Item 1. Business
General
Founded in 1977, Palm Harbor Homes, Inc. and its subsidiaries (collectively, we or Palm Harbor) are a leading manufacturer and marketer of factory-built homes in the United States. We market nationwide through vertically integrated operations, encompassing manufactured and modular housing, chattel and mortgage bank financing as well as insurance. At March 30, 2007, we operated 14 manufacturing facilities in eight states that sell homes in 27 states through 107 of our company-owned retail superstores and builder locations and approximately 350 independent retail dealers, builders and developers. Through our 80% owned subsidiary, CountryPlace Mortgage, Ltd., we offer chattel and non-conforming land/home loans to purchasers of factory-built homes sold by company-owned retail superstores and certain independent retail dealers, builders and developers. The loans originated through CountryPlace are held for our own investment portfolio and ultimately securitized. We provide property and casualty insurance for owners of manufactured homes through our subsidiary, Standard Casualty Company.
Beginning in 1999, the manufactured housing industry entered a cyclical downturn as the result of the tightening of credit standards, limited retail and wholesale financing availability, increased levels of repossessions, excessive retail inventory levels and manufacturing capacities. Industry shipments of manufactured homes were approximately 348,700 in calendar year 1999 and have decreased 66% over the last eight years to a 45 year industry low of 117,400 in calendar year 2006. During this eight-year period, our manufactured housing shipments declined 62%.
Prior to 2006, the increases in manufactured housing shipments to Florida, Arizona and California were the main factor in maintaining industry shipments at approximately 130,000 per year. In 2006, however, the dynamics fueling increased manufactured housing demand in these states changed quickly. Site built homes in these states had experienced rapid price appreciation driven by high land cost. As such, the increase in speculative building resulted in excess inventory. This has caused prices to fall and buyers and sellers are postponing their home buying decisions. It has also greatly reduced the number of over age 55 buyers of manufactured housing since they typically must sell their site built home to buy a manufactured home. In the last six months of calendar 2006, shipments to Florida, Arizona and California were down approximately 41%.
With the manufactured housing industry not showing signs of a quick recovery, we continue to focus on growth opportunities in our modular housing business. We entered the modular home business in June 2002 when we acquired Nationwide Custom Homes (Nationwide). We have since added modular production to seven of our manufactured housing facilities. Industry shipments of modular homes were approximately 38,300 in calendar year 2006, an 11% decrease over calendar year 2005. However, our modular home sales increased approximately 34% and now account for approximately 32% of our recurring net sales.
Factory-Built Operations
Our factory-built operations consist of the production and sale of manufactured homes and modular homes. Our manufactured homes are constructed in accordance with the Federal Manufactured Home Construction and Safety Standards (HUD regulations) and our modular homes are built in accordance with state or local building codes. In connection with our planned strategy to create growth opportunities with modular housing, we have experienced a shift in the number of modular homes sold from 8% of total factory-built home sales in fiscal 2003 when we acquired Nationwide to 27% in fiscal 2007.
In the second quarter of fiscal 2006, the Federal Emergency Management Agency (FEMA) contracted with various factory-built housing homebuilders to produce and deliver manufactured homes in connection with its Hurricane Katrina relief efforts. We contracted with FEMA to produce and deliver 583 homes in fiscal 2006.
The following table sets forth the total factory-built homes sold as well as the number of manufacturing facilities we operated for the fiscal years indicated:
(1)
Includes 583 homes sold to FEMA in fiscal 2006.
The number of operating manufacturing facilities decreased from 18 in fiscal 2006 to 14 in fiscal 2007. We closed one facility in the first quarter of fiscal 2007 that was previously idled but had been reopened for FEMA production in fiscal 2006. We closed two less-than-efficient facilities in each of the second and fourth quarters of fiscal 2007 as part of our planned strategy to more effectively balance our manufacturing and distribution capacity with the current needs of the market. One facility was destroyed by fire in the third quarter of fiscal 2007.
