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Winnebago Industries, Inc. (NYSE:WGO)

F3Q08 Earnings Call

June 20, 2008 10:00 am ET

Executives

Sheila Davis – Manager Public and Investor Relations

Bob Olson – Chairman, Chief Executive Officer, President

Sarah Nielsen – Vice President, Chief Financial Officer.

Analysts

Ed Aaron – RBC Capital Markets

John Diffendal – BB&T Capital Markets

Kathryn Thompson – Avondale Partners

Scott Stember – Sidoti & Company

Craig Kennison – Robert W. Baird & Co.

Bob Simonson – William Blair & Co.

Operator

Good day ladies and gentlemen and welcome to the third quarter 2008 Winnebago Industries’ conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Ms. Sheila Davis, Public and Investor Relations Manager. Please proceed ma’am.

Sheila Davis

Thank you Jasmine. Good morning and welcome to the Winnebago Industries’ conference call to review the company’s results for the third quarter of fiscal year 2008 ended May 31, 2008. Conducting the call today are Bob Olson, Winnebago Industries’ Chairman of the Board, Chief Executive Officer and President and Sarah Nielsen, Vice President, Chief Financial Officer.

I trust each of you have received a copy of the news release with our earnings results this morning. This call is being broadcast live on our website at WinnebagoInd.com. A replay of the call will be available on our website at approximately noon today central time. If you have any questions about accessing any of this information, please call our investor relations department at 641-585-6803 following the conference call.

Before we start, let me offer the following cautionary note. This presentation contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that forward-looking statements are inherently uncertain.

A number of factors could cause actual results to differ materially from these statements. These factors are contained in the company’s filings with the Securities and Exchange Commission over the last 12 months, copies of which are available from the SEC or from the company upon request. I’ll now turn the call over to Bob Olson. Bob.

Bob Olson

Thank you Sheila. Good morning and welcome to Winnebago Industries’ third quarter conference call. While our spring quarter is traditionally the strongest for Winnebago Industries and the RV industry, this year was certainly an exception. The motor home market has declined significantly with retail sales down double digit percents each of the last six months.

This significance in market decline has further accelerated in recent months. Retail sales of class A and C motor homes calendar year to date through April are down 26.1% while March and April, the last recorded by statistical surveys are down over 30%. In addition to the declining retail market, dealer are currently reluctant to replace sold units on their lots on a one-to-one basis as they reduce their inventories and focus on increasing their dealership turn rates.

Our dealer’s inventory of Winnebago, Itasca and Era brand products at the end of the third quarter was 4,341 units, a decrease of 5.7% for the third quarter last year and 10.3% less than dealer inventory at the end of the second quarter of fiscal 2008. We anticipate that dealers will continue to lower their inventories.

Once the dealers and their customers regain confidence in the economy, both wholesale and retail activity should once again pickup and those manufacturers and dealers who have survived this downturn will be in a great position to meet the next upswing in the cyclical industry of ours.

On a wholesale shipment basis, RVIA’s economist Dr. Richard Curtin from the University of Michigan has also revised calendar 2008 downward to 42,800 class A, B and C motor homes, a 23% decrease from actual shipments of 55,400 motor homes in calendar 2007.

As a result of these negative market conditions, and as I said in the news release this morning, we are very disappointed with our operating results for the third quarter. This quarter frankly was more than challenging. As we began the third quarter, we were optimistic the traditional spring market would return to us more favorable conditions.

When it became apparent in April and May that it wasn’t headed in that direction but rather deteriorating further, we were forced to make some very difficult decisions. First, we reduced production with three weeks of shutdown and nine weeks of shortened work schedules in the quarter.

This has enabled us to keep control of our finished goods inventories, but unfortunately, it didn’t address our overheard expense. It was also extremely challenging for our employees who haven’t had the benefit of a whole paycheck for most of the quarter. Consequently, as we announced on June 2, we will be idling our Charles City manufacturing facility by August 1, 2008, bringing the production of class C products back to our Forest City campus.

Secondly we have made further adjustments within the last few weeks to our workforce of salaried, direct and indirect employees in an effort to right size our organization to the current market demand. After August 1, when the Charles City manufacturing facility is idled, we will have reduced our employment level by approximately 850 people or 26% of our workforce through layoffs and attrition since the beginning of our fiscal year.

These have been extremely difficult decisions for us to make, but certainly necessary in the current environment. In addition, we continue our lean journey to drive out waste in our product and processes wherever possible and we continue to reduce budgetary expenses in an effort to match spending to current production volumes.

On the product development side, we continue to work diligently on new products. We have been very pleased with the reaction by our dealer partners and retail customers to our new Era class B motor home as it enters the marketplace.

We continue to ramp up production of the new fuel efficient Era and delivered 47 of these motor homes during the quarter compared to one in our previous quarter. We continue to have availability issues of the Sprinter van chassis which has limited our ability to meet our customer’s demands for this popular new product.

