Summary

 

Drew has two reportable operating segments: the recreational vehicle (“RVs”) and leisure products segment (the “RV Segment”) and the manufactured housing products segment (the “MH Segment”). The RV Segment accounted for   70 percent of consolidated net sales for 2006, and the MH Segment accounted for 30 percent of consolidated net sales for 2006. Approximately 90 percent of the RV Segment sales were of products for travel trailers and fifth-wheel RVs. The balance represents sales of components for motorhomes, as well as specialty trailers for hauling equipment, boats, personal watercraft and snowmobiles, and axles for specialty trailers. Drew’s wholly-owned subsidiaries, Kinro, Inc. and its subsidiaries (collectively, "Kinro"), and Lippert Components, Inc. and its subsidiaries (collectively, "Lippert"), each have operations in both the RV Segment and the MH Segment.

 

Kinro manufactures and markets components primarily for RVs and manufactured homes (“MH”), including windows, doors and screens, and thermoformed bath and kitchen products. Lippert manufactures and markets components primarily for RVs and manufactured homes, including steel chassis, steel chassis parts, slide-out mechanisms and related power units, electric stabilizer jacks, leveling devices, bed lifts, suspension systems, axles and steps. Lippert also manufactures specialty trailers for hauling equipment, boats, personal watercraft and snowmobiles, as well as axles for specialty trailers. Certain products manufactured by Kinro and Lippert are also used in modular homes and office units.

 

In the last 10 years, the Company has acquired 12 manufacturers of products for both manufactured homes and RVs, expanded its geographic market and product lines, added manufacturing facilities, integrated manufacturing, distribution and administrative functions, and developed new and innovative products. As a result, at December 31, 2006, the Company operated 43 manufacturing facilities in 18 states and one in Canada, and achieved consolidated sales of $729 million for 2006.

 

The Company was incorporated under the laws of Delaware on March 20, 1984, and is the successor to Drew National Corporation, which was incorporated under the laws of Delaware in 1962. The Company's principal executive and administrative offices are located at 200 Mamaroneck Avenue, White Plains, New York 10601; telephone number (914) 428-9098; website www.drewindustries.com ; e-mail drew@drewindustries.com . The Company makes available free of charge on its website its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K (and amendments to those reports) filed with the Securities and Exchange Commission as soon as reasonably practicable after such materials are electronically filed.

 

Recent Developments

 

Hurricane-related Business

 

From September 2005 until April 2006, the Company experienced a significant increase in business from both its RV and manufactured housing customers arising from the need for emergency housing caused by the Gulf Coast hurricanes in August and October 2005. Sales of hurricane-related products aggregated approximately $40 million, or 6 percent, of consolidated net sales in 2005, and approximately $20 million, or 3 percent, of consolidated sales in 2006. There were no significant hurricane-related sales subsequent to April 2006.

 

Acquisitions

 

On January 2, 2007, Lippert acquired Trailair, Inc. and certain assets and the business of Equa-Flex, Inc., two affiliated companies, which manufacture several patented products, including innovative suspension systems used primarily for towable RVs.  The minimum aggregate purchase price was $5.5 million, of which $3.3 million was paid at closing and the balance will be paid over the next five years. The aggregate purchase price, including non-compete agreements, could increase to a maximum of $8.1 million if certain sales targets for these products are achieved by Lippert over the next five years. The acquisition was financed with borrowings under the Company's line of credit.  The Company has integrated Trailair and Equa-Flex’s business into existing Lippert facilities.

 

On June 12, 2006, Lippert acquired certain assets and the business of Utah-based Happijac Company, a supplier of patented bed lift systems for recreational vehicles. Happijac, which also manufactures other RV products such as slide-out systems, tie-down systems and camper jacks, had annualized sales of approximately $15 million prior to the acquisition. For the remainder of 2006, subsequent to the acquisition, Happijac had sales of approximately $8.5 million.   The purchase price of $30.3 million was financed through the issuance by the Company to Prudential Investment Management, Inc. and its affiliates, pursuant to the Company’s “shelf-loan” facility, of $15 million of variable interest rate seven-year Senior Promissory Notes, $14.6 million of borrowings under the Company’s line of credit, and the assumption of $0.7 million of equipment loans. Simultaneously, the Company entered into an interest rate swap, effectively converting the $15.0 million of variable rate Senior Promissory Notes to a fixed rate.

 

On March 10, 2006, Lippert acquired certain assets and the business of California-based SteelCo., Inc., a. manufacturer of chassis and components for RVs and manufactured housing, which had annual sales for the year ended November 30, 2005 of approximately $8 million. The purchase price was $4.2 million which was financed by borrowings under the Company’s line of credit. The Company has integrated SteelCo’s business into Lippert’s existing facilities in California. In connection with the transaction, Lippert and SteelCo terminated litigation pending between them. See Item 3. “Legal Proceedings.”

 

Other Developments

 

Industry wholesale production of travel trailer and fifth wheel RVs, the Company’s primary RV market, increased 22 percent in the first six months of 2006, but in the second half of 2006, wholesale production of these types of RVs were down 14 percent.