The principal materials used in the production of our factory-built homes include wood, wood products, gypsum wallboard, steel, fiberglass insulation, carpet, vinyl, fasteners, appliances, electrical items, windows and doors. We believe that the materials used in the production of our factory-built homes are readily available from a wide variety of suppliers and the loss of any single supplier would not have a material adverse effect on our business. The one supplier which accounted for more than 5% of our total purchases during the fiscal year ended March 30, 2007 represented 9.1%, of our total purchases during the fiscal year ended March 30, 2007. Prices of certain materials such as lumber, gypsum, steel and insulation can fluctuate significantly due to changes in supply and demand. Although we and others in the industry typically have been able to pass higher material costs on to the consumer through price increases, such increases typically lag the escalation of material costs. No assurances can be made that we will be able to pass these costs on in future years.
We received the 2006 Manufactured Housing Institute’s (MHI) National Industry Award for “Manufacturer of the Year” in April 2006. MHI is the national trade organization representing all segments of the manufactured and modular housing industry, including manufacturers, retailers, community owners, suppliers, financial institutions, state associations and developers. All MHI members were eligible to vote in the selection process, making this award one of the most prestigious honors bestowed in the industry.
Manufactured Homes
We manufacture single and multi-section manufactured homes under various brand names including Palm Harbor™, Masterpiece™, Keystone™, CountryPlace, River Bend and Windsor Homes™. Approximately 91% of the manufactured homes we produced in fiscal 2007 were multi-section as compared to 94% (excluding the 583 single-section homes we produced for FEMA) in fiscal 2006. We offer over 600 floor plans, ranging in size from approximately 800 to 3,200 square feet. Approximately 90% of the manufactured homes we produce are structurally or decoratively customized to the homebuyer’s specifications. Although we produce a wide price range of manufactured homes, the average retail sales price (excluding land) of our manufactured homes was approximately $79,000 during fiscal 2007.
Our homes are manufactured in indoor facilities, which have approximately 100,000 square feet of floor space and employ an average of 205 associates who generally work one shift per day, five days per week.
Construction of our homes is performed in stages using an assembly-line process. Each section is permanently attached to a steel support chassis, various components such as floors, interior and exterior walls and a roof are added and function testing is performed. We currently build a typical manufactured home in approximately five days. Our facilities have the capacity to produce an aggregate of approximately 76 sections per day. The current rate of production is 37 sections per day.
Our typical manufactured home contains two to five bedrooms, a living room, family room, dining room, kitchen, two or three bathrooms and features central air conditioning and heating, a range, refrigerator, carpeting and drapes. In addition, we offer optional amenities, including dishwashers, washers, dryers, furniture packages and specialty cabinets, as well as a wide range of colors, moldings and finishes. Optional features usually associated with site-built homes such as stone fireplaces, ceramic tile floors, showers and countertops, computer rooms, skylights, vaulted ceilings and whirlpool baths are also offered. We have a unique package of energy saving construction features referred to as “EnerGmiser™” which includes, among other things, additional insulation to reduce heating and cooling costs, which exceeds statutorily-mandated energy efficiency levels. We have been recognized as a leader in energy-efficient construction twice in the past two years. In March 2007, we were named by the U.S. Environmental Protection Agency (EPA) as a 2007 ENERGY STAR Partner of the Year for our outstanding contribution to reducing greenhouse gas emissions by building energy-efficient homes. We also received the 2006 Gold Energy Value housing Award in the factory-built home/hot climate category by the National Association of Home Builders Research Center.
We are constantly introducing new floor plans, decors, exteriors, features and accessories to appeal to changing trends in different regions of the country. Our manufactured homes are designed and copyrighted after extensive field research and consumer feedback. We have developed engineering systems which, through the use of computer-aided technology, permit customization of homes and assist with product development and enhancement.
The completed manufactured homes are transported by independent trucking companies to either the retail sales center or to the customer’s site. The transportation cost is borne by the independent retailer. Typically, independent installers or subcontractors hired by the retailers are responsible for placing the manufactured home on site, joining the interior and exterior seams, making utility hook-ups and, in certain instances, providing installation and finish-out services. However, our associates, rather than subcontractors, perform the interior and finish out services on factory-built homes sold by us. We believe our finish-out services ensure that our quality procedures are applied during the entire process and increase customer satisfaction, thereby providing us a competitive advantage.
Our backlog of manufactured housing orders as of May 29, 2007 was approximately $46.3 million, as compared to approximately $23.2 million as of May 30, 2006. Since retailers may cancel orders prior to production without penalty, we do not consider our order backlog to be firm orders; however, such cancellations rarely occur. Because of the seasonality of the manufactured housing market, the level of backlog generally declines during the winter months.