Our new 2009 motor homes were successfully introduced in May at our dealer days event in Las Vegas. We’ve broadened the product differentiation between Winnebago and Itasca brands for 2009 providing our dealer partners with new and exciting motor homes to fit each of their needs.

We introduced the newly redesigned Winnebago adventure class A gas motor home with exciting new floor plans and aggressive pricing. Our totally redesigned Itasca Sun Cruiser was also introduced. The Sun Cruiser is now more widely differentiated from the Adventurer and features unique new floor plans at a tremendous value.

We also made significant upgrades to our class A diesel products, particularly the Winnebago Destination and Journey as well as the Itasca Latitude and Meridian while holding the line on pricing.

We believe these changes will allow us to capture additional diesel market share as these products make their way into the marketplace. We also made some very positive changes to our class C product lines, particularly with the Winnebago Aspect and Itasca Cambria. In total, we have 78 floor plans for 2009, 46% of which are new or redesigned.

While we continue to be very bullish about the long term outlook for the RV industry, we remain concerned about the current economic environment and have yet to see signs of a motor home market recovery. Bad news dominates our newspaper and television coverage every day. So it’s certainly easy to understand our customer’s hesitancy to make a large discretionary purchase.

We will continue to monitor the economic conditions of the country and of our own industry and continue to make adjustments, whether that be in labor, facilities or other spending in an effort to right size to the demand of our customers. These tough decisions were made and will continue to be made to help us achieve our primary objective, which is to build quality motor homes profitably.

With that I’ll turn the call over to Sarah for the financial review. Sarah.

Sarah Nielsen

Thank you Bob, good morning everyone. I will now review with you the financial performance of the company’s third quarter of fiscal year 2008. Revenues for the third quarter were $139.7 million, a 39.7% decrease over the third quarter of 2007. The revenue decrease was primarily the result of unit delivery declines of 942 units or 36.7% and a decrease in the average selling price of 7.5%.

The decrease in the ASP was primarily due to the increase in rental unit sales as compared to last year of which the majority are class C products. Our gross profit margin was 1.9% for the third quarter compared to 11.3% for the same quarter last year. Gross profit was significantly impacted by the decrease in production and the resulting low absorption of fixed costs.

Also contributing to the decrease in gross profit margins were additional wholesale and retail promotions and increased class C mix due to more rental sales. Selling expenses were down $426,000 or 7.7% due to reduced bonus and advertising expenses. GA expenses decreased $1.6 million as compared to the same quarter last year due to reduced product liability and legal expense of $980,000 and a reduction in bonus expense of $800,000.

Unfortunately the reduction in operating expense of the 17.8% was not nearly as significant as our revenue decline and gross margin degradation. As a result, we incurred an operating loss of $6.9 million in the quarter as compared to operating income of $14.7 million last year.

Financial income decreased $746,000 over the prior year due to nearly $90 million less invested during the quarter. We did earn a slightly higher rate on these investments in this quarter.

During the third quarter significant tax benefits were also recorded that relate to the following three items. Approximately $4.2 million was recorded based on the favorable settlements of uncertain tax positions with various taxing jurisdictions. However, as a result of these settlements, estimated payments of $6.3 million will be made in the fourth quarter.

Secondly, the effective tax rate was reduced to 23% from 32% due to lower year to date pretax income which resulted in a reduction of the income tax previously recorded of $1.7 million. Lastly, benefits of $1.4 million were recorded due to tax planning initiatives that were recognized during the quarter.

In addition to these significant items, a tax benefit of $1.4 million was recorded on a quarterly pretax loss. Net income for the quarter was $3 million as compared to $11.3 million last year.

I will now highlight a few significant balance sheet items. Inventories have increased $9.8 million from the end of the fiscal year but have decreased nearly $18 million from the second quarter of 2008. This is primarily a result of reduced finished goods inventory which was down 34%, accomplished the reduced production during the quarter. Our casting inventory is down 6% from the end of the second quarter but still too high and efforts are ongoing to reduce this inventory position in the coming months.

In regards to our auction rate securities, we did see $11.6 million or 21.4% of liquidity to par value redemptions during the third quarter primarily made up of municipal bonds. We hold $42.6 million of par value auction rate securities as of May 31 of which we have recorded a temporary impairment of $2.5 million, approximately 6% against the assets.

We continue to classify these assets as long term due to the uncertainty of [inaudible] for the redemptions. Over 90% of our remaining portfolio consists of student loan auction rate securities of which we have experienced nominal redemption activity thus far. We don’t expect that we will have a similar level of liquidity out of these investments in our fourth quarter as we did in our third.

However, we do continue to earn a tax equivalent yield greater than what we are earning on our cash balances. We completed the quarter with $46.2 million in cash and cash equivalents. During the first 40 weeks of this fiscal year, cash generated in operations was $10.5 million as compared to $25.1 million of cash generated from our operations last year. Approximately $23 million was generated in the third quarter, primarily due to the reductions in inventories that I’ve already discussed.

I’ll now turn the call over to the operator for the question and answer portion of the call.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Ed Aaron – RBC Capital Markets.

