MONACO COACH CORP /DE/ - 10-Q Quarterly Report

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

ý Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the period ended: October 2, 2004

o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the period from to

Commission File Number: 1-14725

MONACO COACH CORPORATION

Delaware		35-1880244
(State of Incorporation)		(I.R.S. Employer
		Identification No.)

91320 Industrial Way

Coburg, Oregon 97408

(Address of principal executive offices)

Registrant’s telephone number, including area code (541) 686-8011

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 ý NO o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

YES ý NO o

The number of shares outstanding of common stock, $.01 par value, as of October 2, 2004: 29,414,436

MONACO COACH CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited: dollars in thousands, except share and per share data)

	January 3, 2004		October 2, 2004
ASSETS
Current assets:
Cash	$	13,398	$	8,406
Trade receivables, net	89,170		129,314
Inventories	127,746		162,595
Resort lot inventory	13,978		8,241
Prepaid expenses	3,029		5,700
Deferred income taxes	33,836		33,650
Total current assets	281,157		347,906

Property, plant, and equipment, net	141,662		138,928
Debt issuance costs net of accumulated amortization of $815, and $1,200, respectively	596		277
Goodwill	55,254		55,254
Total assets	$	478,669	$	542,365

LIABILITIES
Current liabilities:
Current portion of long-term note payable	$	15,000	$	15,000
Accounts payable	64,792		96,328
Product liability reserve	20,723		20,595
Product warranty reserve	29,643		34,027
Income taxes payable	3,395		6,826
Accrued expenses and other liabilities	26,373		32,635
Total current liabilities	159,926		205,411

Long-term note payable	15,000		3,750
Deferred income taxes	17,495		18,141
	192,421		227,302

STOCKHOLDERS’ EQUITY
Preferred stock, $.01 par, 1,934,783 shares authorized, no shares outstanding
Common stock, $.01 par value; 50,000,000 shares authorized, 29,246,143 and 29,414,436 issued and outstanding, respectively	292		294
Additional paid-in capital	54,919		56,829
Retained earnings	231,037		257,940
Total stockholders’ equity	286,248		315,063
Total liabilities and stockholders’ equity	$	478,669	$	542,365

See accompanying notes.

MONACO COACH CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited: dollars in thousands, except share and per share data)

	Quarter Ended						Nine-Months Ended
	September 27, 2003			October 2, 2004			September 27, 2003			October 2, 2004

Net sales	$	303,231		$	358,869		$	845,113		$	1,071,619
Cost of sales	266,458			315,454			747,534			938,073
Gross profit	36,773			43,415			97,579			133,546

Selling, general, and administrative expenses	25,667			31,036			77,060			82,556
Operating income	11,106			12,379			20,519			50,990

Other income, net	11			43			502			256
Interest expense	(767		)	(370		)	(2,558		)	(1,147		)
Income before income taxes	10,350			12,052			18,463			50,099

Provision for income taxes	4,088			4,616			7,293			18,792

Net income	$	6,262		$	7,436		$	11,170		$	31,307

Earnings per common share:
Basic	$	.22		$	.25		$	.38		$	1.07
Diluted	$	.21		$	.25		$	.38		$	1.04

Weighted average common shares outstanding:
Basic	29,080,716			29,410,086			29,021,742			29,354,598
Diluted	29,625,959			29,962,722			29,478,842			29,981,063

See accompanying notes.

MONACO COACH CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited: dollars in thousands)

	Nine-Months Ended
	September 27, 2003			October 2, 2004

Increase (Decrease) in Cash:

Cash flows from operating activities:
Net income	$	11,170		$	31,307
Adjustments to reconcile net income to net cash (used) provided by operating activities:
Loss on sale of assets	20			240
Depreciation and amortization	7,202			8,029
Deferred income taxes	4,297			832
Changes in working capital accounts:
Trade receivables, net	11,075			(40,144		)
Inventories	43,467			(34,849		)
Resort lot inventory	4,712			5,737
Prepaid expenses	724			(2,679		)
Accounts payable	(551		)	31,536
Product liability reserve	(696		)	(128		)
Product warranty reserve	(2,769		)	4,384
Income taxes payable	(2,440		)	3,431
Accrued expenses and other liabilities	633			6,262
Net cash provided by operating activities	76,844			13,958
Cash flows from investing activities:
Additions to property, plant, and equipment	(16,969		)	(7,069		)
Proceeds from the sale of assets	2,051			1,927
Proceeds from the sale of Naples property	6,650			0
Net cash used in investing activities	(8,268		)	(5,142		)
Cash flows from financing activities:
Book overdraft	1,206			0
Payments on lines of credit, net	(51,413		)	0
Payments on long-term notes payable	(19,500		)	(11,250		)
Debt issuance costs	(304		)	(66		)
Dividends paid	0			(4,404		)
Issuance of common stock	1,435			1,912
Net cash used by financing activities	(68,576		)	(13,808		)
Net change in cash	0			(4,992		)
Cash at beginning of period	0			13,398
Cash at end of period	$	0		$	8,406

See accompanying notes.

MONACO COACH CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The interim condensed consolidated financial statements have been prepared by Monaco Coach Corporation (the “Company”) without audit. In the opinion of management, the accompanying unaudited financial statements contain all adjustments necessary, consisting only of normal recurring adjustments, to present fairly the financial position of the Company as of January 3, 2004 and October 2, 2004, and the results of its operations for the quarters and nine-month periods ended September 27, 2003 and October 2, 2004, and cash flows of the Company for the nine-month periods ended September 27, 2003 and October 2, 2004. The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, and all significant intercompany accounts and transactions have been eliminated in consolidation. The balance sheet data as of January 3, 2004 was derived from audited financial statements, but does not include all disclosures contained in the Company’s Annual Report to Stockholders. These interim condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto appearing in the Company’s Annual Report to Stockholders for the year ended January 3, 2004.

