Winnebago Industries, Inc. (WGO) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Winnebago Industries Second Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I will now turn the call over to your host, Don Heidemann, Treasurer and Director of Finance. Please go ahead.

Thank you Stephanie. Good morning, and welcome to Winnebago Industries’ conference call to review the Company’s results for the fiscal 2016 second quarter, which ended February 27, 2016. Conducting the call with me today will be Michael Happe, President and Chief Executive Officer and Sarah Nielsen, Vice President and Chief Financial Officer. This call is being broadcast live on our website at investor.wgo.net and a replay of the call will be available on our website at approximately 1:00 PM Central Time today. The news release with our second quarter earnings results was posted on our website earlier this morning. If you have any questions about accessing any of this information, please call our Investor Relations department at 641-585-6160. Certain statements made during today’s conference call regarding Winnebago Industries and its operations may be considered forward-looking statements under the securities laws and involve a number of risks and uncertainties. As a result, the Company cautions you that forward-looking statements are inherently uncertain and a number of factors many of which are beyond the Company’s control could cause actual results to differ materially from these statements. These factors are identified in our 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. With that said, I would now like to introduce our new President and CEO, Michael Happe. Mike?

Thank you, Don, and good morning everyone. I would like to start the call by providing some initial comments regarding my on-boarding activities over the first 60 days and an overview of the key drivers of Winnebago's results during our recent second quarter. Our CFO, Sarah Nielsen, will follow by diving deeper into the details related to our Q2 financials. And lastly, I will be back with some initial observations of the challenges and opportunities facing Winnebago in the future including the second half of fiscal 2016. Now first let me say what a privilege it is to be able to join the Winnebago Industries’ team during this important time in its rich history. Winnebago is not only one of the RV industry's most respected brands but it is truly an iconic American brand with a proud legacy. That brand has been nurtured and strengthened through the years by a culture and an organization of devoted employees committed to meeting and exceeding customer's expectations. We also partnered with some of the finest RV dealers in the industry to provide a great experience for our end customers. So they themselves can create lifelong memories time and time again. I'm optimistic that over time we can build on the solid foundation and history, and elevate our market and financial performance within the RV industry. There is material runway in front of us on both elements. My first two months have been spent climbing a very significant learning curve. Much of this period has been on the road, visiting our facilities around North America, meeting with most of our top dealers, interacting with key suppliers and engaging the investor community. The focus has been on understanding the Company's legacy getting to know our people, engaging with the dealer channel, learning about our products, aligning with Board’s expectations and quickly understanding the key strategic initiatives and progress here at Winnebago. It has been a busy period but well worth the immersion. There are still a lot for me to learn. As mentioned previously, there are several key strategic initiatives we continue to focus on that should provide this company material traction for improved market and financial performance in the future. Implementing a new ERP system will empower our employees to make more timely effective business decisions and be more productive, transforming our purchasing function through comprehensive strategic sourcing processes, identifying material short-term COG savings and establishing long-term procurement discipline will have benefits. Opening a new manufacturing and service facility in Oregon will create a more streamlined assembly process for our evolving Class A diesel product line-up and free up significant hours in North Iowa for incremental motorized production in our Class A gas and C categories here. Lastly, we will leverage the industry's finest brand and drive increased market share via expanded products, distribution outlets and enterprise focus around our towables business. Now moving to the recently concluded fiscal second-quarter. Fundamentals within the RV industry continue to be strong in the near term. We also believe that the long-term prospects for continued growth in the RV industry remain positive, factors such as demographics, access to financing, low fuel prices and a North American population excited to engage the great outdoors are all contributing to this positive industry momentum. In our second quarter, Winnebago achieved strong sales and profit improvement results within our towables business where shipments grew faster than the industry due to new product introductions and further expansion of our dealer channel. In the motorhome business however, we are not completely satisfied with the revenue achieved in the quarter, especially in light of the solid growth within the motorized segment industry wide. While we had very strong bookings in the quarter, which resulted in a growing and robust backlog, we are still navigating numerous manufacturing challenges from an output standpoint. First, we intentionally added labor hours and lengthened internal inspection processes to increase our focus on product quality protecting our brand's reputation in the future. This has temporarily decreased our manufacturing efficiency and thus impacted our shipment capacity in the quarter. We are seeing positive early signs that this renewed focus on quality will pay off and are optimistic we will see both lower warranty expense on our P&L and increased productivity as we streamline these product quality processes in the future. Continued work to transition Winnebago out of the aluminum extrusion business and the initial stages of transferring Class A diesel manufacturing to Oregon also had a slight impact on motorhome production output. We are also aware of several trends in the market which have put pressure on our current line-up of Class A products. Our shipment results in Q2 in the segment were improved over Q1. Winnebago has intentionally focused its previous new product development efforts in recent quarters on select segments within Class B and Class C product areas with some excellent success. In fact, we have number one and growing market share in an attractive Class B category. We will work to address where we can profitably compete in the growing value segment of Class A gas products. We are aware of this market trend and considering specific strategies on how we mitigate the share erosion. Notwithstanding these factors, our team worked extremely hard and achieved materially higher profitability for the company overall in the second quarter and the team remains intently focused on finding further areas of productivity and profit leverage in the future. Now I will turn the call over to Sarah who will review the Q2 financials in more detail. Sarah?