Modular Homes
We manufacture modular homes through our wholly owned subsidiary, Nationwide Custom Homes, Inc. Nationwide operates two facilities in Martinsville, Virginia, one in Arabi, Georgia, and one in Siler City, North Carolina. In addition, seven of our manufactured housing facilities produce modular homes principally under the brand name Discovery Custom Homes. We produce a wide price range of modular homes with an average retail sales price (excluding land) of $165,000 during fiscal 2007.
Our modular homes include single story ranch homes, split-levels, cape cods and two and three story homes. Like a manufactured home, a typical modular home contains two to five bedrooms, a living room, family room, dining room, kitchen, two or three bathrooms. It also features central air conditioning and heating, a range, refrigerator and carpeting, and offers optional amenities, decors, exteriors and floor plans.
Each modular home is assembled in sections. The process begins on a production line where a team of associates creates the floor and walls of the house. The section is then wheeled down a tracked path where various stages of finish are performed and components are added-from wiring and insulation early in the process to fixtures and floor coverings just prior to shipping. Modular homes are typically completed in one to two weeks.
The homes are shipped directly off the manufacturing line to either the retail superstore or the customer’s site. Once on site, the homes are typically crane set on the foundation, the roof is raised and the final seam of roof shingles along the ridges of the roofline is applied.
We have won various awards for our modular product in the past couple years. In March 2005, our Cambria model won a design award from the National Modular Housing Council for “Best Modular Home (over 1,800 square feet)-Production Category.” In September 2005, we won the Ohio Manufactured Housing Association Award for Outstanding Modular Manufacturer of the Year for enhancing the image of the manufactured and modular homes industry through outstanding customer service and business practices.
Our backlog of modular orders as of May 29, 2007, was approximately $46.3 million, as compared to approximately $54.9 million as of May 30, 2006.
Retail
Our homes are sold through a distribution network consisting of retail superstores that we own and independent dealers, builders and developers. The percentage of homes sold by our company-owned superstores was 59%, 54% (excluding the 583 homes sold to FEMA) and 60% in fiscal 2007, 2006 and 2005, respectively. The following table sets forth the number of homes we sold through each of these distribution channels, as well as the number of company-owned retail superstores and independent dealers, builders and developers during the past three fiscal years:
(1)
Includes 82 homes sold to FEMA in fiscal 2006.
(2)
Includes 501 homes sold to FEMA in fiscal 2006.
We first established company-owned retail superstores in 1992 and currently have 103 superstores in 20 states. A typical retail superstore consists of a sales office, which is a factory-built home, and factory-built model homes of various sizes, floor plans, features and prices. Currently, 61 of our retail superstores have modular model homes on display and many of our retail superstores also sell used and repossessed homes. Customers may purchase one of the model homes or may order a home that will be built at one of our manufacturing facilities and customized to meet their needs.
Through Nationwide, we have four builder locations in Virginia and North Carolina. Our typical builder location consists of a modular model home which serves as both a sales office and a design center which allows customers to select the floorplan and various amenities in their home.
Our independent retailer network principally consists of local dealers and builders that market land/home packages and developers of communities. No single independent retailer accounted for 5% or more of our net sales during fiscal 2007, 2006 or 2005.
Independent Dealers, Builders and Developers
Approximately 39% of the modular homes we sold in fiscal 2007 were sold through Nationwide’s independent distribution network, which consists of approximately 150 local builders and developers with whom we have developed relationships through direct marketing, trade shows, the Internet and referrals. Nationwide transports the home to the builder’s/developer’s site and the builder/developer contracts crews to lift the home with a crane onto its foundation and subsequently perform the finish-out services. Modular homes typically require a larger amount of work to be done on-site (compared to a manufactured home) to complete the production of the homes. Currently seven of our manufactured housing facilities also build modular homes and sell homes directly to builders and developers. Approximately 20% of the modular homes we sold in fiscal 2007 were sold from these seven facilities directly to builders and developers.
General Contractors
During fiscal 2005, we began to serve as a general contractor for both manufactured and modular homes with respect to virtually all aspects of the sale and construction process in certain regions of the country. This could include foundation work, driveways, landscape installations and other amenities the customer requests in addition to the home. We anticipate expanding this role to additional geographic regions in future periods. During fiscal year 2007, we completed 619 jobs for our company-owned superstores and builder locations and 346 for independent dealers, builders and developers.