2. Inventories

Inventories are stated at lower of cost (first-in, first-out) or market. The composition of inventory is as follows:

	January 3, 2004		October 2, 2004
	(in thousands)
Raw materials	$	60,946	$	72,987
Work-in-process	60,604		70,014
Finished units	6,196		19,594
	$	127,746	$	162,595

3. Line of Credit

The Company’s line of credit facility consists of a revolving line of credit of up to $95.0 million (the “Revolving Loan”). At the election of the Company, the Revolving Loan bears interest at variable rates based on the Prime Rate or LIBOR. At October 2, 2004, the interest rate was 4.75%. The Revolving Loan is due and payable in full on June 30, 2005, and requires monthly interest payments. The balance outstanding under the Revolving Loan at October 2, 2004 was zero. The revolving line of credit is collateralized by all the assets of the Company. The agreement contains restrictive covenants as to the Company’s leverage ratio, current ratio, fixed charge coverage ratio, and tangible net worth. As of October 2, 2004, the Company was in compliance with these covenants.

4. Long-term Notes Payable

The Company has long-term notes payable of $18.8 million outstanding at October 2, 2004. The term notes bear interest at varying rates that fluctuate based on the Prime rate or LIBOR, and are determined based on the Company’s leverage ratio. The term notes require monthly interest payments and quarterly principal payments and are collateralized by all the assets of the Company. Additional prepayments for portions of the term notes are required in the event the Company sells substantially all or any motor coach resort locations. The term notes are due and payable in full on October 3, 2005.

The following table displays the scheduled future principal payments by fiscal year that will be due on the term loan.

Year	Amount of Payment Due
	(in thousands)
2004	$	3,750
2005	15,000
	$	18,750

5. Earnings Per Common Share

Basic earnings per common share is based on the weighted average number of shares outstanding during the period. Diluted earnings per common share is based on the weighted average number of shares outstanding during the period, after consideration of the dilutive effect of stock options. The weighted average number of common shares used in the computation of earnings per common share are as follows:

	Quarter Ended		Nine-Months Ended
	September 27, 2003	October 2, 2004	September 27, 2003	October 2, 2004
Basic
Issued and outstanding shares (weighted average)	29,080,716	29,410,086	29,021,742	29,354,598

Effect of Dilutive Securities
Stock Options	545,243	552,636	457,100	626,465
Diluted	29,625,959	29,962,722	29,478,842	29,981,063

6. Stock Option Plans

At October 2, 2004, the Company had three stock-based employee compensation plans. The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123, Accounting for Stock-based Compensation, to stock-based employee compensation.

	Quarter Ended									Nine-Months Ended
	September 27, 2003							October 2, 2004		September 27, 2003		October 2, 2004

Net income - as reported	$						6,262	$	7,436	$	11,170	$	31,307
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects	194							236		532		574
	$					6,068		$	7,200	$	10,638	$	30,733

Earnings per share:
Basic - as reported	$				0.22			$	0.25	$	0.38	$	1.07
Basic - pro forma	$			0.21				$	0.24	$	0.37	$	1.05

Diluted - as reported	$		0.21					$	0.25	$	0.38	$	1.04
Diluted - pro forma	$	0.20						$	0.24	$	0.36	$	1.03

7. Commitments and Contingencies

Repurchase Agreements

Many of the Company’s sales to independent dealers are made on a “floor plan” basis by a bank or finance company which lends the dealer all or substantially all of the wholesale purchase price and retains a security interest in the vehicles. Upon request of a lending institution financing a dealer’s purchases of the Company’s product, the Company will execute a repurchase agreement. These agreements provide that, for up to 18 months after a unit is shipped, the Company will repurchase a dealer’s inventory in the event of a default by a dealer to its lender.

The Company’s liability under repurchase agreements is limited to the unpaid balance owed to the lending institution by reason of its extending credit to the dealer to purchase its vehicles, reduced by the resale value of vehicles which may be repurchased. The risk of loss is spread over numerous dealers and financial institutions.

The approximate amount subject to contingent repurchase obligations arising from these agreements at October 2, 2004 is $580.4 million, with approximately 6.2% concentrated with one dealer. If the Company were obligated to repurchase a significant number of units under any repurchase agreement, its business, operating results, and financial condition could be adversely affected. The Company has included the disclosure requirements of FASB Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” in its financial statements, and has determined that the recognition provisions of FIN 45 apply to certain guarantees routinely made by the Company including contingent repurchase obligations to third party lenders for inventory financing of dealer inventories. The Company has recorded a liability of approximately $750,000 for potential losses resulting from guarantees on repurchase obligations for products shipped to dealers. This estimated liability, is based on the Company’s experience of losses associated with the repurchase and resale of units in prior years. If the Company were obligated to repurchase a significant number of units under any repurchase agreement, its business, operating results, and financial condition could be adversely affected.

Product Liability

The Company is subject to regulations which may require the Company to recall products with design or safety defects, and such recall could have a material adverse effect on the Company’s business, results of operations, and financial condition.

