ITEM 1. BUSINESS

Introduction

SMC Corporation (SMC or the Company) is one of the largest manufacturers of high-line motor coaches in the United States. SMC was incorporated in Oregon in 1986 and production operations began in 1987. SMC has relocated its headquarters to Bend, Oregon from Harrisburg, Oregon and has six operating subsidiaries. The Company's executive offices are located at 20545 Murphy Road, Bend, Oregon, 97701, and its telephone number is (541) 995-8214. The subsidiaries of the Company are Safari Motor Coaches, Inc. (Safari), Magnum Manufacturing, Inc. (Magnum), Beaver Motor Coaches, Inc. (Beaver), Electronic Design & Assembly, Inc. (ED&A), Composite Technologies, Inc. (CTI), and Harney County Operations, Inc. (HCO). Safari and Magnum are located in Harrisburg, Oregon; Beaver and ED&A are located in Bend, Oregon; and CTI and HCO are located in Hines, Oregon.

General Background

Within the multi-billion dollar recreational vehicle industry, the majority of SMC's products are positioned among the most expensive. SMC predominately builds luxury Class A motor coaches - motorized, fully self-contained motorhomes with features such as solid hardwood cabinetry, powerful diesel engines, and residential decor that separate these coaches from the rest of the market.

This select segment was targeted from SMC's founding and the Company rapidly grew to become a leader in the luxury market. Mathew Perlot, SMC's founder and Chief Executive Officer, considered this market particularly attractive - anticipating the aging of the "baby boomers" and believing that this maturing, affluent group would provide growing support for this product. The initial product included coaches ranging from 30 to 34 feet and retailed for about $100,000. Over the next several years SMC expanded its product offerings to both higher and lower price points, to include coaches ranging in length from 24 to 40 feet, and with retail prices ranging from $70,000 to $230,000.

Magnum began production of chassis for Safari products in 1993 and has since expanded operations to provide chassis for seven of the eight model lines of Safari and Beaver products. By manufacturing chassis specially designed for applications in the recreational vehicle (RV) industry, the Company believes it has quality, ride and cost advantages over competitors that do not build their own chassis.

SMC acquired the Beaver brand names and production facilities in 1994. At that time the Beaver product ranged in retail price from $180,000 to $350,000. The line has since been broadened to include a lower-priced coach, the Monterey. This expansion of product offerings has enabled Beaver to expand distribution of its products.

In 1996 the Company began to seek product opportunities in the lower-priced segment of the recreational vehicle industry when it entered the Class C market through acquisition of a facility in the Midwest. The Company continued its penetration into the upper range Class C market in 1997 through its operations at HCO and the introduction of a Safari brand Class C motor coach. This model has retail prices ranging from $66,000 to $85,000. In 1998 the Company introduced the Desperado, another Class C model, as the Company continues to expand in the Class C market. Although the Company's primary market focus remains the high-line luxury motor coaches it built its foundation on, the Company plans to continue to develop this segment of its business.

In 1998 the Company maintained its core market -- high-line motor coaches with retail prices typically over $150,000. The Company's estimated market share of high-line retail sales was 25.3%, 27.6%, and 29.1% in 1998, 1997, and 1996, respectively. Total retail sales in this segment of the market was approximately 4,100 units in 1998.

Also, at the HCO facility, the Renegade, a new Class A motor coach, was introduced in 1998. With retail prices starting at $134,000, the Renegade is targeted toward the entry-level of the Class A market --buyers that are value-oriented but still demanding features and quality. This segment of the market has become very popular. The Company sold 178 Renegade units in 1998. The production facility in Hines, Oregon has ample production capacity to meet expected demand for both the Renegade Class A coaches as well as the Class C production.

At the Beaver facility, the newly designed Contessa Class A model was introduced in December 1997. The Contessa had been a Beaver product before the Company acquired Beaver in 1994, but had been dormant since that time. Priced below the existing Patriot model but above the Monterey, the Contessa has been resurrected with a new design and feature set that has been widely accepted. Sales for the Contessa were very favorable in 1998, with sales of 112 units.

At the Safari facility, a new Class A model, the Zanzibar, was introduced in June 1998. This model is priced at the lower range of the Class A market, targeting a market similar to that of the Renegade, but designed with the distinction of a Safari brand product. The sales for the Zanzibar unit were 148 in 1998.

