terminated. However, the termination of the 1996 Plan did not affect any options which were outstanding and unexercised under that Plan. A total of 1,500,000 shares of common stock are authorized for issuance under the 2005 Plan. As of March 29, 2008, shares authorized for grant and available to be granted under the 2005 Plan totaled 1,430,000 shares.

b.
The 2005 Non-Employee Directors Stock Option Plan (the “2005 Directors Plan”) provides for the issuance of up to 500,000 shares of our common stock, which is reserved for grant to non-employee directors. Options are granted upon the director’s initial election and automatically on an annual basis thereafter at fair market value on the date of such grant. Stock option grants become exercisable at a rate of 1/12th of the shares subject to the stock option on each monthly anniversary of the date of grant. Except in the case of death, disability, or retirement, options granted under the 2005 Directors Plan expire ten years from the date of grant. We had a 1993 Non-employee Director Plan, (the “1993 Plan”), that was terminated upon adoption of the 2005 Directors Plan. However, the termination of the 1993 Plan did not affect any options which were outstanding and unexercised under that Plan. As of March 29, 2008, shares available to be granted under the 2005 Directors Plan totaled 410,000 shares.

The following table sets forth the summary of activity under our stock incentive plans for the quarter ended March 29, 2008:

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Options Outstanding
 
   
Shares Available for Grant
   
Number of Shares
   
Weighted Average Exercise Price
 
Balance at December 31, 2007
    1,870,000       830,598     $ 6.81  
Granted
    (30,000 )     30,000       1.93  
Expired
    --       (303,350 )     10.18  
Balance at March 29, 2008
    1,840,000       557,248     $ 4.72  
                         
Options exercisable at March 29, 2008
            532,246     $ 4.85  

The weighted average fair values of options granted during the quarters ended March 29, 2008 and March 31, 2007 were $0.94 and $2.29, respectively. No options were exercised during the quarters ended March 29, 2008 and March 31, 2007. The aggregate intrinsic value of options outstanding and options exercisable as of March 29, 2008 was zero.

Stock-based Compensation

We use the Black-Scholes option pricing model to determine the fair value of stock option shares granted. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as other assumptions, including our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends. We estimate the expected term of options granted by calculating the average term from our historical stock option exercise experience. We estimate the volatility of our common stock by using the historical volatility in our common stock over a period similar to the expected term on the options. We base the risk-free interest rate that we use in the option valuation model on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options. We do not anticipate paying any cash dividends in the foreseeable future and therefore use an expected dividend yield of zero in the option valuation model. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. Based on historical data, we assumed zero forfeitures in our 2008 calculation of stock-based compensation expense. All stock-based payment awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods.

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

   
March 29, 2008
   
March 31, 2007
 
Expected dividend yield
    0.00 %     0.00 %
Expected stock price volatility
    52.10 %     59.23 %
Risk free interest rate
    3.28 %     4.68 %
Expected life (years)
    5.07       5.00  

No restricted stock awards were granted in the quarters ended March 29, 2008 and March 31, 2007. We recognize the estimated compensation cost of restricted stock awards, defined as the fair value of our common stock on the date of grant, on a straight line basis over the three year vesting period. During the quarters ended March 29, 2008 and March 31, 2007, 23,334 restricted stock awards vested in each quarter. Restricted stock awards that were unvested as of March 29, 2008 totaled 23,332 shares. Deferred compensation of $147 as of March 29, 2008 represents the unamortized cost of these unvested restricted stock awards.

Stock-based compensation in the quarters ended March 29, 2008 and March 31, 2007 totaled $45 and $75, respectively. We charge stock-based compensation to selling, general and administrative expense in our condensed consolidated statement of operations. Future compensation cost on unvested stock-based awards as of March 29, 2008 is estimated to be $169, which will be charged to expense through March 2009.


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Overview

Cavalier Homes, Inc. and its subsidiaries produce, sell, and finance manufactured housing. The manufactured housing industry is cyclical and seasonal and is influenced by many of the same economic and demographic factors that affect the housing market as a whole. As a result of the growth in the industry during much of the 1990s, the number of retail dealerships, manufacturing capacity and wholesale shipments expanded significantly, which ultimately created slower retail turnover, higher retail inventory levels and increased price competition. Since the beginning of 2000, the industry has been impacted by an increase in dealer failures, a severe reduction in available consumer credit and wholesale (dealer) financing for manufactured housing, more restrictive credit standards and increased home repossessions which re-enter home distribution channels, each of which contributed to a reduction in wholesale industry shipments to a 45 year low in 2007.

For the first two months of 2008, the latest data available from the Manufactured Housing Institute (“MHI”), floor shipments are 2.5% less than the same period in 2007 due to the continuation of challenging manufactured housing market conditions. Continuing turmoil in the credit markets in 2008 could further reduce the number of floor shipments.