The Company has from time to time been subject to product liability claims. To date, the Company has been successful in obtaining product liability insurance on terms the Company considers acceptable. The terms of the policy contain a self-insured retention amount of $500,000 per occurrence, with a maximum annual aggregate self-insured retention of $3.0 million. Overall product liability insurance, including umbrella coverage, is available to a maximum amount of $100.0 million for each occurrence, as well as in the aggregate. There can be no assurance that the Company will be able to obtain insurance coverage in the future at acceptable levels or that the cost of insurance will be reasonable. Furthermore, successful assertion against the Company of one or a series of large uninsured claims, or of one or a series of claims exceeding any insurance coverage, could have a material adverse effect on the Company’s business, results of operations, and financial condition.

Litigation

The Company is involved in various legal proceedings which are incidental to the industry and for which certain matters are covered in whole or in part by insurance or, otherwise, the Company has recorded accruals for estimated settlements. Management believes that any liability which may result from these proceedings will not have a material adverse effect on the Company’s consolidated financial statements.

Aircraft Lease Commitment

The Company has an aircraft under an operating lease, with annual renewals for up to three years. Currently the Company began its first year of renewal in February 2004, with two optional years remaining. If at the end of the initial lease period the Company elects to return the aircraft, the Company has guaranteed up to $16 million in the event the lessor’s net sales proceeds are less than $18.5 million.

2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements include, but are not limited to, those below that have been marked with an asterisk (*). In addition, statements containing words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “seeks,” and variations of such words and similar expressions are intended to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to differ materially from those expressed or implied by such forward-looking statements, including those set forth below under the caption “Factors That May Affect Future Operating Results” and elsewhere in this Quarterly Report on Form 10-Q. The reader should carefully consider, together with the other matters referred to herein, the factors set forth under the caption “Factors That May Affect Future Operating Results.” We caution the reader, however, that these factors may not be exhaustive.

GENERAL

Monaco Coach Corporation is a leading manufacturer of premium Class A and Class C motor coaches and towable recreational vehicles (“towables”). Our product line currently consists of a broad line of motor coaches, fifth wheel trailers and travel trailers under the “Monaco,” “Holiday Rambler,” “Royale Coach,” “Beaver,” “Safari,” and “McKenzie” brand names. Our products, which are typically priced at the high end of their respective product categories, range in suggested retail price from $76,000 to $1.4 million for motor coaches and from $25,000 to $65,000 for towables.

RESULTS OF OPERATIONS

The following table illustrates the results of operations for the quarters ended September 27, 2003, and October 2, 2004. All dollars represented are in thousands.

	Quarter Ended September 27, 2003	% of Sales		Quarter Ended October 2, 2004	% of Sales		$ Change	% Change
Net sales	$303,231	100.0	%	$358,869	100.0	%	$55,638	18.4	%
Cost of Sales	266,458	87.9	%	315,454	87.9	%	48,996	18.4	%
Gross Profit	36,773	12.1	%	43,415	12.1	%	6,642	18.1	%
Selling, general and administrative expenses	25,667	8.5	%	31,036	8.7	%	5,369	20.9	%

Operating income	$11,106	3.6	%	$12,379	3.4	%	$1,273	11.5	%

Performance in the third quarter of 2004

We are pleased with the record revenues generated for the third quarter of 2004. Profits for the third quarter of 2004 were somewhat improved over that of the third quarter of 2003. Gross margins, while consistent with the same period last year, were negatively affected compared to the second quarter of 2004. Continued pressure from commodity prices in the steel, lumber, petroleum-based products, and other related industries negatively affected profits. In response to these rising costs, we passed along proportional price increases in our products during the first and second quarters of 2004. Currently the rate of price increases in the commodities markets has slowed down, but we can not rule out the possibility of future price increases becoming necessary.* In addition to pricing issues, a general slowdown in the recreational vehicle industry has created competitive wholesale pricing constraints. In response to this, we have engaged in wholesale price discounts to our dealer network to avoid building finished goods inventory. This program, while successful, also negatively affected our gross margin.

Selling, general, and administrative (S,G&A) expenses in the third quarter of 2004 were higher than both the third quarter of 2003 and second quarter of 2004. Retail sales promotions, designed to move product off of

dealer lots, were successful, but also increased our S,G&A expenses. These promotions, coupled with increased advertising and litigation settlement expense, resulted in higher S,G&A than is normal. Accordingly, we have begun an intensive review of our S,G&A structure, and expect that we will begin to return to more normalized levels by the middle of 2005.*

Quarter ended October 2, 2004 compared to quarter ended September 27, 2003

Third quarter net sales increased 18.4% to $358.9 million compared to $303.2 million for the same period last year. Gross diesel motorized revenues were up 6.9%, gas motorized were up 66.7% and towables were up 50.5%. Diesel products accounted for 71.8% of our third quarter revenues while gas products were 17.4%, and towables were 10.8%. The overall increase in revenues reflected improving market conditions, continued low interest rates, and increased interest in recreational vehicles. Our overall unit sales were up 38.1% in the third quarter of 2004 to 3,364 units, with diesel motorized unit sales up 3.0% to 1,341 units, gas motorized unit sales up 71.3% to 769 units, and towable unit sales up 83.1% to 1,254 units. Our total average unit selling price decreased to $106,000 from $124,000 in the same period last year, reflecting our strong gains in the sale of lower priced gas motor homes and towable products.