Markets Served
During the fiscal year ended March 30, 2007, the percentage of our net sales by region was as follows:
The two states which accounted for greater than 10% of our net sales were Florida and Texas, both with 21% of total net sales.
Factory-built housing is a regional business and the primary geographic market is within a 250-mile radius for a manufactured housing facility and within a one to two day drive for a modular housing facility. Each of our manufactured housing facilities typically serves approximately 30 to 75 retailers, and the facility sales staff maintains personal contact with each retailer, whether company-owned or independent. We believe that our decentralized operations allow us to be more responsive in addressing regional customer preferences of product innovation and home design.
Consumer Financing
We maintain relationships with conventional lenders who provide two basic types of consumer financing in the factory-built housing industry: chattel or personal property loans for purchasers of a home with no real estate involved and land/home and mortgage loans which finance the land, home and all improvements on the property. There are two types of mortgage loans-conforming and non-conforming. Conforming loans conform to FHA, VA, Freddie Mac and Fannie Mae standards. Generally, the type of required foundations installed must conform to Federal requirements and the borrower must meet certain criteria. Non-conforming loans are financed by a major bank or lending institution which does not require a specific foundation type and have more flexible criteria. Beginning in fiscal 2000 and continuing through fiscal 2007, many consumer lenders have tightened credit-underwriting standards which has resulted in reduced lending volumes and lower sales volumes of manufactured homes.
Some of our customers obtain third-party construction financing, which allows for progress payments to be made to us at periodic intervals during the manufacturing, sale and closing process. This type of financing is primarily available to those customers obtaining land/home and mortgage loans, which finance the land, home and improvements of a piece of real property. Such third-party construction financing through our customers is generally more advantageous to us in that the cash is received earlier and can be used for various corporate purposes.
In addition, we provide financing to our customers on competitive terms through our 80% owned subsidiary, CountryPlace. Through CountryPlace, we offer customary chattel loans, non-conforming land/home loans for manufactured homes and land/home loans in various stages of completion. CountryPlace does not participate in the sub prime market. The loans originated through CountryPlace are held for our own investment portfolio and ultimately securitized. We believe that providing this financing alternative to our customers improves our responsiveness to the financing needs of prospective purchasers and provides us with an additional source of earnings.
Insurance
We offer property and casualty insurance as well as extended warranties for owners of manufactured homes through our subsidiary, Standard Casualty. Standard Casualty specializes in the manufactured housing industry, primarily serving the Texas, Georgia, Arizona and New Mexico markets. In Texas, the policies are written through one affiliated managing general agent, which produces all premiums, except surety, through local agents, most of which are manufactured home dealers. All business outside the state of Texas is written on a direct basis through local agents. There are approximately 150 active producing agents.
During fiscal 2007, 61% and 91% of homeowners who purchased a home through our own retail superstores purchased property and casualty insurance and extended warranties, respectively. At the end of fiscal 2007, Standard Casualty had approximately 10,600 policies in force.
Wholesale Financing
In accordance with factory-built housing industry practice, substantially all retailers finance a portion of their purchases of manufactured homes through wholesale “floor plan” financing arrangements. Under a typical floor plan financing arrangement, a financial institution provides the retailer with a loan for the purchase price of the home and maintains a security interest in the home as collateral. The financial institution which provides financing to the retailer customarily requires us to enter into a separate repurchase agreement with the financial institution under which we are obligated, upon default by the retailer and under certain other circumstances, to repurchase the financed home at declining prices over the term of the repurchase agreement (which generally ranges from 12 to 18 months). The price at which we may be obligated to repurchase a home under these agreements is based upon our original invoice price plus certain administrative and shipping expenses. Our obligation under these repurchase agreements ceases upon the purchase of the home by the retail customer.
The risk of loss under such repurchase agreements is mitigated by the fact that (i) approximately 59% of our homes are sold through our company-owned stores for which no repurchase agreement exists; (ii) a majority of the homes we sell to independent dealers, builders and developers are pre-sold to specific retail customers; (iii) we monitor each dealer’s, builder’s and retailer’s inventory position on a regular basis; (iv) sales of our manufactured homes are spread over a large number of dealers, builders and developers; (v) none of our independent dealers, builders and developers accounted for more than 5% of our net sales in fiscal 2007; (vi) the price we are obligated to pay declines over time and (vii) we are, in most cases, able to resell homes repurchased from credit sources in the ordinary course of business without incurring significant losses. We estimate that our potential obligations under such repurchase agreements were approximately $22.7 million as of March 30, 2007. During the fiscal years ended March 30, 2007, March 31, 2006 and March 25, 2005, we incurred losses under these repurchase agreements totaling $0, $157,000 and $65,000, respectively.