Thanks, Mike, and hello everyone. Year-over-year second-quarter operating income improved 13% and net income increased by nearly 16% despite revenues being down a bit. The improved profitability was in part driven by a second consecutive growth quarter of gross margin expansion and continued strong results from our towables group. Additionally, we experienced lower general and administrative expenses in the second quarter. Revenues declined 3.8% year-over-year in the second quarter largely the result of lower motorized unit volume of 3.4%. This decreased volume primarily relates to our increased focus on quality. As previously discussed, we have reduced our throughput in an effort to limit rework and future warranty-related expenses. We continue to focus on the production of our higher margin products in each category, which continues to positively influence our gross margin. Also partially attributable to the revenue decline was our planned exit of extrusion operations which impacted sales by about $4.4 million. Partially offsetting some of the revenue pressures that we experienced with continued strong results from our towables group in the second quarter where revenues grew 34% as a result of nearly 58% unit growth over last year on lower price point units. As we are not labor constrained at towables we believe that we will continue to generate above market unit growth in this category. Second-quarter gross margins expanded 90 basis points year-over-year mostly due to improved product mix which includes better results at towables as well as overall production allocation towards higher margin motorized products. We also benefited from our strategic sourcing project. Second-quarter gross margin improvement was partially offset by higher manufacturing costs as well as unfavorable trends and warranty expense. While warranty expense trends were better in the second quarter than in the first, we acknowledge that we still have room to improve. However we believe our efforts to increase labor hours in the area of inspection along with the slowed production rate will improve over warranty expense in future quarters. Second-quarter operating expense declined year-over-year driven mainly by lower G&A expenses attributable to increased amortization of post retirement healthcare benefits. Thus far this year we have invested $6 million into ERP of which $2.8 million have been immediately expensed. For the remainder of fiscal 2016, we anticipate ERP spending to be similar to the first half of the year. The overall effective income tax rate for the second quarter of fiscal 2016 was 30.6% compared to the effective tax rate of 32.4% for the same period last year. The decrease is primarily a result of the passage of the Protecting Americans from Tax Hikes Act of 2015, which extends or makes permanent various tax credits that had previously expired. For the full year, we anticipate a tax rate approximating 33%. Moving to our balance sheet and cash flow, I’d to highlight that our operating cash flow was much improved during this year's second quarter compared to last year as we used approximately 750,000 for operating activities compared to over 14 million last year. This relates to the improved management of our receivables and inventory notwithstanding the preparation for another robust rental season. As a result, we ended the quarter with a healthy cash balance of nearly $37 million despite capital expenditures of approximately $13.2 million in the second quarter of which $9.7 million was for the purchase of our West Coast facility. In addition, during the second quarter, we repurchased just over 127,000 of our Company common stock for approximately $2.3 million for an average price of $18.49 under our share purchase program. Just over $4 million of availability remains on the program. Finally, in the second quarter, our motorhome dealer inventory increased 15% compared to the first quarter but was virtually similar to levels a year ago at the end of the second quarter. The increase on a sequential basis reflects our dealer's seasonal stocking of inventory in preparation of the spring selling season. Moving to towables, dealer inventory increased by 26% versus the first quarter and by 23% on a year-over-year basis. The increases are the result of the popularity of our new products and the successful growth of our distribution base. Within both motorized and towables, we continue to believe that there is an alignment between retail demand and our dealer's inventory levels. This concludes my review and now I'd like to pass it back onto Mike.