Gross profit for the third quarter of 2004 increased to $43.4 million, up from $36.8 million in 2003, and gross margin remained constant at 12.1% in the third quarter of 2003 and 12.1% in the third quarter of 2004. The consistency in gross margin when compared to the prior year was due to a combination of factors, including a reduction in discounts off of wholesale invoices of approximately ..5% of sales, improvements in warranty expense of .2% of sales, improvements in direct labor of .5% of sales, and a .7% reduction in indirect costs as a percentage of sales. These improvements were offset by an increase in direct material costs of 1.6% of sales, and a .2% increase in delivery expense as a percent of sales. Our overall gross margin may decline in future periods if the mix of products continues to shift from higher to lower gross margin units, if we are unable to match lower plant utilization levels with corresponding reductions in our fixed costs, or if we encounter unexpected manufacturing difficulties or competitive pressures.*

Selling, general, and administrative expenses (S,G&A) increased by $5.4 to $31.0 million in the third quarter of 2004 and increased as a percentage of sales from 8.5% in 2003 to 8.7% in 2004. S,G&A expenses in the third quarter of 2004 included decreases in retail promotions of .5% as a percentage of sales that were offset by increases in marketing and advertising costs of .1% of sales, increases in litigation settlement expenses of .3% of sales, and .3% increase as a percent of sales in other areas including contract services and miscellaneous items.

Operating income was $12.4 million, or 3.5% of sales, in the third quarter of 2004 compared to $11.1 million, or 3.6% of sales, in the similar 2003 period. The decrease in operating margins reflects increased S,G&A as a percentage of sales.

Net interest expense was $370,000 in the third quarter of 2004 versus $767,000 in the comparable 2003 period, reflecting a lower level of borrowing during the third quarter of 2004.

We reported a provision for income taxes of $4.6 million, or an effective tax rate of 38.3%, in the third quarter of 2004, compared to $4.1 million, or an effective tax rate of 39.5%, for the comparable 2003 period. The decrease in the effective tax rate was due primarily to a reduction in the valuation allowance previously provided for certain net operating loss carryforward benefits that were not expected to be realized. Due to changes in federal income tax rules, we determined in the second quarter of 2004 that we would be able to fully realize the future tax benefits from these net operating loss carryforwards and that the related valuation allowance was no longer necessary. Further reductions in the effective tax rate resulted from increases in our extraterritorial income exclusion benefits on foreign sales and a change in state income tax law. We expect the effective tax rate to be 38.3% through the remainder of 2004.*

Net income for the third quarter of 2004 was $7.4 million compared to $6.3 million in the third quarter of 2003 due to an increase in sales combined with a lower operating margin, a decrease in interest expense, and an improvement in the effective tax rate.

Nine months ended October 2, 2004 compared to nine months ended September 27, 2003

Net sales increased 26.8% to $1.1 billion in the nine-month period ended October 2, 2004 compared to $845.4 million for the same period last year. Gross diesel motorized revenues were up 18.0%, gas motorized revenues were up 55.2%, and towables were up 56.5%. Diesel products accounted for 73.5% of our first nine months’ revenues while gas products were 16.7%, and towables were 9.8%. The overall increase in revenues was driven by improving market conditions, continued low interest rates, and continued interest in recreational vehicles. Our overall unit sales were up 39.4% in the first nine months of 2004 compared to the similar period in 2003 with diesel motorized unit sales up 11.7% to 4,129 units, gas motorized unit sales up 54.1% to 2,248 units, and towable units sales up 82.1% to 3,470. Our average unit selling price decreased in the first nine months of 2004 compared to the similar 2003 period to $108,000 from $119,000, reflecting our continued emphasis on increasing the sale of lower priced gas motor homes and towable products.

Gross profit for the nine-month period ended October 2, 2004 increased to $133.5 million from $97.6 million in 2003, and gross margin increased to 12.5% in 2004 from 11.6% in 2003. The increase in gross margin over the prior year was due to a combination of factors, including a reduction in discounts off of wholesale invoices of approximately .1% of sales. In addition, other direct costs, such as labor, with related benefits, improved by .7% as a percentage of sales, warranty expense improved by .4% as a percentage of sales, and indirect cost of sales related to factory overhead improved by .6% as a percentage of sales. These benefits were offset by a higher material usage rate of .8% as a percentage of sales due to increases in commodity prices, as well as shifts in product mix that have a higher cost as a percentage of sales. We experienced additional margin pressure due to higher delivery costs of .1% of sales. Our overall gross margin may decline in future periods if the mix of products continues to shift from higher to lower gross margin units or if we encounter unexpected manufacturing difficulties or competitive pressures.*

S,G&A expenses increased by $5.5 to $82.6 million in the first nine months of 2004 and decreased as a percentage of sales from 9.1% in 2003 to 7.7% in 2004. S,G&A in the first nine months of 2004 included decreases in retail promotions of 1.0% of sales, decreases in litigation settlement expense of .3% of sales, and reductions in other areas of general expenses of .2%. These decreases were offset by increases in contract services of .1% of sales related to certain consulting projects.

Operating income was $51.0 million, or 4.8% of sales, in the nine-month period ended October 2, 2004 compared to $20.6 million, or 2.4% of sales, in the similar 2003 period. The increase in operating margins reflected improved gross margins as well as reduced S,G&A as a percentage of sales.

Net interest expense was $1.1 million in the first nine months of 2004 versus $2.6 million (after capitalization of $135,000 for construction-in-progress) in the comparable 2003 period, reflecting a lower level of borrowing during the first half of 2004.