At the Magnum facility, a new chassis was developed for the Beaver Marquis. Previously, the Marquis was constructed on a Gillig brand chassis. Gillig ceased production of the chassis in 1997. Magnum acquired the rights to manufacture the chassis from Gillig and, after making some modifications for the Marquis' specific requirements, now produces the chassis at a lower overall cost to the Company. With the new chassis, Magnum now produces the chassis for all of the Company's models except the Trek and Class C models, resulting in significant overall costs savings to the Company.

Originally the Company had acquired the Midwest facility to gain entrance into the Class C market. However in 1996 the Company determined that the losses being incurred through operation of the Midwest facility were not acceptable. The Midwest facility was

closed in 1996 and a pre-tax restructuring charge of $2.4 million was incurred related to this decision in 1996. The exit plan was completed as planned, and no further restructuring charges were necessary in 1997. Production of Class C motor coaches has been transferred to the Company's HCO production facilities in Hines, Oregon. This facility now produces the Renegade (Class A), Safari (Class
C) and the Desperado (Class C) products.

In 1998, the Company opened a service center facility in Tampa, Florida to provide better, more timely, and cost effective customer service. This service center operation is a branch of the existing service centers located in Harrisburg and Bend, Oregon, and the Company is able to use the resources of skilled technicians during slow service periods in Oregon at the facility in Florida.

Industry Background

Recreational vehicles encompass a wide range of mobile housing options, including folding camping trailers, van conversions, truck campers, fifth wheel trailers, Class A, B and C motor coaches, and bus conversions. The retail prices of these vehicles range from under $3,000 for the simplest folding camping trailer to over $750,000 for the most expensive bus conversion. The Recreational Vehicle Industry Association (RVIA) has reported that one in ten households in the U.S. owns a recreational vehicle, resulting in a total ownership of approximately nine million recreational vehicles.

Although retail sales of recreational vehicles and Class A motor coaches have fluctuated over the last five years, retail sales of high-line motor coaches have remained steady during this period according to Statistical Surveys, Inc. The following table shows (i) unit shipments to dealers of all recreational vehicles, all motor coaches, and Class A motor coaches in the U.S., based on RVIA data, and (ii) unit retail sales of high-line motor coaches in the U.S. and unit retail sales of Safari and Beaver coaches as a percentage of the high-line market, based on data distributed by Statistical Surveys, Inc.

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                                                        1994        1995        1996        1997        1998
                                                              (In thousands, except percentage data)
Unit shipments from manufacturers to dealers:
  All recreational vehicles                            518.8       475.2       466.8       438.8       441.3
  All motor coaches                                     58.1        52.8        55.3        55.0        63.5
  Class A motor coaches                                 37.3        33.0        36.5        37.6        42.9

Unit retail sales and market share data:
  High-line motor coaches                                3.6         3.9         4.2         4.4         4.1
  SMC percentage of high-line market:*                  24.6%       24.5%       29.1%       27.6%       25.3%
                                                       =====       =====       =====       =====       =====

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*    For all years includes sales for both Safari and Beaver motor coaches
     (excluding Trek).

SMC focuses primarily on the high-line segment of the Class A motor coach market. Class A motor coaches incorporate kitchen, sleeping and bathroom facilities built on a self-powered chassis. The term "high-line motor coach" is almost synonymous with "diesel pusher." For reasons of cooling and drive train engineering, almost all motor coaches are powered either by a gasoline engine mounted in the front or a diesel engine mounted in the rear. Diesel pushers are more expensive, but can be built longer and are generally more powerful. Thus most high-line coaches are diesel pushers - with horse power ratings over 300, and at this time nearly all high-line diesel pushers retail for over $150,000.

All of SMC's products except the Trek, Desperado, Safari Class C, and Renegade models are high-line coaches with retail prices over $150,000. Although the Trek shares many high-line features of the Company's other models, its retail price ranges from $83,000 to $105,000, and it is therefore excluded from market data compiled for high-line products. The Desperado is a Class C motor coach with retail prices ranging from $61,000 to $80,000. The Safari Class C price ranges from $66,000 to 85,000. The new Class A Renegade model retails in the price range of $134,000 to $145,000.