Thank you Sarah. I will start with an overview of outlook and drivers for the second half of this fiscal year, then we will provide a more specific update on the strategic initiatives mentioned earlier and close with some initial thoughts on future areas of opportunity for the Company. As I spent time in the field visiting with some of our largest dealers, the following key attributes about Winnebago’s business were consistently mentioned. First, the Winnebago brand name remains extremely strong in the market. Second; our reputation for leadership in the area of product quality is still sound despite some of the recent challenges we face. Third, our dealer relationships especially on the motorized side are rock solid and provide us with a foundation for future growth in motor homes and the ability to leverage placement of our towables product line as well. And fourth, our culture is very focused on customer service and retaining strong relationships after the sale with our end customers. All of these factors form a strong foundation to build upon. Looking at the second half of the fiscal year, we remain optimistic that the momentum in our towables business will continue due in large part to the introduction of enhanced product offerings and expansion of our dealer network and improved productivity. Over time, we believe we have a significant opportunity in the towables business to even better leverage the Winnebago brand and our relationships with other channel partners while also creating more consistency in the product quality levels and the sales and service experience that we have historically reached on our motorized side. On the motorhome business, we will continue to face pressure on overall market share as a result of the factors that were cited at the beginning of this call. We are aggressively working to address many of the manufacturing inefficiencies in the back half of fiscal 2016 but we will not compromise the quality of the products we ultimately place into the market nor the quality of the manufacturing transition of our high-end diesel products that are beginning to move from North Iowa to Oregon. When looking at our product mix in the coming months, we will continue to focus on building our Class B and C market share and deliver a large amount of rental units during the third quarter consistent with similar timing in previous fiscal years. Additionally, our new diesel power Class C Fuse product line which was unveiled at the December RVIA show in Louisville, Kentucky and was named top RV Debut by RV Business, is being well received by our dealers and the retail customers. Although the value segment of the Class A gas category will continue to be a short-term challenge for us, our brand new Vista and Sunstar 29VE floor plan featuring an optional tailgate exterior kitchen package was our top seller at this year's Tampa RV super show. In addition to managing increased quality during this period of constrained motorized manufacturing, we will stay focused on driving higher levels of profitability than in previous years. Now summer time in Iowa also brings back the annual Grand National Rally held here in Forest City when more than 1,000 Winnebago owners migrate back to the heartland and celebrate their affection for the Winnebago brand and the RV lifestyle. This event provides our team here with valuable voice of customer feedback on how we can improve in the future and I look forward to meeting many of our loyal customer owners during this event. Now let’s move a review of a few of our strategic initiatives. I will first start with our ERP implementation which is a systems transformation within Winnebago. This upgrade is long overdue and will revolutionize our ability to manage information, identify value creation opportunities and allow us to make more timely effective business decisions. Importantly, it is a scalable system capable of supporting our anticipated long-term growth ambitions. There are no material changes to the cost of the overall implementation and timing from our last conference call in December. We still expect ERP implementation to be completed in the back half of fiscal 2017. Our next initiative is the expansion to the West Coast through the new manufacturing and service facility in Junction City, Oregon. Having had the opportunity to spend several days in the region reviewing the project and the campus in person and visiting with our local dealers in that area, I am highly encouraged by the potential this project can have for Winnebago in the future. There is immense energy within the company and the local community to help establish and start up a successful operation. Opening a new plant especially one focused on high-end premium Class A diesel products is not a simple undertaking. We are using this opportunity to set up our entire value stream in the most efficient way possible from the very beginning of this plan. There are no material changes to the previously communicated costs or timing of this initiative. The first few production units are in process as we speak and our goal is certainly to ramp up to a robust manufacturing schedule by the end of fiscal 2017. We will have significant incremental capacity for additional diesel products out of that facility in the years that follow. As a reminder, this initiative will also open up significant production capacity in our Forest City campus that will allow us to specifically target increased output of Class A gas and Class C products. No doubt we wish we have this extra production capability right now as the industry continues its upward progress but the work is started and we will do this in an organized disciplined manner so there are no implementation start-ups surprises and we have future success for years to come. Lastly, I have been extremely pleased with the work being done by the strategic sourcing team. A major component of this initiative was the introduction of new processes to analyze in-source components and commodities and partner with our existing suppliers for increased savings and efficiencies. We have found success with this program in its first full year and it has put a spotlight on further expansion opportunities of the strategic sourcing initiative across the organization as we apply these tools and processes to other areas. Furthermore, the project and its lessons learnt will be invaluable as we expand manufacturing in Oregon as there we will utilizing a larger percentage of third-party suppliers on those diesel products as compared to our more vertically integrated model here in North Iowa. We are currently in the process of establishing our savings goals and targets for the fiscal 2017 year. From a strategic standpoint, here is what we will be focused on in the months ahead. Strategy; I will be working closely with the Winnebago Executive Leadership team, select key management within the Company and our Board Of Directors to craft a stronger future state vision of what Winnebago aspires to be in the future. And how that is different in a meaningful way from our competitors. Once we agree on that future state vision and our upcoming multi-year roadmap, we will first share it with our valued employees and teammates here at Winnebago and then work to provide you with appropriate visibility to our BHAGS and future strategies. Structure; we will be evaluating our organizational design, our manufacturing footprint and the accountability and governance mechanisms within the company to ensure that we can get ahead of the business much more effectively than we have in the past and put ourselves in better position to fund and execute the long range strategic plans we will create. People; we will focus on future strategies that result in building an even stronger overall team. This will require identifying and developing current key talent in the organization that can create ideas that will unleash growth and profitability but we will also need to add new skillsets to the organization and create stronger levels of external competitiveness and internal accountability within our culture. We want to have a very healthy work environment internally that allows our employees to share in the future gains of the company, but we will also be focused on winning in more effective ways externally. Process. While our new ERP system is likely to help revolutionize our ability to manage what we measure in the future, we will drive a new level of rigor around continuous improvement principles in this business. Given our somewhat inconsistent history of instituting formal CI processes within the company, we strongly believe there is significant value that can be created organically in future years by identifying and driving out waste in a more systematic fashion. Ultimately, we want to capitalize on the power of AND, driving increased market performance via organic inorganic and non-organic growth initiatives and delivering improved financial results and stronger returns to our shareholders and strengthening our customer centric culture and overall team here at Winnebago. Thank you again for your time this morning. Stephanie, will you please open the call for questions at this time.