We reported a provision for income taxes of $18.8 million, or an effective tax rate of 37.5%, for the first nine months of 2004, compared to $7.3 million, or an effective tax rate of 39.5%, for the comparable 2003 period. The decrease in the effective tax rate was due primarily to a reduction in the valuation allowance previously provided for certain net operating loss carryforward benefits that were not expected to be realized. Due to changes in federal income tax rules, we determined in second quarter 2004 that we would be able to fully realize the future tax benefits from these net operating loss carryforwards and that the related valuation allowance was no longer necessary. Further reductions in the effective tax rate resulted from increases in our extraterritorial income exclusion benefits on foreign sales and a change in state income tax law. We expect the effective tax rate to be 38.3% through the remainder of 2004.*

Net income for the first nine months of 2004 was $31.3 million compared to $11.2 million in the first nine months of 2003 due to the increase in sales combined with higher gross margins.

LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of liquidity are internally generated cash from operations and available borrowings under our credit facilities. During the first nine months of 2004, we generated cash of $14.0 million from operating activities. We generated $39.6 million from net income and non-cash expenses such as depreciation and amortization. Other sources of cash included a $31.5 million increase in trade payables, a $6.3 million increase in accrued liabilities, a $3.4 million increase in income tax payable, a $5.7 million decrease in resort lot inventory, and a $4.4 million increase in warranty reserve. Trade payables increased primarily due to increased production levels.

Other liabilities increased due to increases in various reserves related to employee benefits and performance-based compensation. Reduced resort lot inventories reflect strong lot sales for the nine-month period, and the increase in warranty reserve is the result of the strong increase in recreational vehicles sold. These sources of cash were mostly offset by a $40.1 million increase in receivables, a $34.8 million increase in inventories, and a $2.7 million increase in prepaid expenses. Trade receivables increased due to higher shipment levels occurring at the end of the third quarter 2003, compared to the end of the fourth quarter of 2003. This shipment pattern is a result of normal decreased production levels in the fourth quarter due to regularly scheduled plant shutdowns for vacations. Inventory increases are the result of increased production, as well as the below normal finished good levels that existed at the end of 2003. Prepaid expenses were up due to the renewal of certain liability insurance policies that expired during the nine-month period.

We have credit facilities consisting of a revolving line of credit of up to $95.0 million of which zero borrowings were outstanding at October 2, 2004 (the “Revolving Loan”) and term loans with balances of $18.8 million at October 2, 2004 (the “Term Loans”). At our election, the Revolving Loan and Term Loans bear interest at varying rates that fluctuate based on the Prime rate or LIBOR, and are determined based on our leverage ratio. We also pay interest monthly on the unused available portion of the Revolving Loan at varying rates, determined by our leverage ratio. The Revolving loan is due and payable in full on June 30, 2005, and requires monthly interest payments. Additional prepayments for portions of the term notes are required in the event we sell substantially all, or any, motor coach resort location. The Term Loans require monthly interest payments and principal payments that total $3.75 million per quarter. The Revolving Loan and Term Loans are collateralized by all of our assets and include various restrictions and financial covenants. We utilize “zero balance” bank disbursement accounts in which an advance on the line of credit is automatically made for checks clearing each day. Since the balance of the disbursement account at the bank returns to zero at the end of each day, our outstanding checks are reflected as a liability. The outstanding check liability is combined with our positive cash balance accounts to reflect a net cash balance for financial reporting.

Our principal working capital requirements are for purchases of inventory and financing of trade receivables. Many of our dealers finance product purchases under wholesale floor plan arrangements with third parties as described below. At October 2, 2004, we had working capital of approximately $142.5 million, an increase of $21.3 million from working capital of $121.2 million at January 3, 2004. We have been using cash flow from operations to finance our capital expenditures.

We believe that cash flow from operations and funds available under our credit facilities will be sufficient to meet our liquidity requirements for the next 12 months.* Our capital expenditures were $7.1 million in the first nine months of 2004, which included costs related to installation of certain automated machinery, enhancements to the Company’s information system infrastructure, as well as various other routine capital expenditures. We anticipate that capital expenditures for all of 2004 will be approximately $12 to $15 million, which includes expenditures to purchase additional machinery and equipment in both our Oregon and Indiana facilities, as well as upgrades to existing information systems infrastructures.* We may require additional equity or debt financing to address working capital and facilities expansion needs, particularly if we significantly increase the level of working capital assets such as inventory and accounts receivable. We may also from time to time seek to acquire businesses that would complement our current business, and any such acquisition could require additional financing. There can be no assurance that additional financing will be available if required or on terms deemed favorable by us.

As is typical in the recreational vehicle industry, many of our retail dealers utilize wholesale floor plan financing arrangements with third party lending institutions to finance their purchases of our products. Under the terms of these floor plan arrangements, institutional lenders customarily require the recreational vehicle manufacturer to agree to repurchase any unsold units if the dealer fails to meet its commitments to the lender, subject to certain conditions. We have agreements with several institutional lenders under which we currently have repurchase obligations. Our contingent obligations under these repurchase agreements are reduced by the proceeds received upon the sale of any repurchased units. Our obligations under these repurchase agreements vary from period to period, up to 18 months. At October 2, 2004, approximately $580.4 million of products sold by us to independent dealers were subject to potential repurchase under existing floor plan financing agreements with approximately 6.2% concentrated with one dealer. Historically, we have been successful in mitigating losses associated with repurchase obligations. During the first nine months of 2004, the losses associated with the exercise of repurchase agreements were less than $400,000. If we were obligated to repurchase a significant number of units under any repurchase agreement, our business, operating results, and financial condition could be adversely affected.

As part of the normal course of business, we incur certain contractual obligations and commitments which will require future cash payments. The following tables summarize the significant obligations and commitments as of October 2, 2004.