Beginning in fiscal 2000, lenient credit standards, which had facilitated increased industry-wide wholesale shipments in previous years, tightened, resulting in declining wholesale shipments, declining margins and lower retail sales levels for most industry participants through fiscal 2007. During this time, several major floor plan lenders have exited the wholesale financing business and a number of regional banks have either entered the retail financing business or increased their lending volumes.
Competition
The factory-built housing industry is highly competitive at both the manufacturing and retail levels, with competition based upon several factors, including price, product features, reputation for service and quality, depth of field inventory, promotion, merchandising and the terms of retail customer financing. In addition, manufactured and modular homes compete with new and existing site-built homes, as well as apartments, townhouses and condominiums. The efficiency of the assembly-line process, protection from the weather and nationwide purchasing power enable us to produce a home in approximately one to two weeks and typically at a lower cost than a conventional site-built home of similar quality. We do not view any of our competitors as being dominant in the industry, although some of our competitors possess substantially greater manufacturing, distribution and marketing resources than us.
Although many lenders to the factory-built housing industry have reduced their volume or gone out of business, there are still competitors to CountryPlace in the markets where we do business. These competitors include national, regional and local banks, independent finance companies, mortgage brokers and mortgage banks. None of these competitors is considered to be dominant or to have a material impact on the financing opportunities at CountryPlace.
Business Segment Information
We operate principally in two segments: (1) factory-built housing, which includes manufactured housing, modular housing and retail operations and (2) financial services, which includes finance and insurance. See Note 15 of “Notes to Consolidated Financial Statements” in Item 8 of this report for information on our net sales, income (loss) from operations, identifiable assets, depreciation and amortization expense and capital expenditures by segment for fiscal 2007, 2006 and 2005.
Government Regulation
Our factory-built homes are subject to a number of federal, state and local laws, codes and regulations. Construction of our manufactured homes is governed by the National Manufactured Housing Construction and Safety Standards Act of 1974, as amended (the Home Construction Act). In 1976, the Department of Housing and Urban Development (HUD) issued regulations under the Home Construction Act establishing comprehensive national construction standards. The HUD regulations, known collectively as the Federal Manufactured Home Construction and Safety Standards, cover all aspects of manufactured home construction, including structural
integrity, fire safety, wind loads, thermal protection and ventilation. Such regulations preempt conflicting state and local regulations on such matters, and are subject to continual change. Our manufacturing facilities and the plans and specifications of our manufactured homes have been approved by a HUD-certified inspection agency. Further, an independent HUD-certified third-party inspector regularly reviews our manufactured homes for compliance with the HUD regulations during construction. Failure to comply with applicable HUD regulations could expose us to a wide variety of sanctions, including mandated closings of our manufacturing facilities. We believe our manufactured homes meet or surpass all present HUD requirements. Our modular homes are subject to state and/or local codes with certification and regulation and we believe our modular homes meet all state and/or local codes.
Manufactured and site-built homes are all typically built with some products that contain formaldehyde resins. Since February 1985, HUD has regulated the allowable concentrations of formaldehyde in certain products used in manufactured homes and requires manufacturers to warn purchasers as to formaldehyde-associated risks. The Environmental Protection Agency and other governmental agencies have in the past evaluated the effects of formaldehyde. We use materials in our manufactured homes that meet HUD standards for formaldehyde emissions and believe we comply with HUD and other applicable government regulations in this regard.
The transportation of factory-built homes on highways is subject to regulation by various federal, state and local authorities. Such regulations may prescribe size and road use limitations and impose lower than normal speed limits and various other requirements.
Our manufactured homes are subject to local zoning and housing regulations. In certain cities and counties in areas where our homes are sold, local governmental ordinances and regulations have been enacted which restrict the placement of manufactured homes on privately-owned land or which require the placement of manufactured homes in manufactured home communities. Such ordinances and regulations may adversely affect our ability to sell homes for installation in communities where they are in effect. A number of states have adopted procedures governing the installation of manufactured homes. Utility connections are subject to state and local regulation and must be complied with by the retailer or other person installing the home. Our modular homes are also subject to local zoning regulations which govern the placement of homes.