[Operator Instructions] Our first question comes from Craig Kennison with Robert W. Baird. Your line is open.

Good morning. Thanks for taking my questions and Mike, I look forward to working with you. First question is on the capacity expansion, certainly it makes sense to me that for investors looking at where we are at this point in the RV cycle, who might be concerned about adding capacity at a later point in that cycle, especially at the high-end where trends have been relatively softer, how does that make sense to you as you look at the situation?

Craig, I look forward to working with you as well. Really as I’ve come into to the company and with the team started to engage in dialog about both the utilization of our current capacity but also some of the increased capacity that Winnebago had committed to late in calendar year 2015, we’ve really spent a lot of time talking about how we can focus on organic capacity opportunity in North Iowa campus. No doubt we will work, Craig, to get the Oregon facility up and running. We will not race forward and over-resource that facility and invest too far ahead of where the industry is going. But we will have the opportunity obviously to get many of our Class A diesel products out of North Iowa and into an environment where we believe we can more efficiently make them. And as importantly, they can be less of a constraint in the existing facility here in Iowa. But here in North Iowa, we absolutely believe that before we would consider any further new capital investments in capacity here in this region that we have a whole list of internal and organic capacity creation opportunities that we can start to work with our operations team.

Thanks. And my second question has to do with credit. Have you had a chance to meet with many of your financial partners? Do you see any opportunity for strategic change in direction like captive finance and then overall, can you comment on the credit environment whether you are seeing credit availability change in any direction? Thank you.

I’ll probably start with the last one from an end customer standpoint. At this time, we are not seeing a dramatic difference in access to capital or financing from an end customer standpoint nor are we seeing at the current time our dealers becoming any further constrained in a negative way than what - the way we’ve been operating here for some time. So that’s a good thing. The product is still flowing from a retail standpoint and the dealers are certainly still able to take the inventory they need to drive retail. From an internal standpoint and this is more in Sarah and Don’s realm. Certainly we have been engaging with some of our financing partners on an ongoing basis as we normally do. From a credit standpoint, the company continues to have a very cautious position on the balance sheet with no long-term debt and a good cash position. But we are always constantly monitoring our financial relationships with lenders and institutions that are not only familiar with the company, but the industry. And we always try to be aware of the access we would potentially need to have in relationships with them should we decide to deploy a new strategy in the future.

Great. Thank you.

Our next question comes from Kathryn Thompson with Thompson Research Group. Your line is open.

Good morning. This is Wenjun sitting in for Kathryn. In your prepared remarks you mentioned adding labor hours and other action to fix capacity and quality issues. Could you quantify the specific impact from these actions?

Good morning. This is Sarah. We covered from the standpoint of the few key categories that have driven margin – driven our margins both on the positive and then the negative side and I highlighted it’s a function of improved product mix which has been a factor for us for multiple quarters as we really maximized the capacity that we do have. We also have seen savings from a strategic sourcing standpoint continue to flow through. So those are the two key positives and the product mix is the most significant of those two by far. And then on the negative side, we highlighted, we both have pressures that relate to the manufacturing associated with the additional labor and the focus to ensure that we are delivering a quality product as well elevated warranty expenses. So those were the two pressures that net [down to] [ph] the 90 basis point improvement. So that is the key driver that we’d like to share from an external disclosure standpoint to really share with you the key things that are happening inside the quarter and on a year-to-date basis.

Okay, that’s helpful. My second question is on the current trend. What are RV dealers telling you about the current traffic trends and what types of products are currently selling better and how it’s different versus last year? I noticed that in the Class A segment you are not providing the specific unit deliveries, but could you provide more color on how trends are within Class A between gas and diesel? Thank you.

Certainly, well, maybe it would be helpful to talk a little bit about the retail demand as it plays out inside of this time frame. This is a time of the year where there's a lot of retail shows and Mike touched upon the success we saw at the Tampa Super Show in regards to some of the new offerings we were sharing at that point. Class B for us continues to be very strong in regards to the retail demand and as a result, that's a significant component of our shipments and as well as in the Class C category. And then from a Class A diesel standpoint, our lower price point Forza and Solei is performing very well. From a show standpoint, it really starts off in on the January month with the Tampa Super Show and then we have Dallas, Seattle, and other various events happening throughout the quarter. And the traffic we’ve been very pleased with on the retail side in regards to the consumers that are coming into our display. And those I guess would be the key points I’d want to touch upon in regards to your question.

The only thing I am going to add just in terms of some of the dealer visits that I have made here in the last couple of months is that our dealers are - while they are certainly aware that the industry has been on the extended run here of good upward success, they remain very positive about the continued outlook for our RV sales in the industry due to some of the factors that we mentioned in our prepared statement. And so many of the dealers that we continue to engage definitely see traffic continuing to come into their stores and they don't see any significant immediate headwinds to getting off to a good start here in 2016.

Okay, that's all my question for today. Thank you so much.

Thank you.

