NOTE 1

Nature of Operations, Accounting Policies of Consolidated Financial Statements

Nature of operations — Skyline Corporation’s core ongoing business activities consists of designing, producing and marketing manufactured housing, modular housing and park models to independent dealers and manufactured housing communities throughout the United States and Canada. Manufactured housing represents homes built according to a national code, modular housing represents homes built to a local code, and park models are built to specifications established by the American National Standards Institute. These dealers and communities often utilize floor plan financing arrangements with lending institutions. The Corporation’s net sales are predominately from its housing products. Note 2 of Notes to Consolidated Financial Statement describes the recreational vehicle segment that was sold on October 7, 2014. Accordingly, the accompanying financial statements (including footnote disclosures unless otherwise indicated) reflect these operations as discontinued operations apart from the Corporation’s continuing housing operations.

The following is a summary of the accounting policies that have a significant effect on the consolidated financial statements.

Basis of presentation — The consolidated financial statements include the accounts of Skyline Corporation and its wholly-owned subsidiaries as referenced in Exhibit 21 (the “Corporation”). All intercompany transactions have been eliminated. Certain prior year amounts related to discontinued operations have been reclassified to conform to current year presentation.

Accounting Estimates — The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Key estimates would include accruals for warranty, workers’ compensation, marketing programs and health insurance as well as valuations for long-lived assets and deferred tax assets.

Revenue recognition — Substantially all of the Corporation’s products are made to order. Revenue is recognized upon completion of the following: an order for a unit is received from a dealer or community (customer); written or verbal approval for payment is received from a customer’s financial institution or payment is received; a common carrier signs documentation accepting responsibility for the unit as agent for the customer; and the unit is removed from the Corporation’s premises for delivery to a customer. Freight billed to customers is considered sales revenue, and the related freight costs are cost of sales. Volume based rebates paid to dealers are classified as a reduction of sales revenue. Sales of parts are classified as revenue.

Accounts Receivable — Trade receivables are based on the amounts billed to dealers and communities. The Corporation does not accrue interest on any of its trade receivables. In fiscal 2015, a $536,000 allowance for doubtful accounts was established for an approximately $536,000 accounts receivable the Corporation has with one customer. The allowance for doubtful accounts was established due to uncertainty in the amount of money that will ultimately be collected.

Inventories — Inventories are stated at the lower of cost or market. Cost is determined under the first-in, first-out method. Physical inventory counts are taken at the end of each reporting quarter.

Workers’ Compensation Security Deposit — Workers’ compensation security deposit represents funds placed with the Corporation’s worker’s compensation insurance carrier to offset future medical claims and benefits.

Note Receivable — The Corporation’s note receivable represents the amount owed for the sale of two idle recreational vehicle facilities in Hemet, California; less cash received on the date of closing and cash received from principal repayments. The note was fully repaid in December 2014.

Property, Plant and Equipment — Property, plant and equipment are stated at cost. Depreciation is computed over the estimated useful lives of the assets using the straight-line method for financial statement reporting and accelerated methods for income tax reporting purposes. Estimated useful lives for significant classes of property, plant and equipment, including idle property, are as follows: Building and improvements 10 to 30 years; machinery and equipment 5 to 8 years. At May 31, 2015, undeveloped land in McMinnville, Oregon is presently for sale. At May 31, 2014, the Corporation’s idle properties consisted of manufacturing facilities in Ocala, Florida and Elkhart, Indiana; which sold during fiscal 2015.

Long-lived assets are reviewed for impairment whenever events indicate that the carrying amount of an asset may not be recoverable from projected future cash flows. If the carrying value of a long-lived asset is impaired, an impairment charge is recorded for the amount by which the carrying value of the long-lived asset exceeds its fair value. The Company believes no impairment of long-lived assets exists at May 31, 2015.

Warranty — The Corporation provides the retail purchaser of its homes, park models and recreational vehicles with a full fifteen-month warranty against defects in design, materials and workmanship. The warranties are backed by service departments located at the Corporation’s manufacturing facilities and an extensive field service system.

Estimated warranty costs are accrued at the time of sale based upon current sales, historical experience and management’s judgment regarding anticipated rates of warranty claims. The adequacy of the recorded warranty liability is periodically assessed and the amount is adjusted as necessary.

Income Taxes — The Corporation recognizes deferred tax assets based on differences between the carrying values of assets for financial and tax reporting purposes. The realization of the deferred tax assets is dependent upon the generation of sufficient future taxable income.

Generally accepted accounting principles require that an entity consider both negative and positive evidence in determining whether a valuation allowance is warranted. In comparing negative and positive evidence, continual losses in recent years is considered significant, negative, objective evidence that deferred tax assets may not be realized in the future, and generally is assigned more weight than subjective positive evidence of the realizability of deferred tax assets. As a result of its extensive evaluation of both positive and negative evidence, management maintains a full valuation allowance against its deferred tax assets. The Corporation reports a liability, if any, for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. The Corporation recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense.

Consolidated statements of cash flows — The Corporation’s cash flows from operating activities were not affected by income taxes in fiscal 2015 and 2014. Cash flows from financing activities were affected by interest paid of approximately $339,000 in fiscal 2015. Cash flows from financing activities were not affected by interest paid in fiscal 2014.