As we announced in February 2008, we received an order to build and deliver an additional 100 homes under the contract we entered into in June 2007 with the Mississippi Emergency Management Agency (“MEMA”) under the Alternative Housing Pilot Program as part of that state's ongoing efforts to provide permanent and semi-permanent housing for residents displaced by Hurricane Katrina. We shipped a total of 170 homes to MEMA in the first quarter of 2008, including 28 homes from this 100-unit order. MEMA awarded us an additional 50 homes in March 2008, which we expect to ship in the second quarter.

Industry/Company Shipments and Market Share

Based on information provided by MHI, wholesale floor shipments of HUD-Code homes were down 72% cumulatively from the year ended December 31, 1999 through December 31, 2007 as shown by the data in the following table:

   
Floor Shipments
 
   
Nationwide
   
Cavalier’s Core 11 States
 
Year
 
Industry
   
Increase (decrease) from prior
year
   
Cavalier
   
Increase (decrease) from prior
year
   
Market
Share
   
Industry
   
Increase (decrease) from prior
year
   
Cavalier
   
Increase (decrease) from prior
year
   
Market
Share
 
1999
    582,498             34,294             5.9 %     284,705             30,070             10.6 %
2000
    431,787       (25.9 )%     18,590       (45.8 )%     4.3 %     199,276       (30.0 )%     15,941       (47.0 )%     8.0 %
2001
    342,321       (20.7 )%     21,324       14.7 %     6.2 %     149,162       (25.1 )%     17,884       12.2 %     12.0 %
2002
    304,370       (11.1 )%     21,703       1.8 %     7.1 %     124,127       (16.8 )%     18,039       0.9 %     14.5 %
2003
    240,180       (21.1 )%     12,411       (42.8 )%     5.2 %     87,265       (29.7 )%     10,584       (41.3 )%     12.1 %
2004
    232,824       (3.1 )%     10,772       (13.2 )%     4.6 %     88,958       1.9 %     8,912       (15.8 )%     10.0 %
2005
    246,750       6.0 %     10,648       (1.2 )%     4.3 %     105,508       18.6 %     9,905       11.1 %     9.4 %
2006
    206,822       (16.2 )%     8,261       (22.4 )%     4.0 %     86,748       (17.8 )%     7,774       (21.5 )%     9.0 %
2007
    163,761       (20.8 )%     7,378       (10.7 )%     4.5 %     69,115       (20.3 )%     6,568       (15.5 )%     9.5 %
Two months ended 3/1/08
    22,673               1,209               5.3 %     10,890               1,124               10.3 %

During 2007, our floor shipments decreased 10.7% as compared to 2006, while industry wide shipments decreased 20.8%, with our market share in 2007 increasing to 4.5%. In our core states, our market share in 2007 increased to 9.5% from 9.0% in 2006 due to new products we introduced in early 2007 and our participation in the MEMA Alternative Housing Pilot Program. For the two months ended March 1, 2008, our total market share increased to 5.3% and our market share in our core 11 states increased to 10.3% due primarily to the impact of our contract with MEMA.

Modular Housing

We primarily produce HUD-Code homes. We also produce modular homes, which are constructed to local, regional or state building codes. Modular homes generally have a different and more complex roof system than HUD-Code homes, are typically two or more sections, and, when combined with land, usually qualify for traditional mortgage financing, which generally has better terms than financing for a HUD-Code home. The national market for modular housing was 32,300 homes in 2007 according to the latest data available from the National Modular Housing Council (“NMHC”). Modular homes shipped industry wide in 2007 decreased 16.1% from 2006. We shipped 348 and 398 modular homes during 2007 and 2006, respectively, for a year over year decrease of 12.6%. In the first quarters of 2008 and 2007, we shipped 77 and 178 modular homes, respectively, for a year over year decrease of 56.7%. We believe the decline in modular home shipments is primarily

13


attributable to economic conditions, including the downturn in the general housing market and the turmoil in the credit markets.

Industry Finance Environment

A major factor that impacts the manufactured housing industry is the availability of credit and the tightening/relaxation of credit standards. In more recent years, the industry has been impacted significantly by reduced financing available at both the wholesale and retail levels, with several lenders exiting the marketplace or limiting their participation in the industry. In 2007, the mortgage credit markets experienced a significant upheaval related to sub-prime mortgages, which has continued to impact the overall credit and financial markets in the first quarter of 2008. More restrictive credit standards will impact the ability of home buyers to obtain financing and the downturn in the real estate markets have increased home repossessions. We believe these factors have impacted the manufactured housing industry, particularly modular housing products. We believe a meaningful expansion for our industry will be delayed until there is substantial entry of finance resources to the manufactured housing market.