Our next question comes from Gerrick Johnson with BMO Capital Markets. Your line is open.

Hey, good morning. Sarah, first question, perhaps you could give us the sales by category, motor home versus towables and maybe the ASPs by classes like you’ve traditionally have done in the prior calls. And then also wanted to ask about Class B. You just talked about Class B retail still being strong, but it looks like it’s the first time your Class B shipments are down in about three years or so. Are you seeing constraints there in Class B or perhaps dealers’ inventory is at a higher level, so what's going on with the Class B shipments? Thank you.

Well, to start answer on the ASP side, from the standpoint of my prepared remarks, I highlighted that on the motorized side, we really saw the substantial linkage of our volume and our units because ASPs on the motorized side were essentially flat in the quarter on a year-over-year basis. From a towable’s perspective, our ASPs were down approximate 16% and that was a result of really strong sales of new products at lower price point that we didn't have in the market on a year-over-year basis, But in regards to breaking out ASPs on a five class basis, that isn’t anything that I am going to be staring on the call this morning. With Mike’s arrival, we’ve really taken the opportunity to reevaluate what's required for us to be disclosing, what our competitors in fact disclose and what business information that we think is very important to share with you. So we want to be very mindful of disclosing information that could put us at a competitive disadvantage and that has resulted in certain changes of disclosures we’ve made verbally on the call and in our external communications. So that is a little bit of a change. We’ve taken the opportunity with the new perspectives to really sit back and evaluate and we are going to continue to benchmark ourselves with those in the industry and outside of the industry on that front So maybe, lastly, moving on to your questions on the B deliveries, the retail demand for that product is still very strong. When we look at where the demand is, it's not a function of any weakness or softness in the demand. We’ve highlighted that we slowed down a bit in the quarter to ensure that we are focusing on delivering quality products. And so that is really the key story in regards to why unit deliveries would be up or down at any certain point. It was more of a - and we have to improve some of that internal processes and we are working very hard on that to be able to timely deliver what is demanded in the marketplace.

Okay, got it. Thank you, Sarah.

Our next question comes from Mike Swartz with SunTrust. Your line is open.

Good morning, everyone. Just wanted to touch on some of the commentary around product quality, warranty costs and give us maybe a little I guess reference. What are warranty costs looking like right now? And I guess what is the benchmark or what is the standard you are trying to get to and any kind of color around timing of when we can expect you to hit that target?

Well, from a warranty standpoint we really hold ourselves to a high standard and so when you compare ourselves to maybe what would be similar to others, it's a little bit of a difference on level. And so that is I guess first and foremost I want to highlight in regards to the level of warranty spend and as a relation of our revenues. So we are normally in that 1% to 1.5% range and we are a little bit at the higher end at that point of revenues. And that is an area we've been focusing on for multiple quarters. Obviously the tail on warranty can be very long in regards to what’s in the marketplace now and when we had originally built it. And you look back in the last few years with a significant increase of our production capacity and the fiscal ’13, fiscal ‘14 and then into ‘15 and the significant amount of new employees that we’ve hired and having the appropriate training in place and managing a lot of new products that we brought to the markets. All of those are factors where there is risk in regards to ensuring that the product quality is where we wanted. So in the last six months we’ve really tightened in regards to looking at the inspection process and we have to drive it back to the line and having the units come off the line in a completed state and that's where we are focusing our energies and there's been a lot of progress made and we are working very hard on that.

Okay, thank you. And then just with the rental business just remind us – I know you’ve kind of gave us a little color on last call. This sounds like it is going to be very similar to last year in terms of sequence in the third and fourth quarter. But just in terms of size or ASPs, is there any way you can frame that for us?

Well, the third quarter is big rental quarter for us and it is going to be up in that 10%, 15% range over last year and last year we had a little bit of a dynamic where there was some rental products shipped in the early part of the fourth quarter. So, this year it’s all for the most part planned to be delivered inside of Q2. So it's very much an opportunity and exciting part of what our deliveries are going to be in the next three months. And it’s part of story of our backlog increase on a year-over-year basis, but those I guess are few key points to answer that question.

Okay, that’s helpful. And then just finally I think, Sarah, you said that ERP costs were, what, about $2.8 million year to date – fiscal year-to-date?

Thant’s correct. That was fiscal year-to-date. So it’s approximately $1.4 million spent in both Q1 and Q2 on ERP, that was immediately expense.

Okay, that was my question. Were there any incremental sourcing costs or any costs from Oregon flowing through the P&L in the second quarter?

We are definitely ramping up and starting up so there will be some cost associated with that and we are working hard to ensure as Mike highlighted that we approach that in line with our plans on the time table and setting it up in a manner that allows us to really improve the whole flow of the production process with that Class A diesel product.

Okay, thank you. That’s it for me.

Our next question comes from Seth Woolf with Northcoast Research. Your line is open.