The high-line segment of the Class A RV market has seen consistent growth since 1989, and in recent years this market has attracted many other companies. Many "mainstream" RV builders, such as Fleetwood, Winnebago, and Coachmen, have developed offerings in this market. Meanwhile, some luxury builders, such as Monaco Coach and Country Coach, have broadened their product lines. Some companies are not surviving. Beaver Coaches was acquired by SMC in 1994, Holiday Rambler was purchased by Monaco Coach in early 1996, and Country Coach was acquired by National RV Holdings in late 1996.

Several long-term trends favor the luxury segment of the RV industry. The most significant indicator of future growth potential is the change in RV-owner demographics. Households over fifty years old form the principal market for luxury RVs. As the "baby-boom" generation ages, this demographic group is expected to increase from approximately 50 million people today to 70 million by the year 2005. The Company believes that on average this generation is expected to retire earlier and have more discretionary income than preceding generations, which is expected to provide a growing base for RV sales.

This trend is also reflected in the substantial increase in the number and quality of facilities available for RV use and in companies serving the RV market. The increased availability of accessories and facilities will continue to make the RV lifestyle more attractive.

Three other factors also have a lesser impact on the RV industry:

Fuel Availability and Price Stability

Diesel fuel has been relatively abundant and inexpensive since the beginning of the 1980's. The Company believes the needs of the transportation industry for diesel fuel may contribute to continued availability and pricing stability. All of the Company's Class A motor coaches are powered by diesel engines. Consequently, an interruption in the supply or a significant increase in the price of or tax on the sale of diesel fuel on a regional or national basis could have a material adverse effect on the Company's results of operations. Diesel fuel has from time to time been difficult to obtain, and there is no assurance that the supply of diesel fuel will continue uninterrupted, that rationing of diesel fuel will not be imposed or that the price of or tax on diesel fuel will not significantly increase in the future.

Low Interest Rates

Interest rate levels affect the cost of a motor coach for consumers who finance their purchase and, more significantly, the cost of inventory maintenance for motor coach dealers. Recent periods of relatively low interest rates have facilitated dealer financing resulting in generally higher dealer stocking levels.

Favorable Tax Treatment

U.S. tax laws generally allow individuals who itemize deductions to deduct interest paid on loans used to finance the purchase of either a first or second residence. The definition of "residence" has been interpreted to include motor coaches of the type manufactured by the Company. The Company believes the tax deductibility of interest paid on loans used to purchase a Class A motor coach increases the attractiveness of ownership. These laws, however, have historically been amended frequently, and it is likely that further amendments and additional tax laws will be applicable to financing the purchase of motor coaches in the future. There is no assurance that favorable tax treatment for financing the purchase of motor coaches will not be amended or repealed.

Sales and Marketing

SMC has two distinctive brands that are marketed through separate dealer networks. (Sales of Class C motor coaches to date have not been a significant part of the Company's business.) The Beaver and Safari product are deliberately kept differentiated to help increase total penetration of the high-line market. The Beaver product is marketed as a "traditional" luxury RV. Its fiberglass wall construction, air suspension, and "classic" RV styling places the Beaver models near the mainstream of high-line coaches. The Safari product is avant-garde in comparison. Its aluminum exterior is unique in this market, and innovations such as the Velvet-Ride(TM) Suspension and power disk brakes further separate the Safari from the rest of the luxury RV market. This two-pronged attack on the luxury market has allowed SMC to successfully maintain a market share in this niche, with an estimated market share of over 25% in 1998.

The Company markets its products through independent dealers throughout the United States and Canada. Few dealers carry both the Safari and Beaver brand products. SMC has made dealer development a priority, because it believes that an expanded dealer base results in greater retail sales exposure and ultimately more retail sales volume. Total Class A dealer locations were 94, 87 and 107 as of December 31, 1998, 1997 and 1996 respectively.

The Company grants exclusive distribution rights to a dealer within a geographic region. Dealers are selected based on location, financial stability, marketing expertise, sales history, integrity and repair and service capability. The Company provides a variety of support services to its dealers, including promptly supplied product literature, display materials and space rental subsidies for trade shows and exhibitions and a dealer newsletter with updates on product development and other product information. The Company offers training and technical support to dealer salespeople, including a plant tour video and a product handbook, and Company representatives visit dealers on a regular basis for sales training and assistance.