Ed Aaron – RBC Capital Markets

First of all, it looks like you didn’t really maybe get your full share of the industry’s wholesale shipments this quarter, particularly in class A.

The class A numbers that you reported down I think over 50% on a units basis which is far worse than the industry and I realize that your retail share might be down a little bit, but it’s still kind of hard to reconcile and I was wondering whether you think it’s fair to say that your competitors are maybe overproducing in this environment while you’re maybe being more disciplined about what you’re putting into the channel.

Bob Olson

I don’t know if they’re overproducing but I think it’s a case where we know that our dealers that we talk to are still reducing their inventories. And I think you’ve got another dynamic out there that we’ve had several competitors go out of business the last few months. And I think you’ve got some of those products that are out there hitting the channel as well.

One of the things that we have watched very closely and you can see that by what we reduced our finished goods by, we are being very, very critical on ourselves not to build open inventory because we do feel that until this thing turns around and we get some good economic indicators out there that dealers are going to continue to lower their inventories.

And we think that they’re just being very, very conservative right now as far as ordering product. And we know from us for sure and we’re assuming that it’s probably from some of the other manufacturers as well.

Ed Aaron – RBC Capital Markets

Last quarter you mentioned with your inventories that I think you were targeting a number of $100 million or so or maybe even somewhat less than that by the end of the year and I was wondering if you were still on track for that?

Sarah Nielsen

Yes that is still our goal and it looks to be a feasible goal based on what we see now to be in the $100 million range by the end of the fiscal year.

Ed Aaron – RBC Capital Markets

You mentioned earlier about the companies that survive the downturn are going to be well positioned for the next cycle and just kind of wondering what you’re hearing out there in terms of, I mean we know of a few smaller companies that have kind of gone by the wayside here but I’m wondering what you’re hearing out there as far as anything more that maybe we haven’t heard about yet but you think might be coming.

Bob Olson

I haven’t heard anything specifically about any individual dealers or manufacturers. But I can tell you that we hear how tough it is out there. And if you don’t have your company on solid ground going into something like this, it’s going to be tough to be able to survive it.

There’s a lot of companies that weren’t making a lot of money when things were good and so when things get to the situation that they are right now, it’s going to make it that much more difficult to survive this.

One thing that I can tell you is that we were notified by Ford during the last couple of days that their chassis plants, they’ve extended their shutdowns, they’re going to be shut down from basically the last two weeks of June through August. And I think that really sets the tone for how difficult this industry is right now.

Operator

Your next question comes from John Diffendal – BB&T Capital Markets.

John Diffendal – BB&T Capital Markets

In terms of the capacity moves you’ve made and certainly I just want to sort of think through sort of post the plant mothballing next quarter. Given where the industry sort of run rate is today and class A’s or just general motor home business, with the moves taken here and then the other ones incrementally you mentioned, would you be profitable, would you view that your operating income while and being at a profitable level post these moves or are there still more to do?

Bob Olson

I think we’re still sorting that out. We’ve done a lot in a very short period of time and I know Sarah and her crew are going through the numbers now trying to identify, I guess we’re trying to let the dust settle so we know, is this enough or are we going to have to do more?

I think one of the variables that are out there right now are just want is the appetite of our dealers from a standpoint of ordering more versus reducing their inventories. And I think that’s a very difficult question that we’ve got right now.

You know you go back into the 90’s when things were probably more comparable to where we are today and you look at what the average inventories that were back then compared to today and I think there’s still room for inventory reductions.

And that doesn’t bode well for us or any of the other OEMs that are out there. Because the dealers are looking at it, they need to reduce their inventories in order to get the turn until this retail turns around.

And I know that’s a long about way to answer your question, but this thing is so volatile form a standpoint that there are so many variables that impact it that I really think that we’ve got to monitor this thing each day in order to figure out do we have enough cuts made or not.

John Diffendal – BB&T Capital Markets

Part of it, I think you mentioned that your utilization rate in the quarter was less than 35% but that was on the old configuration. I mean another way to ask it maybe is after the changes and sort of where you are today, what sort of utilization rate would you hope to be running at?

Bob Olson

Again, a tough question but preliminarily what we see right now, where we’re at and if nothing else changes from a demand standpoint, we think we’ll be up above 50% someplace.

John Diffendal – BB&T Capital Markets

Secondly, can you comment on the industry promotion and discounting environment? I guess we’ve had, Fleetwood announced recently they’re taking some promotions on their Sprinter chassis product line. Can you give us some general thoughts on what’s going on right at the moment in terms of discounting given the environment?

Bob Olson

I think we’re seeing an increase in discounting by everybody. I think everybody is looking for ways that they can stimulate this business to try and get people to buy. I’ll be first to admit, our discounting dollars are up, higher than I’d like to see them. But on the same hand, with the economic conditions that we’re in right now, if we don’t do something to try and stimulate the market, we could get left in the dust.