Hi, good morning, everyone. I just wanted to start off with the Class Bs and Cs, kind of follow up on a point Gerrick made earlier. I understand you guys are kind of recalibrating your production capacity and you are putting more focus on the Bs and Cs away from the As. But I was really surprised to see the decline especially considering that the Bs are coming out of Lake Mills where you haven't talked about as much labor constraints. And then also with the Cs – I would have thought just with the channel fill associated with the Fuse alone, we would have seen a better number than that. I was just wondering if you could elaborate.

There really isn’t any additional commentary probably to provide than what I mentioned before. We struggled in regards to delivering what we'd like inside the quarter and that's a little bit on the backlog dynamic as well as we need to improve the timeliness and delivering a product that our dealers are looking for inside the quarter. So it's a function of being able to do that and the timeframe that’s ideal as - not a function of the demand on the side of the dealers.

So if I might just add to that that certainly as I’ve come in and started to learn the business retail is definitely in king and if we can maintain significant retail momentum in a category like Class B, for example, over time the shipments will certainly normalize over an extended amount of time. And as you just mentioned, we are definitely trying to balance certain mix from our production schedule in line with increasing quality on several different categories. And I would say if you look over an extended period of time, we are still very pleased with shipments in Class B as an example over the first six months of the year. And we continue to have a good backlog position there and dealer inventories are definitely in line. So, yeah, if you look on a three months year-over-year basis at times, probably the way that this business for us is still slightly constrained on the motor home side. You may see some irregularities mix-wise every now and then and but if we look over an extended period of time I think you will see those play out in line with what’s probably happening in the market.

Okay, that’s helpful. And then I guess as we look at the backlog, was there any of the new Class A's that are going to be produced in Junction City? Is there any of that in there? And if so, could you maybe quantify what the impact would be?

What we are focused on doing is getting the plant up and running and it’s product that we can make in smaller quantities here in Forest City today. Mike touched upon, we have an opportunity to take a pretty complex product out of this campus and build it in a more efficient way in a different location. So we do have the capabilities of producing a small amount of that product here. So the demand on, for example, the 45 foot offering that we showed at the Louisville Show and at the Tampa Super Show to that extent is included in the backlog, but it's more a function of how much do we have the capacity to build and where will that be built is what we are working on right now to have an opportunity to deliver more to the marketplace in a timely fashion.

And so if I will just add to that this is not just manufacturing move existing Class A diesel product. There is really a holistic effort here at Winnebago to improve the competitive position in the future in that category through not just more efficient manufacturing, but we are working very much on future products in that category and refreshing and improving the value proposition and even working with our dealer channel to make sure that we have diesel distribution where we needed and with the dealers, and so it's really – my take is right now this is - again manufacturing is a big part of this .We have to move to products from North Iowa to Junction City. We have to do that in a cost efficient and timely manner so that we don't give you or the market any surprises. But part and parcel to that we are going to be working on other parts of the marketing mix, so that as those products come rolling off the line in Junction City in the near to mid future, they are even more effective in the market based on some other factors within our strategy. So more to come.

Our next question comes from David Whiston with Morningstar. Your line is open.

Thanks. Good morning. Just one question for Sarah and one question for Mike. The selling expenses on a comp size basis were up 10 bps in the quarter, despite lower motorized deliveries, is that just a function of the warranty issues?

Warranty is in cost of goods sold, not included within selling. So the standpoint of -- the key items in selling, there are elements of selling that variable, but there are some that are on a fixed basis and so we were basically flat on the dollar side inside the quarter, but slightly lower revenues, it went up 2.2% of overall revenues.

Okay. And Mike in your closing remarks, you mentioned on the people side, it sounds like you have some skillsets you need to get from outside the company. So curious if you could elaborate more specifically on what you’re looking for there that you don’t have today? And you also, I believe, at least twice mentioned the word accountability and I was just curious if you could give a little more detail as to what you’re seeing today that perhaps you don’t like?

Well, let’s start with the skillsets and I just want to start this answer by reiterating that there is a really good team here, existing at Winnebago and employees that are extremely committed to the business, they have extensive pride in what’s been built through the years. That being said, this is an organization that we need to evolve in a number of different ways and it will take a little bit of time, but I’ll just give you probably three examples. One is we can do a better job here at the company on strategic planning and we need to be more disciplined and extensive across, not just the business units, but the functions in building the roadmap of where we will be, not just within the next 12 months, but 3 to 5 to even potentially 10 years out from now. So we’ll need to add some help there overtime. Continuous improvement, not just in the operations functions, but across the organization. This has been a company that has been so focused on rebounding from the downturn of the last cycle in 2008, 2009. It has been so focused on building back up its unit production and improving its product value proposition in many areas. One of my observations is that we’ve not taken enough time to even slowdown a little bit internally and do some of the continuous improvement work that ensures that our processes are scalable and that our resources are being spent in the most productive way possible. And so again, I think there is an opportunity for us to have some continuous improvement even arguably some lean expertise in to the company. And the last area is business development. We will be very focused on organic growth. We do however need to also add a dimension of non-organic business development planning to our toolbox so that in addition to what our competitors have potentially considered or done in the past, we can be more active in considering what opportunities in the market might not only fit with our strategy but might be financially accretive for the company in the future. And so those are just three areas that we definitely have to work on. So the second part of your question was again…

I was asking about accountability.