The Company focuses its advertising on consumer publications which emphasize the RV lifestyle. In 1995, the Company consolidated all of its media production in-house because it was cost-effective to do so. In-house media development has also added flexibility and responsiveness to the process, which frequently involves "rush" jobs to take advantage of market opportunities.

A key part of the Company's marketing effort is the sponsorship and active promotion of Safari International and the Beaver Ambassador Club, both of which are active owners clubs for owners of Safari and Beaver products, respectively. Members of these groups socialize, discuss common experiences and enjoy motor coaching activities together, thus helping to build customer loyalty and enthusiasm. The Company publishes quarterly newsletters for members of the owners' clubs, as well as a quarterly magazine, the "Rendezvous," which is circulated to owners, prospective purchasers, suppliers, dealers

and employees. In addition, the Company annually sponsors "homecoming" rallies at the Safari and Beaver factories, open to all Safari and Beaver coach owners.

Dealers typically finance their inventory through revolving credit facilities established with asset-based lending institutions, including specialized finance companies and banks. It is industry practice for these "floor plan" financiers to require motor coach manufacturers to repurchase motor coaches previously sold to the dealer if the dealer defaults on its financing agreements or if the lender otherwise has a reasonable basis to be concerned about the ability of the dealer to meet its obligations to the lender. This agreement typically applies for a period of 12 to 18 months from the date of the dealer's purchase from the manufacturer. See "Item 7 -- Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."

The Company takes several steps to reduce its exposure to coach repurchase risk. A dealer is typically required to make periodic payments of principal, referred to as "curtailment," to the flooring financing institution commencing in the seventh month after purchase of the coach. A coach manufacturer may waive these curtailment payments at the request of a dealer, but the Company generally will not do so and, in any event, will do so only if the dealer owes to the flooring institution no more than 90% of the wholesale price of the coach. The Company also monitors the inventory levels and financial circumstances of its dealers through reports generated by the flooring institutions and through frequent contact by its sales personnel with the dealers. If a dealer is experiencing undue difficulty in selling the Company's coaches, the Company will often work with that dealer to voluntarily move the coaches to a dealer that can sell additional inventory. The Company believes, however, that its most fundamental protection against significant loss due to repurchase obligations is the production and marketing of motor coaches that are sufficiently popular to enable the Company quickly to resell, at satisfactory prices, any coaches it may be required to repurchase. For 1996 the Company made no repurchase payments under flooring arrangements. In both 1997 and 1998, the Company repurchased a total of 8 motor homes in each year under the requirements of the repurchase obligations with two of its flooring financing institutions when two separate motor home dealerships went out-of-business. No significant losses were incurred upon the subsequent resale of the motor homes.

For 1997, sales to one of the largest motor coach dealers in the U.S. and located just a few miles from the Safari facility, accounted for approximately 10% of net sales. Another large dealer, with two locations in Oregon, accounted for 12% of net sales in 1997, and 14% of net sales in 1998.

Product Information By Subsidiary

Beaver

Marquis

The Marquis is positioned at the top of the Beaver product line. With retail prices of over $390,000, it is one of the most expensive and luxurious motor coaches in production today. The Marquis has traditionally been the most visible and best recognized of the Beaver models. The Marquis motor coach was further upgraded in 1997 to its current ultra-luxury position. As part of this strategy, production of the Marquis was slowed and a craftsman-intensive team production program was developed to produce each vehicle. New cabinet technologies were introduced, allowing the use of exotic veneers and richer lacquers. The Marquis is now positioned as a limited production, prestige product. Previously built on a chassis supplied by an outside supplier, in 1997 the Company began building the Marquis on a chassis developed by Magnum at an overall cost savings for the Company.

Patriot

In July 1995, SMC introduced the 1996 Patriot on the all-new Magnum B-Series chassis. This new Magnum chassis replaced a chassis from an outside chassis vendor used since the Patriot model was introduced in 1992. The Patriot model has a retail price ranging from $223,000 to $309,000, depending upon options which include the upgraded Thunder option which features a powerful 425-horsepower engine and a heavy-duty transmission.