Capacity and Overhead Cost

Our plants operated at capacities ranging from 38% to 54% in 2007. We closed one of two manufacturing lines in Millen, Georgia in September 2007 and consolidated our Winfield, Alabama production line with our operations in Hamilton, Alabama. During the first quarter of 2008, our plants operated at 54% of total capacity with individual plants operating from a low of 36% to a high of 78% of capacity. We will continue to monitor the relationship between demand and capacity and may take additional steps to adjust our capacity or enhance our operations based on our views of the industry and its general direction.

Outlook

In 2008, we will continue to focus on programs to improve manufacturing efficiencies, increase gross margins, reduce costs overall, and improve liquidity. We believe this internal focus was instrumental in the positive results we achieved in the first quarter. However, 2007 was a very challenging year for our industry, and we do not anticipate any meaningful improvement in our industry in 2008 as the economy struggles with the crisis in the credit and financial markets. Further changes in general economic conditions that affect consumer purchases, availability of adequate financing sources, increases in repossessions or dealer failures and further commodity price increases could affect our results of operations.

Results of Operations

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

   
Quarter Ended
 
Statement of Operations Data:
 
March 29, 2008
   
March 31, 2007
   
Differences
 
Revenue:
                                   
Home manufacturing
  $ 48,681           $ 42,045           $ 6,636       15.8 %
Financial services
    835             857             (22 )     (2.6 )
Total revenue
    49,516       100.0 %     42,902       100.0 %     6,614       15.4  
Cost of sales
    41,216       83.2       36,922       86.1       4,294       11.6  
Gross profit
    8,300       16.8       5,980       13.9       2,320       38.8  
Selling, general and administrative
    8,277       16.7       9,815       22.8       (1,538 )     (15.7 )
Operating income (loss)
    23       0.1       (3,835 )     (8.9 )     3,858       n/m  
Other income (expense):
                                               
Interest expense
    (124 )     (0.3 )     (164 )     (0.4 )     40       24.4  
Other, net
    185       0.4       (28 )     --       213       n/m  
      61       0.1       (192 )     (0.4 )     253       n/m  
Income (loss) before income taxes and equity in earnings of equity-method investees
    84       0.2       (4,027 )     (9.4 )     4,111       n/m  
Income tax provision
    11       --       22       (0.1 )     (11 )     (50.0 )
Equity in earnings of equity-method investees
    45       --       158       0.4       (113 )     (71.5 )
Net income (loss)
  $ 118       0.2 %   $ (3,891 )     (9.1 )%   $ 4,009       n/m  


14



   
Quarter Ended
 
Operating Data:
 
March 29, 2008
   
March 31, 2007
 
Home manufacturing:
                       
Floor shipments:
                       
HUD-Code
    1,745       95.8 %     1,480       89.3 %
Modular
    77       4.2       178       10.7  
Total floor shipments
    1,822       100.0 %     1,658       100.0 %
Home shipments:
                               
Single-section
    495       42.8 %     275       28.6 %
Multi-section
    662       57.2       685       71.4  
Wholesale home shipments
    1,157       100.0       960       100.0  
Shipments to company-owned retail locations
    (3 )     (0.3 )     (21 )     (2.2 )
MEMA shipments
    (170 )     (14.7 )     --       --  
Shipments to independent retailers
    984       85.0       939       97.8  
Retail home shipments
    5       0.4       28       2.9  
Shipments other than to MEMA
    989       85.4 %     967       100.7 %
Other operating data:
                               
Installment loan purchases
  $ 8,923             $ 11,780          
Capital expenditures
  $ 70             $ 606          
Home manufacturing facilities (operating)
    5               7          
Independent exclusive dealer locations
    62               71          

Revenue

Revenue for the first quarter of 2008 totaled $49,516, increasing $6,614 or 15.4%, from 2007’s first quarter revenue of $42,902. Home manufacturing net sales accounted for virtually the entire change, increasing by $6,636 from $42,045 in the first quarter of 2007. Home shipments increased 19.9%, with floor shipments increasing by 9.9%. The increase in manufactured home revenue and shipments were primarily due to the 170 MEMA units shipped in the first quarter of 2008 for approximately $8,070. Multi-section home shipments, as a percentage of total shipments, were 57.2% in the first quarter of 2008 as compared to 71.4% in 2007. Single-section homes, as a percentage of total shipments, increased to 42.8% in the first quarter of 2008 from 28.6% in the same quarter of 2007. The primary cause of the bulge in single-section shipments in the first quarter 2008 was due to single-section units shipped to MEMA. Of the non-MEMA shipments, 55% in 2008 and 50% in 2007 were to exclusive dealers. The number of independent dealers participating in our exclusive dealer program declined from 71 at March 31, 2007 to 62 at March 29, 2008. This reduction in our exclusive dealer program is due primarily to a shift by some of these dealers to other dealer agreements that we offer. Total home shipments (wholesale and retail) for the first quarter of 2008 were 1,159 versus 967 in 2007. Inventory of our product at all retail locations, including the Company-owned retail center, decreased to approximately $83,200 at March 29, 2008 from $87,200 at March 31, 2007.