PAYMENTS DUE BY PERIOD

Contractual obligations (in thousands)	1 year or less		1 to 3 years		4 to 5 years		Thereafter		Total
Long-term Debt (1)	$	15,000	$	3,750	$	0	$	0	$	18,750
Operating Leases (2)	734		2,479		1,957		3,599		8,769
Total Contractual Cash Obligations	$	15,734	$	6,229	$	1,957	$	3,599	$	27,519

AMOUNT OF COMMITMENT EXPIRATION BY PERIOD

Other commitments (in thousands)	1 year or less		1 to 3 years		4 to 5 years		Thereafter		Total
Lines of Credit (3)	$	0	$	95,000	$	0	$	0	$	95,000
Guarantees (2)	0		16,000		0		0		16,000
Repurchase Obligations (4)	0		580,400		0		0		580,400
Total Commitments	$	0	$	691,400	$	0	$	0	$	691,400

(1) See Note 4 to the Condensed Consolidated Financial Statements.

(2) Various leases including manufacturing facilities, aircraft, and machinery and equipment. See Note 7 to the Condensed Consolidated Financial Statements.

(3) See Note 3 to the Condensed Consolidated Financial Statements. The amount listed represents available borrowings on the line of credit at October 2, 2004.

(4) Reflects obligations under manufacturer repurchase commitments. See Note 7 to the Condensed Consolidated Financial Statements.

INFLATION

In the first nine months of 2004, we experienced significant increases in the prices of certain commodity items that we use in the manufacturing of our products. These include, but are not limited to, steel, copper, aluminum, petroleum, and wood. While these raw materials are not necessarily indicative of widespread inflationary trends, they have had a material impact on our production costs, and accordingly, we have passed along price increases to offset these increased costs. However, even though we have been able to pass along past price increases, there is no guarantee that we will be able to pass along future increases. While we have seen some of these costs begin to level off, potential future increases in raw material costs could have a material adverse impact on our business going forward.

CRITICAL ACCOUNTING POLICIES

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to warranty costs, product liability, and impairment of goodwill. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies and related judgments and estimates affect the preparation of our consolidated financial statements.

WARRANTY COSTS Estimated warranty costs are provided for at the time of sale of products with warranties covering the products for up to one year from the date of retail sale (five years for the front and sidewall frame structure, and three years on the Roadmaster chassis). These estimates are based on historical average repair costs, as well as other reasonable assumptions as have been deemed appropriate by management.

PRODUCT LIABILITY We provide an estimate for accrued product liability based on current pending cases, as well as for those cases which are incurred but not reported. This estimate is developed by legal counsel based on professional judgment, as well as historical experience.

IMPAIRMENT OF GOODWILL We assess the potential impairment of goodwill in accordance with Financial Accounting Standards Board (FASB) Statement No. 142. This initial test involves management comparing our market capitalization, to the carrying amount, including goodwill, of our net book value, to determine if goodwill has been impaired.

INVENTORY RESERVES We write down our inventory for obsolescence, and the difference between the cost of inventory and its estimated market value. These write-downs are based on assumptions about future sales demand and market conditions. If actual sales demand or market conditions change from those projected by management, additional inventory write-downs may be required.

INCOME TAXES In conjunction with preparing our consolidated financial statements, we must estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating actual current tax expense together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the consolidated balance sheets. We must then assess the likelihood that the deferred tax assets will be recovered from future taxable income, and to the extent management believes that recovery is not likely, a valuation allowance must be established. Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against net deferred tax assets.

FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS

WE MAY EXPERIENCE UNANTICIPATED FLUCTUATIONS IN OUR OPERATING RESULTS FOR A VARIETY OF REASONS Our net sales, gross margin, and operating results may fluctuate significantly from period to period due to a number of factors, many of which are not readily predictable. These factors include the following:

• The margins associated with the mix of products we sell in any particular period.

• Our ability to utilize and expand our manufacturing resources efficiently.

• Shortages of materials used in our products.

• A determination by us that goodwill or other intangible assets are impaired and have to be written down to their fair values, resulting in a charge to our results of operations.

• Our ability to introduce new models that achieve consumer acceptance.

• The introduction, marketing and sale of competing products by others, including significant discounting offered by our competitors.

• The addition or loss of our dealers.

• The timing of trade shows and rallies, which we use to market and sell our products.

• The impact of inflation on the cost of our raw materials.

• Factors affecting the recreational vehicle industry as a whole, including economic and seasonal factors.

Our overall gross margin may decline in future periods to the extent that we increase the percentage of sales of lower gross margin towable products or if the mix of motor coaches we sell shifts to lower gross margin units. In addition, a relatively small variation in the number of recreational vehicles we sell in any quarter can have a significant impact on total sales and operating results for that quarter.

Demand in the recreational vehicle industry generally declines during the winter months, while sales are generally higher during the spring and summer months. With the broader range of products we now offer, seasonal

factors could have a significant impact on our operating results in the future. Additionally, unusually severe weather conditions in certain markets could delay the timing of shipments from one quarter to another.

We attempt to forecast orders for our products accurately and commence purchasing and manufacturing prior to receipt of such orders. However, it is highly unlikely that we will consistently and accurately forecast the timing, rate, and mix of orders. This aspect of our business makes our planning inexact and, in turn, affects our shipments, costs, inventories, operating results, and cash flow for any given quarter.