Recently issued accounting pronouncements — In April 2014, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) No. 2014-08 Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. ASU No. 2014-08 changes the requirements for reporting discontinued operations in that a discontinued operation may include a component of an entity, a group of components of an entity, or a business or non-profit activity. In addition, a disposal of a component of an entity or a group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift that has or will have a major effect on an entity’s operations and financial results when certain conditions are met. For public business entities, ASU No. 2014-08 is effective for all disposals (or classifications as held for sale) of components of an entity that occur within annual periods beginning on or after December 15, 2014, and interim periods within those years. Early adoption is permitted, but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issuance.

The Corporation did not utilize early adoption of ASU No. 2014-08 regarding the sale of its recreational vehicle segment as referenced in Note 2. It will, however, adopt this pronouncement for any disposals (or classifications as held for sale) that may occur after May 31, 2015.

Management’s Plan — The Corporation’s consolidated financial statements were prepared on a going concern basis, which assumes continuity of operations and realization of assets and satisfaction of liabilities in the ordinary course of business. Due to recurring losses, the Corporation experienced negative cash flows from operating activities. The level of historical negative cash flows from operations raise substantial doubt about the Corporation’s ability to continue as a going concern. To continue as a going concern, management determined that certain strategies need to be pursued to raise capital, increase sales and decrease costs. These strategies include but are not limited to:

•

Divest Non-Core Assets: Management is focused on driving profitable growth in the Corporation’s core housing business.

Progress:

In October 2014, the Corporation sold its recreational vehicle segment to focus solely on its core housing business and to raise cash. Additional information regarding the sale is in Note 2 of Notes to Consolidated Financial Statements.

In addition to the sale of the RV business, the Corporation sold an idle housing facility in fiscal 2015 and two idle housing facilities and one undeveloped parcel of land in fiscal 2014. A buyer is also being sought for an undeveloped parcel of land the Corporation owns.

•

Increase Sales:

•

Working to increase sales to manufactured housing dealers by gaining a greater presence on the properties of manufactured housing dealers and manufactured housing communities.

•

Continuing to work with manufactured housing communities to identify opportunities for increasing sales.

•

Increasing sales of modular homes and park models by cultivating relationships with modular housing developers and campground owners that are outside the Corporation’s historical distribution channels.

•

Establishing additional distribution channels and forging new strategic relationships.

Progress:

Manufactured housing net sales in fiscal 2015 increased 23 percent compared to fiscal 2014. One factor for the increase was due to increased sales to manufactured housing dealers. Another factor was the Mansfield facility having twelve months of sales in fiscal 2015 versus four months in fiscal 2014. Finally, in fiscal 2015 manufactured housing sales to the Corporation’s six largest communities increased approximately 24 percent compared to fiscal 2014.

Park model net sales increased approximately 103 percent compared with fiscal 2014. Included in this increase was a 119 percent increase in sales to the Corporation’s six largest communities.

Modular housing net sales for fiscal 2015 decreased approximately 5 percent as compared to fiscal 2014. As referenced in “Net Sales and Unit Shipments,” prior year net sales included $3,900,000 from a contract with National Community Renaissance of California that was outside the Corporation’s normal business model. The Corporation does not plan on performing this type of contract in the foreseeable future. When the effect of this contract is excluded from prior year net sales, fiscal 2015 net modular sales increased approximately 12 percent.

During the second quarter, the Corporation established a relationship with a manufactured housing retailer that specializes in internet-based marketing and provides factory tours to potential customers. This retailer operates retail sales centers located at four of the Corporation’s housing facilities. This relationship is expected to help drive additional sales by more fully exploiting this increasingly important distribution channel for the Corporation’s products. This initiative began generating sales to four locations in the third and fourth quarters.

•

Decrease Costs: Skyline continues to streamline costs with a focus on maximizing efficiencies and resources.

Progress:

The Corporation’s Purchasing Department has obtained significant price concessions from certain suppliers. In addition, Management has continued to analyze staffing needs and make reductions when considered appropriate. In connection with the sale of the RV business and in determining staffing needs for fiscal 2016, the Corporation identified and implemented reductions in corporate personnel who received compensation of approximately $630,000 is fiscal 2015.

•

Raise Additional Capital:

Progress:

On March 20, 2015, the Corporation entered into a Loan and Security Agreement with First Business Capital Corp. providing for a renewable three-year secured revolving credit facility. Under the new credit facility, the Company may obtain loan advances up to a maximum of $10 million, subject to certain collateral-obligation ratios. Outstanding loan advances under the facility will bear interest at 3.75% in excess of The Wall Street Journal’s published one year LIBOR rate. The facility will be used to support the Company’s working capital needs and other general corporate purposes, and is secured by substantially all of the Company’s and its subsidiaries’ assets. Additional information regarding the revolving credit facility is in Note 12 of Notes to Consolidated Financial Statements. Subsequent to May 31, 2015, the Corporation on two occasions did not meet a covenant requiring a monthly loss not exceeding $500,000. In addition, at least one monthly loss exceeding $500,000 is projected during the third fiscal quarter of fiscal 2016; a period where net sales are at its lowest for the year. The inability to meet the aforementioned covenants represents an event of default, which if not cured or waived could negatively affect the Corporation’s ability to obtain financing under the facility and thereby have an adverse effect on liquidity. The Corporation has requested a waiver of the existing covenant defaults together with a modification of this covenant.

Management believes that it will be able to execute their strategies as noted above. Management is prepared to modify these strategies as appropriate to meet prevailing business and market conditions.