Accountability, yeah. Thank you for the reminder there. It’s an organization which strives everyday to do the right thing. As I mentioned, there is an intense pride in what’s been built. What I love about the organization is that there is a focus on meeting and exceeding customer’s needs. Very candidly, I think we can set even higher goals for ourselves, we can use the new system we’re implementing from an ERP standpoint to create metrics and dashboards deeper and more broadly across the organization and we can ask ourselves as executives in our key management and our leaders all across the company to step up and drive improvement in a whole array of different areas. So I want to match up the ability to gain information more effectively via the new ERP system with a culture that does something with it, that makes better decisions, that creates some stretch goals and we identify owners and teams of owners that are accountable for different factors. So for me, that’s about execution. We need to execute at an even higher level, so that we can deliver value to our customers and certainly have consistent financial performance at the end of the day.

That’s very helpful. I appreciate it. Just one follow-up, a lot of this -- once you have the ERP system in place, do you think this is a lot of the execution side of it, is this something that you think you can do already with your background from Toro or do you think you need to bring in a consulting firm now?

Well, from an implementation standpoint, we certainly are using some outside partners right now to help us implement the system. That’s pretty standard for I think most organizations that implement a new ERP system that they get some help from the outside and working with their team to implement it. This is a different system than I used in my past professional experience, but more importantly, the team is excited about the system that’s been chosen. And every day as implementation evolves, the team is finding new ways to potentially refresh or remake their processes or even quite candidly some of their roles in terms of how they can gain access to information in the future. So I think most of our outside help will be used in implementation. Hopefully once we get to sort of the go live status and that is sequentially staggered throughout the organization, by that time, we’ll have developed or even maybe at times acquired a couple of new full time members that can help lead us to utilizing the system in some increasingly positive ways.

Okay. I really appreciate all the color. Thank you.

You’re welcome.

Our next question comes from Matthew Paige with Gabelli & Company. Your line is open.

Good morning, everyone. Could you remind us on how much visibility you have on class A diesel orders and when you get the Oregon plant up and running next fiscal year, are you expecting to fill the plant and need some incremental capacity there?

Well, I think just maybe a couple of key points on that question. We have visibility real time on what our dealers are demanding and obviously that can greatly change based on new product offerings and the success of products at the retail level. Now, on your planning out far into the future quarters and month, years, we’re having to look at where we think the demand will be and what place in that part of that product segment could we have and what is the potential. So there are two aspects of that, we certainly know where the demand is today for ourselves and for others in the marketplace and what successful and then we can use that information to make plans for the future, of course what we’re doing.

Okay. And as you looked at your incremental capacity, where do you stand now against your overall capacity constraints?

Well, specific to the expansion and what we’ve shared and Mike highlighted, we’re still working towards this timetable and it hasn’t changed. We’re just opening up the facility at south and outfitting it with the right equipment and laying out the plan in regards to how the product is going to be built there. The goal is that we will be fully operational and running at a run rate that we feel is reasonable by the latter part of 2017. So it’s going to be staged throughout the rest of this calendar year and in the first six months or so of calendar ‘17 to get to that point.

We should mention as well that especially with the towable side of our business and I just want to make sure we emphasize the good results that the towables team in Indiana is producing. Above the shipment growth levels that the industry has seen, we continue to have capacity in our towables facility in Indiana that will allow us to grow in the future and hopefully continue to gain market share there too. So you really have to break the capacity question down by business, by now facility. This is a company that’s went from 10 years ago to having all of its capacity or its manufacturing really be in North Iowa and now, we’re heading into a period where we’ll have the opportunity to make products in Indiana, the opportunity to make products in North Iowa and the opportunity to make products in Oregon. And we’ll try to put the best products in the best location from an efficiency and profitability standpoint and an output standpoint, but it’s really a new state of normal that we’re heading into for the organization. So just wanted to remind you right the towables and we’re growing and we have capacity to grow in that business in the future as well.

All right. And that’s really helpful and a nice segue into my last question is, Mike, now that you have had some time with the business, where is your final goal for the towables business and how long do you think it will take you to eventually get there and do you need to do an acquisition to be able to achieve those goals?

Well, I’ll say this. The towables business is an important part of Winnebago’s current state and it will become an increasingly important part of our future state. We will work very hard from an enterprise level to provide the towables team the resources they need to grow that business in a manner that’s consistent with the brand and the service and sales experience that we want our channel and our end customers to have. I would say that the answer to your question about the goal for the towables business is quite candidly, we want to be more relevant tomorrow than we are today. If you go out and look at many of our fierce competitors, they have significant market share in the business today built over many years of their own hard work. Winnebago really only got started about 5 or 6 years ago with the acquisition of SunnyBrook and the flywheel is just now beginning to spin and we need to work to establish meaningful market share so that we can begin to benefit more directly from scale and some other resource leverage. So I would say they’re well established on interim goals about moving our market share from very low single digits to somewhere immaterially higher than that. We really can’t state right now that being a market share leader in towables is anything that will happen in the near future because of the market positions of our competitors. But we will leverage this great brand we have to be much more competitive and introduce great products and expand our dealer channel and we’re starting to see some of the fruits of that labor right now. So, from another -- from an acquisitive standpoint, I mentioned earlier the first thing we need to do at this company is to add some expertise and some skills around business development and start to build some muscles about scanning the landscape and looking at what the right opportunities could be. We won’t comment on what market segments or opportunities specifically would be of interest to us, but I can commit to you that at least internally, we will be more active and considering non-organic growth opportunities and then time will tell whether those turn into obviously visible deals or strategies that the market can see.