You know I hate spending those kind of dollars but on the same hand you’ve got to do something. And as difficult as it is, and John you read the newspapers and listen to the radio like I do, we’re not alone in this. I mean it’s auto industry, it’s the truck industry, it’s the boat industry, it’s anybody. There are very few segments out there that aren’t impacted by all of the issues that are going on with today’s economy.

John Diffendal – BB&T Capital Markets

Sarah you were breaking down the tax benefits, did I hear you correctly in saying that if you, just on a normal basis given where the loss was, the regular tax benefit would have been about $1.4 million?

Sarah Nielsen

That’s correct.

John Diffendal – BB&T Capital Markets

So what would that tax rate have been sort of before all the sort of moving around there?

Sarah Nielsen

We had a 23% effective tax rate, excluding all these other items that I touched upon. Now the fourth quarter brings a whole new situation for us as we’ve tentatively quantified restructuring costs which changes that dynamic even more so for us in the fourth quarter.

But it was a pretty complicated tax provision in regards to all the pieces we had going on. And so I expect that to be even more on a fiscal year to date perspective because of some of the other items that will be expensed in our fourth quarter for restructuring.

John Diffendal – BB&T Capital Markets

So a lower rate than the rate cumulatively through the first nine months?

Sarah Nielsen

That’s correct.

Operator

Your next question comes from Kathryn Thompson – Avondale Partners.

Kathryn Thompson – Avondale Partners

First on gross margins, how much was the year over year decline driven by volume versus promotions? And you don’t have to give a specific number but just give us a sense of proportion for each of those two key components. And then also, mix, how much mix was a factor of that?

Sarah Nielsen

We look at the majority in regards to the production and the lower fixed cost absorption, about 60% of our decline was associated to that challenge in our quarter. On the promotional side, that had about a 20% impact to our margins. And then lastly the mix and the pricing and even to a lesser extent inflation is really the balance of that.

Kathryn Thompson – Avondale Partners

And speaking of raw material pricing, I know it’s just yet another issue that you have to deal with. How have you been able to manage rising steel prices in particular and have you been able to pass those prices along?

Sarah Nielsen

Well we just came out with the pricing for the model year 2009 products this spring and we always incorporate into the pricing process an element of estimation on inflationary pressures that we anticipate, materials and labor, etc. So we’re on the early side of that, that helps mitigate what we’re seeing.

But in our normal process is if we see more escalation, we’re going to have to consider some type of adjustment. We always do have adjustments that happen later in the year in regards to new model year chassis entries and some of that happens in August through October timeframe, depending on which chassis manufacturer we’re talking about.

But it was not that long ago, it was I think November of 2006 we had a midyear price adjustment. That has been our approach in the past and you’re right, the prices that we’re seeing are very significant and just a very short amount of time span. So it’s something that we’re closely watching to determine our next step.

Kathryn Thompson – Avondale Partners

As far as capacity utilization because I think you had indicated earlier in the Q&A with John that after the Charles City closure, assuming the current run rate remains unchanged, your capacity utilization would be just above 50%? I wanted to confirm that.

Bob Olson

Yes, probably just a little bit above 50%. It would be in that range, yes.

Kathryn Thompson – Avondale Partners

And what is your capacity utilization about now?

Bob Olson

As we reported in the release, we ran third quarter about 35%.

Kathryn Thompson – Avondale Partners

I just wanted to make sure it wasn’t any different than what was in the release. I know you talked about Ford taking that big chunk of time off and that’s something that we definitely heard when we recently visited some plants in Northern Indiana, how much time did you take off in June in total and how much time do you anticipate taking off. I know it’s very difficult to quantify, but could you see something similar to what Ford is doing?

Bob Olson

I hope not, not that long anyway, I mean they’re down a long time. You know one thing I will tell you is that right now we’ve already, and I think it’s been in some of the publications that we’ve announced that we are going to take an additional week at our normal summer shutdown. You know we always have one week and we’ve extended that to two.

One of the reasons why we shut or idled Charles City was that our hope is is that we can get our capacity capabilities in line more with demand and we want to be able to try and run five day weeks on the three remaining lines and staff accordingly so we can give our employees full week paychecks.

And that’s been very difficult for us because not only do we have the people, it’s been gut wrenching to tell them that they don’t have a job because of no fault of their own. But the other side that doesn’t get a lot of publication is that we’ve got several hundred employees here that don’t get to take home a full week paycheck.

And with gas prices going up the way they are, food prices going up the way they are, my hats off and thanks to our employees because as tough as that pill is to swallow, I think they understand. And so that’s our goal is we’re going to do everything we can to try and right size so we can operate on 40 hour weeks and hopefully earn a profit doing that.

Kathryn Thompson – Avondale Partners

Would you say that the current slowdown has already eclipsed the slowdown we saw in the early 90’s? And would you liken it closer to what we saw in the late 70’s and early 80’s?

Bob Olson

I’ve been asked that question a lot probably in the last couple years and I’ve kind of answered that that I don’t think it’s as bad as we’ve seen it in the past. I’m starting to change my mind a little bit. I think it is now starting to get to a point, I’m not so sure it’s to the point where we were back in the late 70’s, early 80’s, but I think they’re on par with what we saw in the 90’s.