Revenue from the financial services segment decreased 2.6% to $835 for the first quarter of 2008 compared to $857 in 2007. The revenue decrease is primarily due to a lower level of loan originations and reduced interest income on a lower portfolio balance throughout the quarter compared to the same period in 2007. During the first quarter of 2008, CIS Financial Services, Inc. (“CIS”), our wholly owned finance subsidiary, purchased contracts totaling $8,923 and sold installment contracts totaling $8,911. In the same period of 2007, CIS purchased contracts of $11,780 and sold installment contracts totaling $10,859. CIS does not generally retain the servicing function and does not earn interest income on these sold loans. In the first quarter of 2008, we received $2,320 from the December 31, 2007 sale of a portion of our installment contracts held for investment. At March 29, 2008, we sold an additional $2,094 of our installment contracts held for investment with cash received in early April 2008.

Gross Profit

Gross profit was $8,300, or 16.8% of total revenue, for the first quarter of 2008, an increase from $5,980, or 13.9%, in 2007. The increase in gross profit and gross margin is the result of a number of factors, including (i) the increase in units shipped between the two periods, including the shipment of 170 homes to MEMA in the first quarter 2008, (ii) an increase in our sales prices in the current year, (iii) an improvement in manufacturing efficiencies, and (iv) the full benefit of the closure of two plants/manufacturing lines in the last half of 2007. Our average wholesale sales price per unit (including MEMA) in the first quarter of 2008 increased to approximately $41,000 from $40,100 in the first quarter of 2007. We continued to experience cost increases in the first quarter of 2008 compared to the first quarter 2007 in certain raw materials (primarily steel) and commodity components due primarily to rising oil prices. We were able to minimize the impact of the increase in

15


raw material costs in the first quarter of 2008 through increases in our sales prices. However, if raw material prices continue to increase, we may not be able to further increase our sales prices and could experience a decline in our gross profit and gross margin percentage.

Selling, General and Administrative

Selling, general and administrative expenses during the first quarter of 2008 were $8,277 or 16.7 % of total revenue, compared to $9,815 or 22.8 % in 2007, a decrease of $1,538, as a result of our focus to reduce costs. Lower selling, general and administrative costs were primarily due to (i) a decrease in salaries, wages and employee benefit costs of $672, (ii) lower levels of promotional programs and dealer support costs of $589, and (iii) lower fixed administrative expenses related to our service staff of $185, offset by an increase in bad debt expense related to financial services of $130.

Operating Income (Loss)

Operating income for the quarter was $23 compared to an operating loss of $3,835 in the first quarter of 2007. Segment operating results were as follows: (1) Home manufacturing operating income was $904 in the first quarter of 2008 as compared to a loss of $2,983 in 2007. The improvement in home manufacturing operating results was due to increased revenue and shipments in 2008, improved margins and reduced costs. (2) Financial services operating income was $107 in the first quarter of 2008 as compared to $217 in 2007 primarily due to the increase in bad debt expense of $130. (3) General corporate operating expense, which is not identifiable to a specific segment, decreased from $1,069 in the first quarter of 2007 to $988 in 2008 primarily due to reductions in salaries, wages, and employee benefit costs.

Other Income (Expense)

Interest expense for the quarter was $124 compared to $164 in the first quarter of 2007. This decrease is primarily due to the decrease in outstanding debt between the two periods from scheduled payments in 2007 and the first quarter of 2008.

Other, net is comprised primarily of interest income (unrelated to financial services) and increased $213 to income of $185 for the first quarter of 2008 from a loss of $28 for the same period in 2007. Other, net in the first quarter of 2007 included a loss of $250 on the sale of the net assets of two retail locations.

Income Tax Provision

Since December 31, 2006, we have maintained a valuation allowance to fully reserve our deferred tax assets due to a number of factors, including among others, operating losses and uncertainty of future operating results. We did not record a federal income tax benefit in the quarters ended March 29, 2008 and March 31, 2007 because management believes it is not appropriate to record income tax benefits in excess of anticipated refunds and certain carryforward items under the provisions of SFAS No. 109, Accounting for Income Taxes. The income tax provision of $11 in the quarter ended March 29, 2008 includes $9 for state income taxes payable for certain subsidiaries and $2 of interest related to uncertain tax positions. The income tax provision of $22 in the quarter ended March 31, 2007 includes $19 for state income taxes payable for certain subsidiaries and $3 of interest related to uncertain tax positions. As of March 29, 2008, our valuation allowance against deferred tax assets totaled approximately $17,600. The valuation allowance may be reversed to income in future periods to the extent that the related deferred income tax assets are realized or the valuation allowance is otherwise no longer needed.