Certain of our warranties may be subject to the Magnuson-Moss Warranty Federal Trade Commission Improvement Act, which regulates the descriptions of warranties on products. The description and substance of our warranties are also subject to a variety of state laws and regulations. A number of states require manufactured home producers to post bonds to ensure the satisfaction of consumer warranty claims.
A variety of laws affect the financing of the homes we manufacture. The Federal Consumer Credit Protection Act (Truth-in-Lending) and Regulation Z promulgated thereunder require written disclosure of information relating to such financing, including the amount of the annual percentage rate and the finance charge. The Federal Fair Credit Reporting Act also requires certain disclosures to potential customers concerning credit information used as a basis to deny credit. The Federal Equal Credit Opportunity Act and Regulation B promulgated thereunder prohibit discrimination against any credit applicant based on certain specified grounds. The Real Estate Settlement Procedures Act and Regulation X promulgated thereunder require certain disclosures regarding the nature and costs of real estate settlements. The Federal Trade Commission has adopted or proposed various Trade Regulation Rules dealing with unfair credit and collection practices and the preservation of consumers’ claims and defenses. Installment sales contracts eligible for inclusion in a Government National Mortgage Association program are subject to the credit underwriting requirements of the Federal Housing Association. A variety of state laws also regulate the form of the installment sale contracts or financing documents and the allowable deposits, finance charge and fees chargeable pursuant to installment sale contracts or financing documents. Our sale of insurance products is subject to various state insurance laws and regulations which govern allowable charges and other insurance practices.
Our operations are also subject to federal, state and local laws and regulations relating to the generation, storage, handling, emission, transportation and discharge of materials into the environment. Governmental
authorities have the power to enforce compliance with their regulations, and violations may result in the payment of fines, the entry of injunctions or both. The requirements of such laws and enforcement policies have generally become more strict in recent years. Accordingly, we are unable to predict the ultimate cost of compliance with environmental laws and enforcement policies. See “Item 3. Legal Proceedings.”
Palm Harbor’s insurance operations are regulated by the state insurance boards where they underwrite their policies. Underwriting, premiums, investments and capital reserves are subject to the rules and regulations of these state agencies.
Cash deposits made by customers are classified as restricted cash in some states. As a result of continued governmental regulations regarding consumer protection, more states are requiring deposits to be restricted cash. See Note 1 to the Consolidated Financial Statements.
Seasonality
Our business is seasonal. Generally we experience higher sales volume during the months of March through October. Our sales are slower during the winter months and shipments can be delayed in areas of the country that experience harsh weather conditions.
Associates
As of March 30, 2007, we had approximately 3,800 associates. All of our associates are non-union. We have not experienced any labor-related work stoppages and believe that our relationship with our associates is good.
Website Access to Company Reports and Other Documents
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports are available free of charge on our website at www.palmharbor.com as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. Those reports are also available at the SEC’s website, www.sec.gov. You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Copies of our annual report will be made available, free of charge, upon written request to our corporate secretary at our principal executive office.
We have adopted a code of conduct. A copy of our code of conduct is available at our website, www.palmharbor.com.
Item 1A.
Item 1A. Risk Factors
Certain statements contained in this annual report are forward-looking statements within the safe harbor provisions of the Securities Litigation Reform Act. Forward-looking statements give our current expectations or forecasts of future events and can be identified by the fact that they do not relate strictly to historical or current facts. Investors should be aware that all forward-looking statements are subject to risks and uncertainties and, as a result of certain factors, actual results could differ materially from these expressed in or implied by such statements. These risks include such assumptions, risks, uncertainties and factors associated with the following:
Financing for our retail customers may be limited, which could affect our sales volume.
Our retail customers who do not use CountryPlace generally either pay cash or secure financing from third party lenders, which have been negatively affected by adverse loan experience. Several major lenders, which had previously provided financing for our customers, have exited the manufactured housing finance business.