Operator

Your next question comes from Scott Stember – Sidoti & Co.

Scott Stember – Sidoti & Company

Sarah could you give us what the ASPs were by class versus last year?

Sarah Nielsen

For class A gas, in the third quarter of 08 our ASP was $85,045. Last year it was $87,462, it’s down approximately 2.3%. For class A diesel, our average price this year was $174,718, last year $157,599, so it’s up 10.9%. Our average class A based on the volume and the mix, it was $107,646 versus $108,865, down 1.1%. From a class C standpoint, we’re at $60,647 versus $60,229, slightly up 0.7%. Average A’s and C’s, $78,733 versus $84,859, down 7.2%. And our class B ASP is $69,426 and overall we’re looking at $78,464 versus $84,859, down 7.5% I mentioned earlier.

Scott Stember – Sidoti & Company

Could you just go over the tax issue again? The fourth quarter what we could expect to see as a tax rate and also maybe excluding any benefits and what would be a normalized tax rate to assume for fiscal 2009?

Sarah Nielsen

In the third quarter we had quite a few significant items that we don’t expect to be part of our fourth quarter. As I touched upon we had a $4.2 million recognized or is based on favorable settlements on some of our uncertain tax positions. And that was an item that we had discussed in our Q and our second quarter conference call that could happen in the next 12 months and it did all happen here in the third quarter.

We did have a pretty large true up moving our effective rate down from 32% to 23% and then also we had some tax initiatives that were recognized in the quarter based on efforts that have been ongoing. On a prospective basis, because we have a restructuring charge that has ranged anywhere from $2.5 to $5.5 million, that’s going to further complicate the tax rate for our fourth quarter.

So I expect that to drop yet again in our fourth quarter. On a normalized basis, when we look at fiscal 2009, I would expect it to return to levels we have been historically in that 33% range on a prospective basis. But it is fairly complicated here in the third and fourth quarter due to these unusual items and then further complicated by the operating loss positions.

Scott Stember – Sidoti & Company

Could you talk maybe a little bit about the view in the Navion, that’s been one of the bright spots or few bright spots over the last year or so. Are you starting to see some weakness similar to the rest of the class C market there?

Bob Olson

I think a little bit and primarily that’s due to general economy. You know I don’t care if it’s View or a Vectra, people are looking people are looking out, I think they’re hunkering down and so we’ve seen some degradation just because of the general economic conditions. But you know the other side of the equation is we’ve got a lot of competition in that category now.

We’ve got several manufacturers that have not been able to get that chassis in the past and they now do have it and they’ve come out with some products and some of them are being very aggressive on pricing and so it’s not a standalone product anymore, it’s got to go out there and fight for its place in market share.

So we are seeing some things there but I will say that we continue to look for ways to exploit that chassis because we think that that is a good product for this industry right now with the fuel economy issues that are out there. And we just introduced our Era product which is on the van chassis of the Daimler Chrysler’s Sprinter product and if we could get the chassis in the quantities that we want, we think that that would help our profit situation immensely.

But they are on worldwide allocation and we can’t get them. The other thing that I will say is that just because we’ve introduced the View and the Navion, we don’t sit on our hands, we’re looking at other ways that we can take that chassis and bring new products out to the market as well. So stay tuned.

Operator

Your next question comes from Craig Kennison – Robert W. Baird & Co.

Craig Kennison – Robert W. Baird & Co.

The first question has to do with the additional consolidation opportunities you mentioned in your press release. Obviously given that it’s a separate location, Charles City was a more obvious choice. But could you talk about other opportunities you could have to reduce cost?

Bob Olson

I think there’s several things that we’re currently looking at and doing as the news release said that we’ve had some additional reductions in both salaries, hourly and indirect employees and that’s obviously the first place that you can look. But you have to be extremely careful with that so you don’t start cutting into muscle instead of just fat.

But we’ve got, as you know Craig, we’re very vertically integrated and in good times that’s a very positive for you, in bad times it’s a lot of overhead that you’ve got to absorb. You know we’re continuing to look at different things that we might be able to do in the future, whether that be consolidation of processes, maybe even consolidation of facilities. We don’t know yet.

But like I tell my staff, there are no sacred cows out there and we’re going to look at every nook and cranny to try and get our cost structure to where it needs to be to be profitable.

Craig Kennison – Robert W. Baird & Co.

It seems like you have an opportunity to regain significant market share in the diesel category if others exit and some of your strategies pan out. What would you say is the key to regaining share in the diesel market and when would we most likely see the impact in the statistical survey data?

Bob Olson

I think the obvious answer to that Craig is the product has got to be right. And you know I’ve said this probably in the last three conference calls is I don’t think we did a very good job of getting two the products that we offer in the diesel category, I don’t think we did a very good job of getting them right out of the chute and that’s obviously the Destination, the Latitude and the Journey and the Meridian.