THE RECREATIONAL VEHICLE INDUSTRY IS CYCLICAL AND SUSCEPTIBLE TO SLOWDOWNS IN THE GENERAL ECONOMY The recreational vehicle industry has been characterized by cycles of growth and contraction in consumer demand, reflecting prevailing economic, demographic, and political conditions that affect disposable income for leisure-time activities. For example, unit sales of recreational vehicles (excluding conversion vehicles) peaked at approximately 259,000 units in 1994 and declined to approximately 247,000 units in 1996. The industry peaked again in 1999 at approximately 321,000 units and declined in 2001 to 257,000 units. In 2003, the industry rebounded up to approximately 321,000 units. Our business is subject to the cyclical nature of this industry. Some of the factors that contribute to this cyclicality include fuel availability and costs, interest rate levels, the level of discretionary spending, and availability of credit and overall consumer confidence. The recent decline in consumer confidence and slowing of the overall economy has adversely affected the recreational vehicle market. An extended continuation of these conditions would materially affect our business, results of operations, and financial condition.

WE RELY ON A RELATIVELY SMALL NUMBER OF DEALERS FOR A SIGNIFICANT PERCENTAGE OF OUR SALES Although our products were offered by 339 dealerships located primarily in the United States and Canada as of October 2, 2004, a significant percentage of our sales are concentrated among a relatively small number of independent dealers. For the nine-month period ended October 2, 2004, sales to one dealer, Lazy Days RV Center, accounted for 9.5% of total sales compared to 11.8% of sales in the same period ended last year. For quarters ended September 27, 2003 and October 2, 2004, sales to our 10 largest dealers, including Lazy Days RV Center, accounted for a total of 36.9% and 32.6% of total sales, respectively. The loss of a significant dealer or a substantial decrease in sales by any of these dealers could have a material impact on our business, results of operations, and financial condition.

WE MAY HAVE TO REPURCHASE A DEALER’S INVENTORY OF OUR PRODUCTS IN THE EVENT THAT THE DEALER DOES NOT REPAY ITS LENDER As is common in the recreational vehicle industry, we enter into repurchase agreements with the financing institutions used by our dealers to finance their purchases of our products. These agreements require us to repurchase the dealer’s inventory in the event that the dealer does not repay its lender. Obligations under these agreements vary from period to period, but totaled approximately $580.4 million as of October 2, 2004, with approximately 6.2% concentrated with one dealer. If we were obligated to repurchase a significant number of units under any repurchase agreement, our business, operating results, and financial condition could be adversely affected.

OUR ACCOUNTS RECEIVABLE BALANCE IS SUBJECT TO CONCENTRATION RISK We sell our product to dealers who are predominantly located in the United States and Canada. The terms and conditions of payment are a combination of open trade receivables, and commitments from dealer floor plan lending institutions. As of October 2, 2004, total trade receivables were $129.3 million, with approximately $109.0 million, or 84.3% of the outstanding accounts receivable balance concentrated among floor plan lenders. The remaining $20.3 million of trade receivables were concentrated substantially all with one dealer.

WE MAY EXPERIENCE A DECREASE IN SALES OF OUR PRODUCTS DUE TO AN INCREASE IN THE PRICE OR A DECREASE IN THE SUPPLY OF FUEL An interruption in the supply, or a significant increase in the price or tax on the sale, of diesel fuel or gasoline on a regional or national basis could significantly affect our business. Diesel fuel and gasoline have, at various times in the past, been either expensive or difficult to obtain.

WE DEPEND ON SINGLE OR LIMITED SOURCES TO PROVIDE US WITH CERTAIN IMPORTANT COMPONENTS THAT WE USE IN THE PRODUCTION OF OUR PRODUCTS A number of important components for certain of our products are purchased from a single or limited number of sources. These include turbo diesel engines (Cummins and Caterpillar), substantially all of our transmissions (Allison), axles (Dana and

Meritor) for all diesel motor coaches and chassis (Workhorse and Ford) for gas motor coaches. We have no long-term supply contracts with these suppliers or their distributors, and we cannot be certain that these suppliers will be able to meet our future requirements. Consequently, we have periodically been placed on allocation of these and other key components. The last significant allocation occurred in 1997 from Allison, and in 1999 from Ford. An extended delay or interruption in the supply of any component that we obtain from a single supplier or from a limited number of suppliers could adversely affect our business, results of operations, and financial condition.

OUR INDUSTRY IS VERY COMPETITIVE. WE MUST CONTINUE TO INTRODUCE NEW MODELS AND NEW FEATURES TO REMAIN COMPETITIVE The market for our products is very competitive. We currently compete with a number of manufacturers of motor coaches, fifth wheel trailers, and travel trailers. Some of these companies have greater financial resources than we have and extensive distribution networks. These companies, or new competitors in the industry, may develop products that customers in the industry prefer over our products.

We believe that the introduction of new products and new features is critical to our success. Delays in the introduction of new models or product features, quality problems associated with these introductions, or a lack of market acceptance of new models or features could affect us adversely. For example, unexpected costs associated with model changes have affected our gross margin in the past. Further, new product introductions can divert revenues from existing models and result in fewer sales of existing products.

OUR PRODUCTS COULD FAIL TO PERFORM ACCORDING TO SPECIFICATIONS OR PROVE TO BE UNRELIABLE, CAUSING DAMAGE TO OUR CUSTOMER RELATIONSHIPS AND OUR REPUTATION AND RESULTING IN LOSS OF SALES Our customers require demanding specifications for product performance and reliability. Because our products are complex and often use advanced components, processes and techniques, undetected errors and design flaws may occur. Product defects result in higher product service, warranty and replacement costs and may cause serious damage to our customer relationships and industry reputation, all of which will negatively affect our sales and business.