Reduced availability of such financing is currently having an adverse effect on both the manufactured housing business and our home sales. Availability of financing is dependent on the lending practices of financial institutions, financial markets, governmental policies and economic conditions, all of which are largely beyond our control. Quasi-governmental agencies such as Fannie Mae and Freddie Mac, which are important purchasers of loans from financial institutions, have tightened standards relating to the manufactured housing loans that they will buy. Most states classify manufactured homes as personal property rather than real property for purposes of taxation and lien perfection, and interest rates for manufactured homes are generally higher and the terms of the loans shorter than for site-built homes. Financing for the purchase of manufactured homes is often more difficult to obtain than conventional home mortgages. There can be no assurance that affordable retail financing for manufactured homes will continue to be available on a widespread basis. If third party financing were to become unavailable or were to be further restricted, this could have a material adverse effect on our results of operations.
If CountryPlace’s customers are unable to repay their loans, CountryPlace may be adversely affected.
CountryPlace makes loans to borrowers that it believes are creditworthy based on its credit guidelines. However, the ability of these customers to repay their loans may be affected by a number of factors, including, but not limited to:
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national, regional and local economic conditions;
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changes or continued weakness in specific industry segments;
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natural hazard risks affecting the region in which the borrower resides; and
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employment, financial or life circumstances.
If customers do not repay their loans, the profitability and cash flow from the loan portfolio could adversely affect CountryPlace’s ability to continue to securitize its loans.
If CountryPlace is unable to continue to securitize its loans, it will be required to seek other sources of long-term funding, which funding may not be available.
The loans that are originated by CountryPlace are funded with proceeds from its warehouse borrowing facility and borrowings from us. On July 12, 2005, CountryPlace successfully completed its initial securitization for approximately $141.0 million of loans which were funded by issuing bonds totaling approximately $118.4 million and on March 22, 2007, CountryPlace completed its second securitization for approximately $116.5 million of loans (including approximately $10.4 million of pre-funded loans to be originated in the future) funded by bonds totaling approximately $101.9 million. We anticipate CountryPlace will continue to securitize its loans as a primary source of liquidity. The proceeds from future securitizations will be used to repay any borrowings from the warehouse facility and from us, as well as to originate new loans. The securitization market is dependent upon a number of factors, including general economic conditions, conditions in the securities market generally and conditions in the asset-backed securities market specifically. Although the asset-backed securitization market for manufactured housing lenders has improved in the past year in terms of access to the markets, as well as pricing and credit enhancement levels, poor performance of any loans we may securitize in the future could harm our future access to the securitization market. If CountryPlace is unable to continue to securitize its loans on terms that are economical, or if there is a decline or interruption in the securitization market for manufactured housing loans, and if CountryPlace is unable to obtain additional sources of long-term funding, it could have a material adverse effect on our results of operations, financial condition and business prospects.
If interest rates increase, the market value of un-securitized loans and loans in the warehouse borrowing facility may be adversely affected.
Fixed rate loans originated by CountryPlace are held in a floating rate warehouse borrowing facility prior to long-term financing via securitization, exposing CountryPlace to the risk of increased interest rates between the
time of loan origination and securitization. If interest rates for warehouse borrowings or term financings increase after loans are originated, the loans may suffer a decline in market value and our interest margin spreads could be reduced. From time to time, CountryPlace has entered into interest rate swap agreements to hedge its exposure to such interest rate risk associated with loans held in its warehouse borrowing facility. However, CountryPlace does not always maintain hedges or hedge the entire balances of all warehoused loans. Furthermore, interest rate swaps may be ineffective in hedging CountryPlace’s exposure to interest rate risk.
If CountryPlace is unable to adequately and timely service its loans, it may adversely affect its results of operations.
Although CountryPlace has originated loans since 1995, it has limited loan servicing and collections experience. In 2002, it implemented new systems to service and collect the portfolio of loans it originates. The management of CountryPlace has industry experience in managing, servicing and collecting loan portfolios; however, many borrowers require notices and reminders to keep their loans current and to prevent delinquencies and foreclosures. If there is a substantial increase in the delinquency rate that results from improper servicing or loan performance, the profitability and cash flow from the loan portfolio could adversely affect CountryPlace’s ability to continue to securitize its loans and CountryPlace could incur additional loan losses.
We face increased competition from on site builders of residential housing, which may reduce our net sales.
Our homes increasingly compete with homes that are built on site. The sales of site built homes are declining, which is resulting in more site built homes being available at lower prices. The decreased price of site built homes and the availability of sub prime mortgage financing could make them more competitive with our homes. As a result, the sales of our homes could decrease, which could negatively impact our results of operations and liquidity.