You know we took a gamble and we lost. We are in the process of still getting those through the retail chain. But we did introduce the Destination and Latitude and Journey and Meridian with a lot of changes at our dealer day activities out in Vegas this year. And I can tell you that the dealers seemed to receive it very, very well.

You know we put a new front end and I may be a little biased but I think the front end that we put on the Destination and Latitude is one of the best looking front ends that we’ve got on any of our produce lineups. And then probably the biggest thing that we did was we did go back to conventional cabinetry with the curved European look as being optional.

And we had to learn a hard lesson that the buyer of that product is looking more for a traditional type interior than he is something that’s probably more contemporary. So we’ve done a lot of things and probably one of the biggest things on all of our diesel products in 2009 is we’ve held the line on pricing. There’s very few, especially in today’s economy that can stake claim to that.

And we think that those, there’s several different things there that we think might give us a leg up in the diesel market share. The answer to your question, when we’ll start seeing that, a lot of its going to depend on the general economy, when people really start buying again. It’s also going to depend on if there’s any other manufacturers that go out of business and have fire sales.

It also depends on what kind of discounting goes on. I mean this could end up being a discounting war and which a war I don’t want to fight. But it may come to that. So there’s a lot of variables that are beyond our control right now that could impact when we see market share gained in the diesel product. But we’ve got every intention to try and get some of that market back.

Craig Kennison – Robert W. Baird & Co.

With respect to gross margin, that’s a number that fluctuates a great deal with absorption being one issue and then pricing being another. Can you give us any sense for where you see that headed in the fourth quarter given some of the charges you’re taking and sort of longer term given that yes you’re cutting your capacity but you’ve also decided to be more price conscious on some of your higher margin products.

Sarah Nielsen

In regards to our fourth quarter, because the Charles City and the date that we’re going to have that idled on the first of August, we’re going to have two months in our quarter where those costs are still part of our structure. The fourth quarter is going to be a challenging one in that regard as we work through that process.

We do plan to segregate all of the restructuring related costs in one line item so you see that on a standalone basis. But we’re going to have one month of benefit. And in regards to some of these other things that we’re doing right here in June, there’s more benefits to be had and the goal is to improve what you see here in the third quarter.

So I agree with you, it’s a pretty volatile number when you look at where we are here in the third quarter. But the other challenge for us is in regards to what dealers do do on their inventory positions.

Because that’s where we have I think the biggest challenge on a prospective basis and where is the right level for that amount of inventory to be in our dealer locations and are they going to continue to pull it down or is there a stabilization here in the coming months?

And that’s a hard one to really I guess identify what the right number is. As Bob commented earlier, the 90’s, our dealer inventory was at a lower than where we’re at now. And if we’re really at the 90’s kind of demand or wholesale market, there’s more decline that we need to have that at the right spot.

Bob Olson

I think the other thing that we can’t lose sight of is that it’s going to be a tough remaining calendar 2008. You know we all talk about volatility in fuel prices, we talk about the lending situation where it’s tougher to get credit right now. You’ve got the situation with the election.

You’ve got the housing issue that’s going on. But there’s other things out there that I’m equally concerned about, one being what Sarah just talked about, is you know how far are our dealers going to take their inventories down. Because when they’re taking their inventories down, they’re not ordering from us.

The other thing that hasn’t got a lot of discussion here lately and I’m very, very concerned about it is the fact that I think unemployment rates are going to start to increase and when unemployment rates increase, that means that they don’t have that discretionary income to buy our products. So I think this whole industry is in for a tough go for the balance of calendar 2008.

Craig Kennison – Robert W. Baird & Co.

Related to your cost structure, what would you say your fixed cost structure was prior to the Charles City plant idling and what do you think it will be annualized post that closing in rough figures?

Sarah Nielsen

When you looked back before we made that decision, our fixed costs on an annual basis have been in that $48-$50 million range. The savings that we’re anticipating seeing out of a lot of activities this year, not only with Charles City, we’re looking at reducing that on I would say in a range of $3-$5 million. We’re pulling out of other lines as well in regards to some of the fixed natures and G&A in selling.

We have some improvement on that we’re planning on that on a prospective basis. So the challenge is that the proportion of what we’re doing there isn’t matching up with the revenue declines. So we’re really nowhere, in a state of, is this enough? Have we done enough?

Craig Kennison – Robert W. Baird & Co.

Would it be that difficult, I’m sure it would, but, you’re closing 30% of the capacity and the resulting savings is only $3-$5 million, would it be much more difficult to find another $3-$5 million if market conditions dictated that?

Sarah Nielsen

I think it will be critical, that is our goal and objective to right size this so that we are a profitable organization.

Bob Olson

To answer your question, yes it’s going to be very difficult but we’re going to figure out a way to find that and if necessary we’ll take the appropriate actions to get this place right sized so we meet our goals and as I said before, we want to build a quality product profitably.