Net Income (Loss)

Net income for the first quarter of 2008 was $118 or $0.01 per diluted share compared to a net loss of $3,891 or $0.21 per diluted share in the same period last year. The changes between these two periods are due to the items discussed above.

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Liquidity and Capital Resources

   
Balances as of
 
   
March 29, 2008
   
December 31, 2007
 
Cash, cash equivalents, and certificates of deposit
  $ 19,211     $ 22,043  
Working capital
  $ 23,749     $ 20,906  
Current ratio
 
1.7 to 1
   
1.6 to 1
 
Long-term debt
  $ 3,524     $ 3,678  
Ratio of long-term debt to equity
 
0.1 to 1
   
0.1 to 1
 
Installment loan portfolio
  $ 7,569     $ 9,844  

Quarter Ended March 29, 2008

Cash decreased $2,832 from $22,043 at December 31, 2007 to $19,211 at March 29, 2008. Our cash and cash equivalents in the first quarter of each year generally decrease from the beginning of the year cash balances due to a number of factors: (i) the closing of our facilities at the end of December for plant-wide vacations and holidays, which results in lower average levels of inventories and accounts receivable and higher levels of cash at December 31st, (ii) a return to normal operating levels of inventory and accounts receivable at the end of the first quarter due to production through March month-end, and (iii) lower shipments in the first quarter of each year in comparison to other quarters due to the weather and buying patterns of retail customers. The decline in cash at March 29, 2008 is consistent with this trend, but declined less this year than in prior years due to our focus to increase gross margins, reduce costs, and improve manufacturing efficiencies, including a decrease in inventory levels.

Operating activities used net cash of $5,130 primarily as a result of the following:

 
(a)
an increase in accounts receivable of $8,640 due to the seasonal increase in receivables from the traditional low point in December,
 
(b)
a decrease in amounts payable under dealer incentive programs of $616, offset by
 
(c)
a decrease in inventories of $1,010,
 
(d)
an increase of $1,578 in accounts payable, again reflecting normal production levels in March compared to the seasonality of low production levels in late December, and
 
(e)
net income excluding non-cash payments for depreciation, provision for credit losses and stock based compensation totaling $877.

Investing activities provided cash in the first quarter of 2008 of $2,447, primarily from the cash received on the December 31, 2007 sale of a portion of our installment contracts held for investment. As noted above, cash from the March 2008 sale of an additional $2,094 of installment contracts held for investment was received in early April 2008. Our capital expenditures, excluding a $29 addition financed through a capital lease transaction, totaled $41 during the first quarter of 2008 for normal property, plant and equipment additions and replacements. We believe calendar 2008 capital expenditures will be significantly below the 2007 levels, but expect additions in the remaining quarters in 2008 will be higher than in the first quarter.

The decrease in long-term debt for the first quarter of 2008 was due to scheduled principal payments of $161. Borrowings under our retail floor plan agreement were $12 in the first quarter of 2008.

The installment loan portfolio totaling $7,569 at March 29, 2008 decreased from the balance at December 31, 2007 due to our decision to reduce the balance in this portfolio. Further reduction in the held for investment portfolio is not planned at this time. We expect to utilize cash on hand to fund future installment contracts purchased for resale.

Quarter ended March 31, 2007

Cash decreased $16,979 from $25,967 at December 31, 2006 to $8,988 at March 31, 2007. As noted in the overview, the manufacturing industry is both cyclical and seasonal. Our cash and cash equivalents in the first quarter of each year generally decrease from the beginning of the year cash balances as noted above. The decrease in cash at March 31, 2007 is consistent with this trend. On average, cash decreased approximately $13,000 in the first quarter of each year from 2002 through 2007,

17


excluding 2006, which reflected an increase in cash due to the impact of FEMA home shipments and timing of cash collections.

Operating activities used net cash of $17,267 primarily as a result of the following:

 
(a)
an increase in accounts receivable of $9,242 due to the seasonal increase from the traditional low point of the year at December year end,
 
(b)
an increase in inventories of $6,023,
 
(c)
the net purchase of installment contracts of $921,
 
(d)
the net loss for the quarter of $3,891, offset by
 
(e)
an increase of $3,100 in accounts payable, again reflecting normal production levels in March compared to the seasonality of low production levels in late December.