Contessa

In 1997, the Company introduced the completely redesigned Contessa, which had been a Beaver model prior to the acquisition of Beaver in 1994. The Contessa is a high-end coach powered by a 330-horsepower engine which retails from $196,000 to $244,000, depending upon options.

Monterey

The Monterey was the first all-new Beaver product since the acquisition of Beaver in 1994. Retailing from $156,000 to $201,000, depending upon options, the Monterey provides Beaver with a product priced for broader appeal. The Monterey uses chassis and floor plans that are similar to the Safari Sahara, but differs considerably from the Safari product in styling options. In addition, an air-ride option has been developed to provide the traditional RV owner an alternative which is typically seen in high-line motor coaches.

Safari

Continental

The Continental is the flagship product from Safari. Its design and technology features include disk brakes, B.F. Goodrich's Torsilastic suspension system, and Magnum Intellidrive computerized monitoring display, all as standard equipment. The Continental retails from $233,000 to $298,000, depending upon options, including the Panther option which features a powerful 425-horsepower engine and a heavy-duty transmission.

Serengeti and Ivory

As the oldest of the Safari brand names, the Serengeti has been the core Safari product since its introduction in 1988. The Serengeti retails from $191,000 to $251,000, depending upon options, and its sibling, the Ivory model, occupies the higher end of that price range.

Sahara

The Sahara model was introduced in 1993 and then repositioned in 1994 to stand as a value-oriented luxury coach. The Sahara model retails from $148,000 to $200,000, depending upon options. The product provides many of the features of the Serengeti and Ivory at a lower cost to the customer.

Zanzibar

The Zanzibar was introduced in 1998. The standard equipment offers an array of features found on higher priced models, but at an entry level price. It is constructed on the Magnum `R' chassis. The Zanzibar model retails from $147,000 to $160,000, depending on the options.

Trek

The Trek is constructed on a Chevrolet chassis. As the lowest priced SMC Class A motor coach, it also has a lower profit margin and is intended to acquaint new customers with SMC's products and attract them to the RV lifestyle. The Trek retails from $83,000 to $105,000, depending upon options.

Harney County Operations (DBA Harney Coach Works)

Safari Class C and Desperado

The Safari Class C and the Desperado are both constructed on a Ford or Chevrolet van chassis. The first sales of the Safari Class C were made in 1997 and initial sales of the Desperado were in 1998. These units retail from $61,000 to $85,000, depending upon options, and occupy the high-end of the Class C motor home market.

Renegade Class A

The Renegade is presently constructed on Magnum `R' series chassis with a Cat 275 engine. Shipments began in January 1998. With retail sales prices ranging from $134,000 to $145,000, depending upon options, the Renegade is priced lower than any of the Company's Class A product, except for the Safari Trek. The Renegade is targeted to the expanding entry level Class A market which offers many features of the higher-line models, but at a more affordable pricing structure.

Backlog

Motor coach dealers, particularly those with a relatively large sales volume, from time to time indicate to motor coach manufacturers the number of coaches they expect to purchase in the following months. While the Company regularly receives such indications, the Company includes in its backlog only purchase orders it has received that are sufficiently complete as to specifications (color, floor plan, options, etc.) to permit the Company to schedule production of the coach. Consequently, backlog generally represents orders for coaches scheduled to be manufactured and shipped in the following 45 to 60 days. The Company's backlog at December 31, 1998 was $12.8 million, compared to backlog of $21.3 million at December 31, 1997. Backlog can fluctuate substantially as the result of the receipt of purchase orders in connection with various major motor coach shows and rallies, which are not held at even intervals throughout the year. Consequently, and because orders are generally cancelable without penalty, the amount of backlog at any date is not necessarily indicative of sales in future periods. To date, order cancellations have not been material.

Customer Service

The Company believes one of the most important elements in the success of its business is understanding its customers and their preferences and providing excellent customer service. Customer service is important because many of the Company's customers are repeat purchasers and because a high level of service is expected by purchasers of high quality coaches. In addition, because motor coach purchasers tend to communicate freely their views on the quality of various coaches and business reputations of motor coach manufacturers, the quality of post-sale customer service provided by a motor coach manufacturer is a key factor in establishing a manufacturer's reputation among this group.