Sarah Nielsen

And we’re talking a lot here in regards to cutting, but that’s not the only focus of our efforts. You know really ideally the way is to look for new opportunities that present itself to us, be it new products. And that is, we’re not losing sight of that and there are a lot of things in place in regards to our future on the product category standpoint that is still a significant focal point. And that will have to play itself out, but we aren’t ignoring, that’s really where our two opportunities lie.

Bob Olson

I think the other thing along those lines is as you know, we’re very vertically integrated. And we’ve got all of our plant managers going up, trying to beat the bushes to see if there’s things that they can do in their field of expertise to maybe pick up some revenues as well.

So I think the question was asked before, is all this vertical integration a good thing or a bad thing, it does give you some opportunities if you can find the business. One of the challenges that we have is the fact that there’s very few industries or businesses or sectors in this country right now that are not negatively impacted by the economy.

And so what we’re trying to do is figure out where are those niches that we can get in that we could bring in some additional business into our support facilities and possibly generate some revenues, because it’s difficult to cut your way to prosperity. And so we want to take a more proactive look at the thing and try to generate additional business.

Operator

Your next question comes from Bob Simonson – William Blair & Co.

Bob Simonson – William Blair & Co.

I know Bob you referred to, we’ve got to let the dust settle to see whether we need more or whether we’ve done enough. But can either of you give a guesstimate as to a range or level of sales that you need to be at break even on an operating basis?

Sarah Nielsen

We do that internal calculation very frequently. And we look at it a number of ways in regard to revenues, and we look at it on a unit basis. And because our cost structure in regards to some of the changes we’ve made is going to be different on a prospective basis, that is moving around. But you know in a simple answer to that question, $500 million is a pretty critical revenue point on an annual basis.

Bob Simonson – William Blair & Co.

On the tax settlement that you had, the $4.2 million, was that, is there a cash change in that, did you get money or is it a change, reversing an account?

Sarah Nielsen

When we adopted a new accounting standard in the first quarter, we had to establish a reserve for uncertain tax positions that was significantly greater than what we had had historically. So that is a reversal of a reserve. But it does have an element of a cash outflow as I commented, we’ll have to be making $6.3 million of payments in our fourth quarter. So there’s I guess there’s two elements there in regards to that event. It is not a cash [inaudible] for us.

Bob Simonson – William Blair & Co.

Your G&A came down significantly from first and second quarter levels and from a year ago third quarter level. How much does that move in the fourth quarter? If it’s just under $4.5 million in the third quarter, is there, does it stay there, does it go up to $5 million?

Sarah Nielsen

I commented on that two specific items that really were decreasing our G&A in the quarter over last year. One was positive experienced or reduction in product liability and legal expenses comparatively. That is driven by our history and that is something that can move around a bit. But we’ve had a lot of positive trends.

And the other side of that was from a bonus standpoint. Obviously there aren’t any bonus expenses or accruals to be had in this fiscal year. And last year we had met the objectives to some degree.

And so you’re going to still see that dynamic in the fourth quarter where I anticipate it to be lower in regards to that because on an annual basis I don’t anticipate there’s going to be an opportunity there. So I don’t think there’s going to be a lot of significant dynamic changes between the fourth quarter this year and last year. You’re going to see it down year over year.

Bob Simonson – William Blair & Co.

So if I heard you correctly, it’s the fourth quarter could be higher than the third quarter expense but lower than the fourth quarter of last year?

Sarah Nielsen

I guess my point is that I would anticipate it’s still going to be down year over year in regards to the bonus side. On the other items in regards to product liability and legal, that will be a function of the event that happened in the quarter, but I don’t anticipate it to be significantly different from what we saw in the third.

Bob Simonson – William Blair & Co.

You’ve been asked a couple times about the competitive situation and the other manufacturers, you have some very strong and large dealers, you probably have some smaller ones too. How would you asses them as opposed to the manufacturers? Is the industry losing dealers? Might some of the larger ones go or get out of the business?

Bob Olson

Right now we think that we’ve got some of the strongest dealers in the industry in the Winnebago fold. But I think we’d be remiss to say that that exposure isn’t there. I think in these tough times you’ve always got an increased exposure for dealers going under. Now we’ve had a couple small ones that have run into some trouble, but nothing major. And we’ve not heard anything from our large dealers where they’re in any financial difficulties that we know of right now.

You know I can’t say that for some of the competitive dealerships that are out there, but I can only speak for Winnebago’s. And that’s one of the reasons why all along our strategy is is to align ourselves with some of the strongest dealers that are out in the marketplace. And that was one of our main topics at dealer days is that right now in times like these, I think it’s fair to say that both dealer and manufacturer want to align themselves with the strongest possible partner they possibly can.

And that’s why we’ve always taken that stance to align ourselves with the strong dealers and hopefully dealers look at that and want to align themselves with a strong partners which I think Winnebago fits that bill. And our hope is down the line that some of these other OEMs start to struggle that maybe some of our dealers will start dropping their product lines and align themselves more specifically with Winnebago or Itasca.

Bob Simonson – William Blair & Co.