Capital expenditures were $606 during the first quarter of 2007 primarily for normal property, plant and equipment additions and replacements. The additions also include amounts under programs at one of our plants to provide improved manufacturing techniques for modular products and to increase overall productivity. As these programs are successfully completed at the current plant, we may duplicate the programs at other facilities.

The decrease in long-term debt for the first quarter of 2007 was due to scheduled principal payments of $335. Borrowings under our retail floor plan agreement were $690 in the first quarter of 2007. The amount outstanding under the retail floor plan agreement totaling $1,793 as of March 30, 2007 was assumed by the purchaser of the two Alabama retail sales centers. As of March 31, 2007, no amounts were owed by us under the retail floor plan agreements.

The installment loan portfolio totaling $12,992 at March 31, 2007 increased slightly from the balance at December 31, 2006. Included in the installment loan portfolio at March 31, 2007 was $6,169 of land/home loans. At December 31, 2006, we had $5,475 land/home loans in our portfolio. As we increase our land/home loan purchases, short-term cash requirements will increase due to the length of time involved in consummating the sales transaction. We expect to utilize cash on hand to fund these loan purchases.

General Liquidity and Debt Agreements

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

We have a credit agreement with our primary lender (the “Credit Facility”), which has been amended from time to time with a current maturity date of April 2009. The Credit Facility is comprised of (i) a revolving line of credit that provides for borrowings (including letters of credit) up to $17,500 and (ii) a real estate term loan, which are cross-secured and cross-defaulted. No amounts were outstanding under the revolving line of credit as of March 29, 2008 or December 31, 2007.

The amount available under the revolving line of credit is equal to the lesser of (i) $17,500 or (ii) an amount based on defined percentages of accounts and notes receivable and inventories reduced by the sum of $2,500 and any outstanding letters of credits. At March 29, 2008, $10,469 was available under the revolving line of credit after deducting letters of credit of $4,653.

The applicable interest rates under the revolving line of credit are based on certain levels of tangible net worth as noted in the following table.

Tangible Net Worth
 
Interest Rate
above $62,000
 
Prime less 0.50%
$62,000 $56,500
 
Prime
$56,500 $38,000
 
Prime plus 0.75%
below $38,000
 
Prime plus 1.25%

The bank’s prime rate was 5.25% and 7.25% at March 29, 2008 and December 31, 2007, respectively.

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The real estate term loan agreement contained in the Credit Facility provided for initial borrowings of $10,000, of which $2,684 and $2,737 was outstanding on March 29, 2008 and December 31, 2007, respectively. Interest on the term note is fixed for a period of five years from issuance (September 2003) at 6.5% and may be adjusted at 5 and 10 years. Amounts outstanding under the real estate term loan are collateralized by certain plant facilities and equipment.

The Credit Facility contains certain restrictive and financial covenants which, among other things, limit our ability without the lender’s consent to (i) make dividend payments and purchases of treasury stock in an aggregate amount which exceeds 50% of consolidated net income for the two most recent years, (ii) mortgage or pledge assets which exceed in the aggregate $1,000, (iii) incur additional indebtedness, including lease obligations, which exceed in the aggregate $1,000, excluding floor plan notes payable which cannot exceed $3,000 and (iv) make annual capital expenditures of $5,000. In addition, the Credit Facility contains certain financial covenants requiring us (i) to maintain on a consolidated basis certain defined levels of liabilities to tangible net worth ratio (not to exceed 1.5 to 1), (ii) to maintain a current ratio, as defined, of at least 1.1 to 1, (iii) maintain minimum cash and cash equivalents of $5,000, (iv) achieve an annual cash flow to debt service ratio of not less than 1.35 to 1 for the year ending December 31, 2008, and (v) achieve an annual minimum profitability of $100. The Credit Facility also requires CIS to comply with certain specified restrictions and financial covenants. At March 29, 2008, we were in compliance with our debt covenants.

We have amounts outstanding under Industrial Development Revenue Bond issues (“Bonds”) which totaled $1,670 and $1,775 at March 29, 2008 and December 31, 2007, respectively. One bond issue bearing interest at variable rates ranging from 5.15% to 5.25% will mature at various dates through April 2009; and a second bond issue is payable in annual installments through 2013 with interest payable monthly at a variable rate currently at 2.41% as determined by a remarketing agent. The real estate term loan and the bonds are collateralized by substantially all of our plant facilities and equipment.

We had $522 and $510 of notes payable under a retail floor plan agreement at March 29, 2008 and December 31, 2007, respectively. The notes are collateralized by certain retail new home inventories and bear interest rates ranging from prime to prime plus 2.5% but not less than 6% based on the age of the home.

We entered into a capital lease transaction during the first quarter of 2008 related to machinery and equipment we acquired with an initial cost of $29. At March 29, 2008, $26 was outstanding under the capital lease obligation.