The Company offers a one-year or 12,000-mile warranty, whichever occurs first, on all coaches. Customers have the option to purchase extended warranties, written by others, from Company dealers. The Company's warranty covers all manufacturing-related problems and parts and system failures, regardless of whether the repair is made at a Company service facility or by one of the Company's dealers or authorized service centers. In addition to the Company's warranty, the chassis, drive train, engine and transmission are covered by separate warranties offered by the manufacturers of those components, or by the Company on the chassis manufactured by its Magnum Manufacturing subsidiary. The Company's warranty on the Magnum chassis and drive train is for three years or 36,000 miles, whichever occurs first. Appliances in the coaches are covered by the warranties of manufacturers of those items.

The Company maintains toll-free telephone lines for customers to call with repair or operating questions or problems. Although many questions can be resolved by telephone, the Company often refers the customer to a local dealer or repair facility for additional assistance.

The Company also opened a 24-bay service center in Harrisburg in November 1995 to better serve its customers. In 1997, a leased service center was opened in Tampa, Florida to expand its customer service opportunities further. In late 1998, the Company purchased a service center in Tampa, Florida and moved its service activities from the leased facility in that area. The Company also operates a service center adjacent to its Beaver manufacturing facility in Bend, Oregon.

Manufacturing

The Company uses "lean production" techniques in its coach manufacturing process. These techniques emphasize teamwork, include significant input from worker teams and employ just-in-time inventory controls to improve product quality and manufacturing efficiencies.

The Company believes its coach manufacturing operations are vertically integrated to a substantial degree compared to most other high-line motor coach builders. Components of the Company's motor coaches produced by the Company include chassis constructed by Magnum Manufacturing, Inc., the shell or "house" portion of the coach, fiberglass, countertops, hardwood cabinetry and portions of the interior upholstery. The Company believes this in-house production of certain components results in cost savings to the Company and greater control over quality and inventory.

The construction of each motor coach begins with the preparation of the chassis on which the superstructure of the "house" is built. The floors, walls and roof of the motor coach "house" are built off-line. The coach's front and rear caps are each single pieces molded from fiberglass resins that provide favorable strength-to-weight ratios. The Company believes the lightweight construction of its motor coaches combined with the diesel engines used in nearly all models add significantly to the performance of its motor coaches.

The Company purchases raw materials, parts, subcomponents, electric systems and appliances from approximately 1,000 suppliers. These items are either placed directly into the coach or are incorporated into subassemblies by the Company. All components, subassemblies and finished products are inspected for compliance with the Company's specifications. The Company attempts to minimize its inventory costs by ordering inventory only on an as-needed, or just-in-time, basis. Some supplies, such as fiberglass, are ordered and delivered to the Company's plant on a daily basis, while other items, particularly engines and transmissions, are ordered as much as four months in advance of the expected use date. While the Company generally commences construction on a coach only after receipt of an order from a dealer, it must nonetheless order certain parts or components, some of which represent a significant expenditure, in advance of orders.

Certain components and subassemblies included in the Company's motor coaches are obtained from a single or limited number of suppliers. Transmissions of the type used in the Company's coaches and those of most of its competitors are manufactured solely by Allison Transmission. Although the Company believes it would be able to develop alternate sources

for any of the components, other than transmissions, used in its products, significant delays or interruptions in the delivery of certain components from suppliers or difficulties or delays in shifting to new suppliers could have a material adverse effect on the Company. Presently the company is not experiencing any interruptions or supply limitations from its major suppliers.

Upon completion of the manufacturing process, each coach undergoes a thorough inspection and test drive, and problems discovered are corrected prior to shipment.

Competition

The market for manufacture of mid- to high-line motor coaches is very competitive, and the Company has significant competition in each of its product lines. Other manufacturers of high-line coaches include Blue Bird Corporation, Country Coach, Inc. (acquired in late 1996 by National RV Holdings, Inc.), Fleetwood Enterprises, Inc., Foretravel Inc., Gulf Stream Coach, Inc., Monaco Coach Corporation, and Holiday Rambler Corporation (acquired in early 1996 by Monaco Coach Corporation). The Company competes with a number of other manufacturers, some of which are much larger than the Company and have greater financial and other resources than the Company. Certain of these larger manufacturers have also identified value-oriented high-line motor coaches as an attractive market and have recently developed coaches more directly competitive with the Company's coaches.