 

The Manufactured Housing Institute reported that 2006 industry wholesale shipments of manufactured homes declined 20 percent from 2005. While industry wholesale shipments had been up 1 percent in the first half of 2006, industry wholesale shipments of manufactured homes were down 37 percent for the last six months of 2006.

 

In response to the slowdown in both the RV and MH industries in the latter part of 2006, the Company implemented several cost-cutting measures. In addition to reducing the hourly workforce to match current production levels, the Company closed several facilities and consolidated these operations into other existing facilities. At December 31, 2006, the Company operated 44 manufacturing facilities, down from 48 manufacturing facilities at December 31, 2005. The Company also reduced fixed overhead where prudent, including reducing staff levels by more than 50 salaried employees. These plant consolidations and fixed overhead reductions are expected to reduce costs by more than $4 million in 2007 (before taxes and net of incentive compensation), and the Company is considering additional facilities closings to optimize capacity utilization.

 

In 2006, the Company incurred about $3.3 million of operating losses at its Indiana-based specialty trailer operation, which is about $0.9 million more than the losses at this operation in 2005. This operation was closed at the end of the third quarter of 2006 and will not affect 2007 results.

 

Corporate Governance Rating

 

In March 2007, the Company received notification from Institutional Stockholders Services, Inc., (“ISS”) a Rockville, Maryland-based independent research firm that advises institutional investors, that the Company’s corporate governance policies outranked 96.1 percent of all companies listed in the Russell 3000 index. The Company has no business relationships with ISS.

 

Item 1A. RISK FACTORS.

 

Industry Risk Factors

 

Limited availability of financing for manufactured homes on leased land and higher costs of this financing could continue to limit the ability of consumers to purchase manufactured homes, resulting in reduced demand for our products.

 

Frequently, manufactured homes are purchased, and the land on which they are placed is leased. Loans used to finance the purchase of manufactured homes without land, also known as chattel loans, usually have shorter terms and higher interest rates, and may be more difficult to obtain than mortgages for manufactured or site-built homes that are on owned land. Lenders have been requiring high credit scores and other criteria for these loans, and many potential buyers of manufactured homes may not qualify. The availability, cost and terms of these chattel loans are also dependent on economic conditions, lending practices of financial institutions, governmental policies, and other factors that are beyond our control. Reductions in the availability of financing for manufactured homes and increases in the costs of this financing have limited, and could continue to limit, the ability of consumers to purchase manufactured homes, resulting in reduced demand for our products.

 

Reductions in the availability of wholesale financing may prevent retailers from carrying an adequate inventory of RVs or manufactured homes, which could reduce demand for our products.

 

Retailers of RVs and manufactured homes generally finance their purchases of inventory with financing provided by lending institutions, often called floor plan financing. Reductions in the availability of wholesale financing may prevent retailers from carrying an adequate inventory of RVs or manufactured homes, which could reduce demand for our products.

 

High levels of repossessions of manufactured homes could cause manufacturers to reduce production of new manufactured homes, resulting in reduced demand for our products.

 

Lower credit standards by lenders several years ago and prevailing economic conditions caused an increase in the number of manufactured homes repossessed by lenders. Repossessed homes are resold by lenders, often at substantially reduced prices, which reduces the demand for new manufactured homes. Similar conditions in the future could cause high levels of repossessions which could cause manufacturers to reduce production of new manufactured homes, resulting in reduced demand for our products.

 

Changes in zoning regulations for manufactured homes could lead to reduced demand for our products.

 

Manufactured housing communities and individual home placements are subject to local zoning regulations. In the past, there has been resistance by local property owners and zoning officials to zoning ordinances allowing the location of manufactured homes in certain areas comprised of conventional residences. Continued resistance to these zoning ordinances could have an adverse impact on sales of manufactured homes, which could reduce demand for our products.

 

Gasoline shortages, or higher prices for gasoline, could lead to reduced demand for our products.

 

Increases in the price of gasoline, or anticipation of potential fuel shortages, could adversely affect consumer demand for RVs, which could reduce demand for our products.

 

 
Excess inventories by retailers and manufacturers could cause a decline in the demand for our products.

 

Retailers and manufacturers of RVs and manufactured homes may carry excess inventory, as they periodically have in the past. Sales of excess inventory may cause the manufacturers of RVs and manufactured homes to reduce production of new vehicles and homes, which could cause a decline in demand for our products.

 

The manufactured housing industry has been experiencing a significant decline.

 

Our MH Segment, which accounted for 30 percent of consolidated net sales for 2006, operates in an industry which has been experiencing a decline in production of new homes since 1999. The downturn has been caused in part by limited availability of financing as a result of higher credit standards, an increase in the number of manufactured homes repossessed by lenders and resold at substantially reduced prices, and a reduction in the number of lenders engaged in making loans to finance the purchase of manufactured homes.

 

If these conditions persist, it is not likely that the manufactured housing industry will improve in the short-term, and certain of our customers could experience financial difficulties. These factors would result in reduced demand for products from our MH Segment, as well as difficulties in collecting outstanding accounts receivable.