And would you take on debt to do one of those opportunities if it required that?

I think the answer to that question is it depends, meaning that I think the company has been very comfortable with its balance sheet for some time. There is probably different points of view on whether that’s too conservative or not. So I think certainly, we’ll always be aware of the role of leverage in pursuing non-organic growth opportunities and would tie that directly to the opportunity as well in somewhat of a sort of a pros and cons or cost benefit, risk analysis as well. So certainly aware of the cyclical nature of the industry, but we also potentially don’t want to miss opportunities in the market that might be very feasible for us to consider in a different way historically than what our balance sheet has looked like. So…

All right, appreciate the time. And good luck throughout the spring.

Thank you.

Our final question comes from Morris Ajzenman with Griffin Securities. Your line is open.

Good morning, guys. Two quick follow-ups and then a broader question for Michael. The first follow-up is you talked about Class B shipments being down in the quarter and you referenced that was the focus on quality. Will that play out into the third and fourth quarters as far as this year-over-year slowdown in deliveries based on focus on quality?

Well, first I’ll maybe go back to one of the points that Mike had made on a six month basis, there was a slightly different picture on the Bs and inside the quarter itself and there is going to be at some point a normalization after such accelerated growth in regards to the market position and the retail success we’ve seen with that product. So there is a point in time where that flows through and plays out, but to the extent that we have on the opportunities to more timely ship the product that is in demand, that is first and foremost our objective to ensure that there is no disruption in getting that product out timely. So that is internally at the top of the list, but over the timeframe going forward, it’s going to be a function of how much more does that class B market accelerate or grow and we’ve been a huge driver of that growth and what new additional products can still move that needle and come out to the marketplace that drives additional growth and then the ongoing demand of the products that’s in the channel. So all those will play out into the future.

Okay, the next quick follow-on. Warranty expense, please correct me on this if I was off on this, Sarah. It’s 1% to 1.5% of sales is the normal range and you are at the high end right now?

Yeah. If you look in the quarter specifically, that’s our comp on a year-over-year basis and over the years, I would say that -- then in that 1% to 1.5%, maybe 1.75% range historically and that is an area that we’ve seen some pressure and we’ve worked hard to address the things that contribute to that and the tail can be a little bit longer but to the degree that we can make changes that are impactful, we’re working on that very diligently.

No, I understand. So right now you are at about 1.5% to 1.75% of sales range level?

Yes.

Okay. So incrementally the warranty expense minimizes is about $1.5 million higher than it should be, is that about right?

In the $1 million range. Yes.

Okay, fine. Okay, last question here, Michael, the broader picture. I know you have only been here for a couple of months, but nonetheless if you look back the last 10, 12 years, gross margins moving towards the previous peak ranged between let's call it 12% to 14%, 2004, 2005, 2006. Right now, you are probably averaging at best about 11% [ph] or so. Assuming no acquisitions in the same sort of portfolio of businesses, where do you think gross margins can ultimately rebound to?

Here is the honeymoon period to say that I don’t have a specific number for you that would be meaningful to discuss. I can’t say that I think there are a number of factors that can help us improve gross margin in the future. Amongst them are the work that we’re doing on the strategic sourcing initiatives standpoint, there is no doubt that there is significant productivity opportunities within the operations environment, here, I mentioned that in terms of continuous improvement processes and disciplines and intensity that needs to be added across the company. We are very aware of the mix of the products that we’re making and different profitability levels by even SKU level. And so we certainly hope to manage mix as the market allows us to drive a higher gross margin and if you want to get really far ahead of things, there are things you can do with new product development in terms of DF&A [ph] principles and where your engineering designers and your NPD teams work with manufacturing more closely to lower things like labor content and less parts and a whole number of different factors and I can just tell you we’ll be committed to driving gross margin higher as we can in the future and lot of work to be done to continue some momentum on that, but I don’t want to hazard a guess on what’s potential this early stage, but I can tell you that as I visit with our team and walk the facilities and learn about our processes, there is improvement potential in a material manner that we will chase.

Thank you.

Thank you. And I’ll now turn the call back over to Don Heidemann for closing remarks.

Thank you for joining us today as we reviewed our second quarter financial results. We look forward to speaking to you again when we review our third quarter results on Wednesday June 22. Thanks again.

Thank you. Ladies and gentlemen that does conclude today’s conference. You may all disconnect and everyone have a great day.