The Company believes the principal competitive factors in the manufacture and sale of high-line motor coaches are product quality and design, price, customer service, performance and reliability. The Company believes it is competitive with respect to each of these factors and believes its customer service and the performance and reliability of its products compare favorably to those of its competitors.

Product Design; Patents

The Company strives to be a design innovator in motor coach floor plans, interior features, coach amenities and mechanical systems and believes it is generally recognized in the industry as a design leader. Among the innovations introduced by the Company are the first use of a side aisle floor plan, the Electro-Majic bed, a rear-mounted cooling system, 110 volt residential-style lighting and the successful use of Torsilastic suspension on a high-line motor coach. The Company updates the fabrics, carpets, fixtures and floor plans of its coaches each year and plans for a complete redesign of each model every three to four years.

The Company began development of its Electro-Majic bed in 1988 and in 1992 obtained a patent for this electric powered bed system. Using a hidden electric motor, the system uses small gear tracks attached to the living room walls to lower a double-size bed from the ceiling down to a desired sleeping level. The Electro-Majic bed is used in most Trek models. In two of the Company's best-selling Trek floor plans, the Electro-Majic bed is the primary sleeping space, which allows the entire coach to be used for living, kitchen and bathroom areas. The Company believes there is no comparable motor coach floor plan on the market.

The Company designed and patented an all new air ride suspension system in 1996 for use in its Beaver Patriot and Marquis models. The suspension system is designed to optimize the stability of the moving coach, while at the same time maximizing ride comfort.

Government Regulation

Motor coach manufacturers, such as the Company, are subject to federal, state, and local regulations governing the manufacture and sale of their products, including the provisions of the Motor Vehicle Act. The Motor Vehicle Act provides for, among other things, the recall for modification, repair or replacement of vehicles that contain defects which are potentially dangerous, or which fail to comply with applicable standards. The Company's motor coaches also may be subject to recall by chassis manufacturers in the event the chassis fail to comply with applicable standards. The Company relies upon certifications from its engine suppliers and chassis manufacturers that the Company's motor coaches comply with all applicable emission control standards. Although motor coaches manufactured by the Company have been voluntarily recalled for repair from time to time in the past, the Company has not incurred significant expenses in connection with recalls. Because the Company sells its products in Canada, it is also governed by similar laws and regulations issued by the Canadian government. There is no assurance that future recalls of the Company's products will not occur or that any such recalls will not adversely affect the Company's operations or financial condition.

The Company is also subject to regulations promulgated by the Occupational Safety and Health Administration ("OSHA") concerning workplace health and safety. The Company's plants are periodically inspected by OSHA.

The business and operations of the Company are affected by federal, state, and local environmental regulations relating to air and water pollution, hazardous wastes, and noise. These regulations control the Company's use, storage, and disposal of production chemicals and other wastes. The regulations also restrict the Company's air contaminant emissions and waste water discharges and prohibit noise in excess of certain levels.

The Company holds a federal operating permit as required by Title V of the federal Clean Air Act Amendments of 1990 (a "Title V Permit") for its Safari and Beaver motor coach manufacturing facilities. The combined CTI and HCO facility holds an air contaminant discharge permit ("ACDP"), issued by the Oregon Department of Environmental Quality and has applied for a Title V permit. The Company believes it will be issued the permits necessary to allow it to operate these facilities. The ACDPs and the Title V permits, however, are issued for operations at specified levels, and any increase in emissions beyond those levels, including increases resulting from expanded operations or process modifications, will require permit amendments.

To date, the Company has not been required to make significant expenditures for environmental compliance. The promulgation of additional safety or environmental regulations, or the need to acquire permit amendments, in the future, however, could require the Company to incur additional expense which could adversely impact the Company's results of operations. There is no assurance that the Company will not be required to make significant expenditures in the future with respect to such safety or environmental regulations.

The Company believes it is in material compliance with applicable laws relating to the manufacture and operation of motor coaches and operations of its manufacturing facilities. There is no assurance, however, that future governmental regulations will not be more

stringent, and that compliance with those regulations will not require the Company to incur additional cost.

Employees

At December 31, 1998 the Company had 1,661 full-time employees. None of the Company's employees are represented by a labor union, and the Company has never experienced a work stoppage, slowdown or strike. The Company believes it maintains good employee relations.