 

Business cycles may cause substantial fluctuations in our operating results.

 

Both the manufactured housing and recreational vehicle industries are impacted by business cycles and this may cause substantial fluctuations in our operating results. Business cycles may depend upon general economic conditions, interest rates, consumer confidence, demographic changes, and other factors beyond our control.

 

Company-specific Risk Factors

 

 
Increases in raw material costs could adversely impact our financial condition and operating results.

 

The prices the Company pays for steel, which represents about 50 percent of the Company’s raw material costs, and other key raw materials, such as aluminum, vinyl, glass and ABS resin, have been volatile and have increased significantly since the beginning of 2004. During 2006 and the beginning of 2007, the Company received further cost increases from its suppliers of certain key raw materials. The impact of higher raw materials costs has been substantially offset by surcharges and sales price increases to our customers. Because competition may limit the amount of increases in raw material costs that can be passed through to customers in the form of price increases, future increases in raw material costs could adversely impact our financial condition and operating results.

 

Inadequate supply of imported raw materials used to make our products could adversely impact our financial condition and operating results.

 

We have recently begun to import a significant portion of the raw materials that we use in manufacturing our products. If these imported raw materials become unavailable, or if the supply of these raw materials is interrupted, our manufacturing operations could be adversely affected.

 

Increases in labor rates or reduced availability of labor could adversely impact our financial condition and operating results.

 

Certain geographic regions in which we have manufacturing facilities have very low unemployment rates. This could result in shortages of qualified employees and increased labor costs. Because competition may limit the amount of labor increases that can be passed through to customers in the form of price increases, increased labor costs could adversely impact our financial condition and operating results.

 

We are involved in certain litigation, which if decided adversely to us could have a material adverse affect on our financial condition.

The litigation is described in this Report in Item 3. “Legal Proceedings”.

 

FEMA-related orders resulting from the Gulf Coast hurricanes have ceased which has impacted our operating results.

 

In the last four months of 2005 and in the first four months of 2006, we experienced an increase in business from our RV and manufactured housing customers as a result of FEMA-related orders in connection with the need for emergency housing caused by the Gulf Coast hurricanes. This FEMA-related business has ceased, which has reduced demand for our products.

 

The loss of any customer accounting for more than 10 percent of our consolidated sales could have an adverse impact on our operating results.

 

One customer of the RV Segment accounted for 23 percent, and another customer of both the RV Segment and the MH Segment accounted for 19   percent, of the Company’s consolidated net sales in 2006. The loss of either of these customers could have a material adverse impact on our operating results; however, because we sell a variety of products to these customers in several geographic regions, we believe it is unlikely that we would lose the entire business of either of these customers.

 

Competitive pressures could reduce demand for our products.

Domestic and foreign competitors may lower prices or develop product improvements which could reduce demand for our products.

Adverse weather conditions could reduce demand for our products.

Adverse weather conditions could interfere with the ability of our manufactured housing customers to transport manufactured homes to dealers via roadway, which could impact retail sales of manufactured homes. This could cause manufacturers to reduce production of new manufactured homes, resulting in reduced demand for our products during certain months.

The financial condition of several of our significant customers could adversely impact our financial condition and operating results.

 

Financial difficulties of our significant customers could result in reduced demand for our products, as well as losses due to the inability to collect accounts receivable.

 

Item 1B. UNRESOLVED STAFF COMMENTS.

 

None.

 

RV Segment

 

Through its wholly-owned subsidiaries, the Company manufactures and markets a number of components for RVs, primarily travel trailers and fifth wheels, including aluminum windows, a variety of doors, steel chassis, steel chassis parts, slide-out mechanisms and related power units, and electric stabilizer jacks. During the last few years, the Company introduced several new products for the RV and specialty trailer markets, including products for the motorhome market, a new RV category for the Company. New products include slide-out mechanisms and leveling devices for motorhomes, axles for towable RVs and specialty trailers, entry steps and suspension systems for towable RVs, and bed lifts, thermoformed bath and kitchen products and exterior parts for both towable RVs and motorhomes. The Company estimates that the market potential of these products exceeds $700 million, and in the fourth quarter of 2006, the Company’s annualized sales of these products were more than $100 million.

 

In 2006, the RV Segment represented approximately 70 percent of the Company's consolidated sales, and 68   percent of consolidated segment operating profit. Approximately 90 percent of the Company’s RV sales are of products used in travel trailers and fifth wheel RVs. The balance represents sales of components for motorhomes, as well as specialty trailers for hauling equipment, boats, personal watercraft and snowmobiles, and axles for specialty trailers.

 

Raw materials used by the Company's RV Segment, consisting primarily of fabricated steel (coil, sheet, tube and I-beam), extruded aluminum, glass, and various adhesive and insulating components, are available from a number of sources.

 

Operations of the Company's RV Segment consist primarily of fabricating, welding, painting and assembling components into finished products, and tempering glass. The Company's RV Segment operations are conducted at 27   manufacturing and warehouse facilities throughout the United States and one in Canada, strategically located in proximity to the customers they serve. Of these facilities, 11   also conduct operations in the Company's MH Segment. See