When some of these small ones that did handle your product, when they decide to close down, don’t the finance, the floor plan folks, do they have recourse back to you on those units?

Sarah Nielsen

We have a guarantee repurchase obligation with many of the financial institutions that floor our dealer’s products. And the terms are such that if a dealer defaults, and inventory on their lot is one year or less, up to one year old and inventory is repurchased, we will buy that inventory back at pre-agreed percentages or values.

If it’s six months old or less, we’ll pay 100% of invoice, assuming the condition of the product is not changed. If it’s six to nine months, we’ll pay 90% of the invoice and if it’s nine to 12 we’ll pay 80%. So yes we have an obligation in those instances and that’s been a fairly rare occurrence for us in the last five to ten years but it does happen from time to time.

And I agree with Bob that in an environment like this, there’s probably more risk but we haven’t seen a dramatic change in that activity as of yet. And we do resell that inventory, it’s just resold to other existing dealers. And so the losses that we’ve incurred have typically been very nominal in regards to our activity, our history.

Operator

Your last question comes from Ed Aaron – RBC Capital Markets.

Ed Aaron – RBC Capital Markets

I’m just trying to understand how to think a little bit more about the fourth quarter. Obviously it’s a difficult environment and it’s going to be a tough quarter, but just a couple of questions about it. First, does the restructuring charge that you’ve talked about account for the inefficiencies that you’re going to experience in that consolidation process or is it somehow separate to that?

Sarah Nielsen

Items that we can identify from a restructuring standpoint would be the potential impairments if we do determine that there is a valuation write down on the facility itself for the idling. And then if there are costs associated with a specific event, such as severance, the inventory that we would maybe need to move back to Forest City or equipment.

But that is the extent of what we can include in restructuring. Other items like you’re touching upon, the two months that we will still have that plant up and running, you’re accurate to say that that’s probably not going to be as efficient. And in light of the activities that are taking place and that’s going to have to be part of costs of goods sold.

Bob Olson

That’s a great question because what you’re going to find here is you’re brining into the Forest City fold a new product that they haven’t seen in five years. There’s going to be a learning curve there. We’re going to have some inefficiencies until we get up to speed on how to build some of these C bodies that we’re bringing over to Forest City. Like Sarah says, that will just come as a variance in our normal day to day operations.

Sarah Nielsen

I would say that we historically have built primarily class C in Charles City. A lot of those products had been built in Forest City from time to time and we are very flexible in regards to our ability to produce at either location. There is one particular product that hasn’t been in Forest City for many years that will be new and there’s a learning curve associated with that.

But two of the other product categories we’ve had over here even just a few months ago. So some of that is going to be stuff that some lines over here have seen before. It adds in, there’s just going to be a lot more complexity, more different models to run down three lines here.

Ed Aaron – RBC Capital Markets

And what impact does the model year changeover have on the numbers? Because essentially you’re keeping prices flat in the new model year with input costs that are going up and even in some cases the addition of more content on the coaches. So is that going to be something that hopefully will translate into somehow better sales volume but absent that, is that something that you think is going to be, create more of a headwind on the gross margin relative to what you even might have seen in the most recent quarter?

Sarah Nielsen

One clarification I would want to make is that was a strategy specific to diesel in regards to really having a competitive price point and not having an increase over last year. In the gas lineup, there were some changes in regards to the offerings with the Adventurer specifically and the Sun Cruiser. But the diesel is really where we highlighted on holding the prices.

The rest of the products, we really used the same assumptions and models that we normally have that had that element of the inflationary pressures we’re baking in to kind of add for the next year and that is primarily hitting our third quarter in the month of May and our fourth quarter is entirely all the new model year product.

And that dynamic is similar. In some years there’s been pretty significant chassis changes or elements that really increased the price. And we saw that in our diesel lineup last year and we also saw it with the diesel class C products where that price went up to some degree associated with the chassis that we produced on.

But that is going to make its way through, our strategy on the diesel side is the added volume and to be more competitive in the marketplace, was going to be much more of a benefit to us than the offsetting pricing decision that we are making. And we’re going to see how that plays out in our fourth quarter and if that’s going to be an effective strategy there.

Ed Aaron – RBC Capital Markets

Obviously I know you guys don’t really give guidance, but I’m curious to get your thoughts on the probability that you would assign to being positive on a gross profit basis in the fourth quarter.

Sarah Nielsen

In the third quarter we were positive, barely at 1.9%. We’re making all these changes to move that needle back up so our gross profit on a percentage basis going forward is more similar to the levels we’ve been. We can’t do it all immediately on the first day of the fourth quarter. But that is our goal to move that back up and really see the significant benefits in fiscal 09 more so than we will in the fourth quarter.

Operator

There are no further questions.

Bob Olson

I’d like to thank everyone for joining Winnebago Industries’ conference call today and we look forward to talking with you in October when we report our fourth quarter and fiscal 2008 results. Thank you.

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Source: Winnebago Industries, Inc. F3Q08 (Qtr End 05/31/08) Earnings Call Transcript
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