OUR BUSINESS IS SUBJECT TO VARIOUS TYPES OF LITIGATION, INCLUDING PRODUCT LIABILITY AND WARRANTY CLAIMS We are subject to litigation arising in the ordinary course of our business, typically for product liability and warranty claims that are common in the recreational vehicle industry. While we do not believe that the outcome of any pending litigation, net of insurance coverage, will materially adversely affect our business, results of operations, or financial condition, we cannot provide assurances in this regard because litigation is an inherently uncertain process.*

To date, we have been successful in obtaining product liability insurance on terms that we consider acceptable. The terms of the policy contain a self-insured retention amount of $500,000 per occurrence, with a maximum annual aggregate self-insured retention of $3.0 million. Overall product liability insurance, including umbrella coverage, is available to a maximum amount of $100.0 million for each occurrence, as well as in the aggregate. We cannot be certain we will be able to obtain insurance coverage in the future at acceptable levels or that the costs of such insurance will be reasonable. Further, successful assertion against us of one or a series of large uninsured claims, or of a series of claims exceeding our insurance coverage, could have a material adverse effect on our business, results of operations, and financial condition.

WE MAY BE UNABLE TO ATTRACT AND RETAIN KEY EMPLOYEES, DELAYING PRODUCT DEVELOPMENT AND MANUFACTURING Our success depends in part upon attracting and retaining highly skilled professionals. A number of our employees are highly skilled engineers and other technical professionals, and our failure to continue to attract and retain such individuals could adversely affect our ability to compete in the industry.

OUR RECENT GROWTH HAS PUT PRESSURE ON THE CAPABILITIES OF OUR OPERATING, FINANCIAL, AND MANAGEMENT INFORMATION SYSTEMS In the past few years, we have significantly expanded the size and scope of our business, which has required us to hire additional employees. Some of these new employees include new management personnel. In addition, our current management personnel have assumed additional responsibilities. The increase in our size over a relatively short period of time has put pressure on our operating, financial, and management information systems. If we continue to expand, such growth would put additional pressure on these systems and may cause such systems to malfunction or to experience significant delays.

WE MAY EXPERIENCE UNEXPECTED PROBLEMS AND EXPENSES ASSOCIATED WITH OUR MANUFACTURING EQUIPMENT AUTOMATION PLAN As we continue to work towards involving automated machinery and equipment to improve efficiencies and quality, we will be subject to certain risks involving implementing new technologies into our facilities.

The expansion into new machinery and equipment technologies involves risks, including the following:

• We must rely on timely performance by contractors, subcontractors, and government agencies, whose performance we may be unable to control.

• The development of new processes involves costs associated with new machinery, training of employees, and compliance with environmental, health, and other government regulations.

• The newly developed products may not be successful in the marketplace.

• We may be unable to complete a planned machinery and equipment implementation in a timely manner, which could result in lower production levels and an inability to satisfy customer demand for our products.

NEWLY ISSUED FINANCIAL REPORTING PRONOUNCEMENTS

EITF 04-10

In September of 2004, the Financial Accounting Standards Board (the Board) issued EITF 04-10, “Determining Whether to Aggregate Operating Segments That Do Not Meet the Quantitative Thresholds.” FASB Statement No. 131, “Disclosures about Segments of an Enterprise and Related Information,” requires public companies to report financial and descriptive information about its reportable operating segments. EITF, which is effective for fiscal years ending after October 13, 2004, addresses how to determine if operating segments that do not meet the quantitative thresholds of FASB No. 131 are to be reported as separate segments.

We have not yet determined if the provisions of EITF 04-10 will impact the disclosures to be included in the fiscal year end financial statements.

Proposed Amendment to FAS 128

The Board is amending FAS 128, “Earnings per Share,” to make it consistent with International Accounting Standards, and make earnings per share calculations comparable on a global basis. The amendment changes the computation to require the use of the year-to-date average stock price when computing the number of potential incremental common shares for diluted EPS. The old method was to calculate an average of potential incremental common shares computed for each quarter when computing year-to-date incremental shares.

The amendment is expected to be issued in the fourth quarter of 2004, and will be effective for all periods ending after December 15, 2004.

We have reviewed the provisions of the proposed amendment, and we expect it will not have a significant impact on our earnings per share calculation.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

Condensed Consolidated Balance Sheets as of January 3, 2004 and October 2, 2004.

Condensed Consolidated Statements of Income for the quarters and nine-month periods ended September 27, 2003 and October 2, 2004.

Condensed Consolidated Statements of Cash Flows for the nine-month periods ended September 27, 2003 and October 2, 2004.

Notes to Condensed Consolidated Financial Statements.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Item 4. Controls and Procedures.

PART II - OTHER INFORMATION

Item 6. Exhibits.

Signatures.

Certifications under Section 302(a) and 906 of the Sarbanes-Oxley Act of 2002.

(a)	Exhibits

	31.1	Sarbanes-Oxley Section 302(a) Certification.
	31.2	Sarbanes-Oxley Section 302(a) Certification.
	32.1	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

		MONACO COACH CORPORATION


Dated:	November 12, 2004	/s/ P. Martin Daley
		P. Martin Daley
		Vice President and
		Chief Financial Officer (Duly
		Authorized Officer and Principal
		Financial Officer)

Exhibit Number		Description of Document

31.1		Sarbanes-Oxley Section 302(a) Certification.

31.2		Sarbanes-Oxley Section 302(a) Certification.

32.1		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, and Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.