Since its inception, CIS has been restricted in the amount of loans it could purchase based on underwriting standards, as well as the availability of working capital and funds borrowed under its credit line with its primary lender. From time to time, we evaluate the potential to sell all or a portion of our remaining installment loan portfolio, in addition to the periodic sale of installment contracts purchased by CIS in the future. CIS re-sells loans to other lenders under various retail finance contracts. We believe the periodic sale of installment contracts under these retail finance agreements will reduce requirements for both working capital and borrowings, increase our liquidity, reduce our exposure to interest rate fluctuations, and enhance our ability to increase our volume of loan purchases. There can be no assurance, however, that additional sales will be made under these agreements, or that we will be able to realize the expected benefits from such agreements. At December 31, 2007, we sold a portion of our portfolio held for investment totaling $2,320 with cash settlement in early January 2008. At March 29, 2008, we sold additional installment contracts held for investment totaling $2,094 with cash settlement in early April 2008.

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

Cash to be provided by operations in the coming year is largely dependent on sales volume. Our manufactured homes are sold mainly through independent dealers who generally rely on third-party lenders to provide floor plan financing for homes purchased. In addition, third-party lenders generally provide consumer financing for manufactured home purchases. Our sales depend in large part on the availability and cost of financing for manufactured home purchasers and dealers as well as our own retail locations. The availability and cost of such financing is further dependent on the number of financial institutions participating in the industry, the departure of financial institutions from the industry, the financial institutions’ lending

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practices, the strength of the credit markets in general, governmental policies, and other conditions, all of which are beyond our control. Throughout the past nine years the industry has been impacted significantly by reduced financing available at both the wholesale and retail levels, with several lenders exiting the marketplace or limiting their participation in the industry, coupled with more restrictive credit standards and increased home repossessions which re-enter home distribution channels and limit wholesale shipments of new homes. Unfavorable changes in these factors and terms of financing in the industry may have a material adverse effect on our results of operations or financial condition.

Recently Issued Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS No. 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157. This FSP permits the delayed application of SFAS No. 157 for all non-recurring fair value measurements of non-financial assets and non-financial liabilities until fiscal years beginning after November 15, 2008. We adopted SFAS No. 157 in the first quarter of 2008 for all financial assets and financial liabilities with no material impact on our consolidated statements of operations or financial condition. For disclosure purposes, we estimated the fair value of our installment contracts receivable at $6,838 using Level 3 inputs as defined in SFAS No. 157. In general, these inputs were based on the actual sales prices we received from the sale of comparable installment contracts and the underlying collateral value on certain loans based on appraisals, when available, or industry price guides for used manufactured housing.

Off-Balance Sheet Arrangements

Our material off-balance sheet arrangements consist of repurchase obligations and letters of credit.

We are contingently liable under terms of repurchase agreements with financial institutions providing inventory financing for retailers of our products. Under the repurchase agreements, we were contingently liable at March 29, 2008, for a maximum of approximately $61,000 in the event we must perform under the repurchase commitments.

We have provided letters of credit totaling $4,653 as of March 29, 2008 to providers of certain of our surety bonds and insurance policies. While the current letters of credit have a finite life, they are subject to renewal at different amounts based on the requirements of the insurance carriers. We have recorded insurance expense based on anticipated losses related to these policies.


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

We purchase retail installment contracts from our dealers, at fixed interest rates, in the ordinary course of business, and periodically resell a majority of these loans to financial institutions under the terms of retail finance agreements. The periodic resale of installment contracts reduces our exposure to interest rate fluctuations, as the majority of contracts are held for a short period of time. Our portfolio consisted of fixed rate contracts with interest rates generally ranging from 6.5% to 14.0% and an average original term of 278 months at March 29, 2008. We estimated the fair value of our installment contracts receivable at $6,838 using Level 3 inputs as defined in SFAS 157. In general, these inputs were based on the actual sales prices we received from the sale of comparable installment contracts and the underlying collateral value on certain loans based on appraisals, when available, or industry price guides for used manufactured housing.

We have one industrial development revenue bond issue that is exposed to interest rate changes. Since this borrowing is floating rate debt, an increase in short-term interest rates could adversely affect interest expense. Additionally, we have one other industrial development revenue bond issue at fixed interest rates. We estimated the fair value of our debt instruments at $4,436 using rates we believe we could have obtained on similar borrowings at March 29, 2008.

Additionally, we have a revolving line of credit (of which no amounts were outstanding at March 29, 2008) and a retail floor plan agreement that are exposed to interest rate changes, as they are floating rate debt based on the prime interest rate. The

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bank’s prime rate was 5.25% at March 29, 2008. We have $522 and $510 of notes payable under a retail floor plan agreement at March 29, 2008 and December 31, 2007, respectively. The notes bear interest rates ranging from prime to prime plus 2.5%, but not less than 6%, based on the age of the home.


Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our chief executive officer and chief financial officer, management has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) as of March 29, 2008. Based on that evaluation, our chief executive officer and our chief financial officer have concluded that our disclosure controls and procedures were effective as of March 29, 2008.

Changes in Internal Controls Over Financial Reporting

There have been no internal control changes that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting since December 31, 2007.

CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS

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

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

 
·
the cyclical and seasonal nature of the manufactured housing industry and the economy generally;
 
·
the severe and continuing downturn in the manufactured housing industry;
 
·
limitations in our ability to pursue our business strategy;
 
·
changes in demographic trends, consumer preferences and our business strategy;
 
·
changes and volatility in interest rates and the availability of capital;
 
·
changes in the availability of retail (consumer) financing;
 
·
changes in the availability of wholesale (dealer) financing;
 
·
changes in level of industry retail inventories;
 
·
the ability to attract and retain quality independent dealers in a competitive environment, including any impact from the consolidation of independent dealers;
 
·
the ability to attract and retain executive officers and other key personnel;
 
·
the ability to produce modular and HUD-code products within the same manufacturing plants;
 
·
the ability to substantially grow our modular business;
 
·
competition;
 
·
contingent repurchase and guaranty obligations;
 
·
uncertainties regarding our retail financing activities;
 
·
the potential unavailability of and price increases for raw materials;
 
·
the potential unavailability of manufactured housing sites;
 
·
regulatory constraints;
 
·
the potential for additional warranty claims;
 
·
litigation; and

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

Any or all of the forward-looking statements in this report, in the 2007 Annual Report to Stockholders, in the Annual Report on Form 10-K for the year ended December 31, 2007 and in any other public statements we make may turn out to be wrong. These statements may be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Many factors listed above will be important in determining future results. Consequently, no forward-looking statement can be guaranteed. Actual future results may vary materially.

We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in future filings with the Securities and Exchange Commission or in any of our press releases. Also note that, in the Annual Report on Form 10-K for the period ended December 31, 2007, under the heading “Risk Factors,” we have provided a discussion of factors that we think could cause the actual results to differ materially from expected and historical results. Other factors besides those listed could also adversely affect us. This discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995.



Reference is made to the legal proceedings previously reported in our Annual Report on Form 10-K for the year ended December 31, 2007 under the heading “Item 3 – Legal Proceedings”.

During the first quarter of 2008, we were named as a defendant in an action entitled “In Re: FEMA Trailer Formaldehyde Product Liability Litigation”, Docket Number MDL 1873 in the United States District Court for the Eastern District of Louisiana, New Orleans Division.

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


There have been no material changes in our risk factors since December 31, 2007. See risk factors at December 31, 2007 within our Form 10-K.


On January 29, 2008, our Board of Directors approved the Compensation Committee’s recommendation with respect to performance targets for 2008 incentive compensation under the 2005 Incentive Compensation Plan (the “Plan”) for each of Messrs. Roberson, Brown and Murphy. The performance target for the award of 2008 cash incentive bonuses for all of our named executive officers is based on pre-tax income for the year. For purposes of this calculation, the Board defined “pre-tax income” as our income from operations before income taxes (including the deduction for incentive compensation) plus our equity in earnings from equity-method investees.

The Compensation Committee established the 2008 target and threshold levels to be pre-tax income of $1,700,000. If the threshold is achieved, Mr. Roberson will earn incentive compensation of $100,000 and Mr. Brown and Mr. Murphy will each earn incentive compensation of $65,000. The executive officers will earn additional incentive compensation if pre-tax income

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in 2008 exceeds the target with Mr. Roberson earning 5% of pre-tax income in excess of the target and Mr. Brown and Mr. Murphy earning 3% of pre-tax income in excess of the target. The maximum amount of incentive compensation to be paid under this program is equal to each executive’s base salary for 2008. Base salaries for Messrs. Roberson, Brown and Murphy are $275,000, $235,000, and $210,000, respectively.


The exhibits required to be filed with this report are listed below.

31.1
Certification of principal executive officer pursuant to Exchange Act Rule 13a-15(e) or 15d-15(e).
31.2
Certification of principal financial officer pursuant to Exchange Act Rule 13a-15(e) or 15d-15(e).
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Certification of CEO and CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


 
CAVALIER HOMES, INC.
 
(Registrant)
   
Date: April 24, 2008
/s/ David A. Roberson
 
David A. Roberson
 
President and Chief Executive Officer
   
Date: April 24, 2008
/s/ Michael R. Murphy
 
Michael R. Murphy
 
Chief Financial Officer
 
(Principal Financial and Accounting Officer)

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