Our business is highly cyclical, in a prolonged down cycle, highly competitive, seasonal and there may be significant fluctuations in our quarterly results.
The factory-built housing industry is highly cyclical, in a prolonged down cycle, highly competitive, and seasonal and has experienced wide fluctuations in aggregate sales in the past. We are subject to volatility in operating results due to external factors beyond our control such as:
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access to capital markets;
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the level and stability of interest rates;
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unemployment trends;
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the availability of retail financing;
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the availability of wholesale financing;
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the availability of homeowners’ insurance in coastal markets;
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housing supply and demand;
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industry availability of used or repossessed manufactured homes;
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international tensions and hostilities;
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levels of consumer confidence;
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inventory levels;
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severe weather conditions;
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regulatory and zoning matters; and
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changes in general economic conditions.
Sales in our industry are also seasonal in nature, with sales of homes traditionally being stronger in the spring, summer and fall months. The cyclical and seasonal nature of our business causes our net sales and operating results to fluctuate and makes it difficult for management to forecast sales and profits in uncertain times. As a result of seasonal and cyclical downturns, results from any quarter should not be relied upon as being indicative of performance in future quarters.
Reduced availability of wholesale financing may adversely affect our inventory levels of new homes.
We finance a portion of our new inventory at our retail superstores through wholesale “floor plan” financing arrangements. Through these arrangements, financial institutions provide us with a loan for the purchase price of the home. Since the beginning of the industry downturn in 1999, several major floor plan lenders have exited the floor plan financing business. Although we currently have a floor plan facility with a financial institution totaling $70 million, there can be no assurance that we will continue to have access to such a facility or that we will not be forced to reduce our new home inventory at our retail superstores.
Our repurchase agreements with floor plan lenders could result in increased costs.
In accordance with customary practice in the factory-built housing industry, we enter into repurchase agreements with various financial institutions pursuant to which we agree, in the event of a default by an independent dealer, builder or developer in its obligation to these credit sources, to repurchase factory-built homes at declining prices over the term of the agreements, typically 12 to 18 months. The difference between the gross repurchase price and the price at which the repurchased home can then be resold, which is typically at a discount to the original sale price, is an expense to us. Thus, if we were obligated to repurchase a large number of factory-built homes in the future, this would increase our costs, which could have a negative effect on our earnings. Tightened credit standards by lenders and more aggressive attempts to accelerate collection of outstanding accounts with independent dealers, builders and developers could result in defaults by independent dealers, builders and developers and consequently repurchase obligations on our part may be higher than has historically been the case. During fiscal 2007, 2006 and 2005, our losses incurred under these repurchase agreements totaled $0, $157,000 and $65,000, respectively.
We are dependent on our principal executive officer and the loss of his service could adversely affect us.
We are dependent to a significant extent upon the efforts of our principal executive officer, Larry H. Keener, Chairman and Chief Executive Officer. The loss of the services of our principal executive officer could have a material adverse effect upon our business, financial condition and results of operations. Our continued growth is also dependent upon our ability to attract and retain additional skilled management personnel.
We are controlled by two shareholders, who may determine the outcome of all elections.
Approximately 53% of our outstanding common stock is beneficially owned or controlled by our Chairman Emeritus, Lee Posey, and Capital Southwest Corporation and its affiliates. As a result, these shareholders, acting together, are able to determine the outcome of elections of our directors and thereby control the management of our business.
Increased prices and unavailability of raw materials could have a material adverse effect on us.
Our results of operations can be affected by the pricing and availability of raw materials. In fiscal 2007, average prices of our raw materials were flat compared to fiscal 2006, however, in fiscal 2006 and 2005 we experienced an increase in the average prices of our raw materials of 5% and 6%, respectively. Although we attempt to increase the sales prices of our homes in response to higher materials costs, such increases typically lag behind the escalation of materials costs. Although lumber costs have moderated, three of the most important raw materials used in our operations-lumber, gypsum wallboard and insulation-have experienced significant
price fluctuations in the past several fiscal years. Although we have not experienced any shortage of such building materials today, there can be no assurance that sufficient supplies of lumber, gypsum wallboard and insulation, as well as other materials, will continue to be available to us on terms we regard as satisfactory.
If inflation increases, we may not be able to offset inflation through increased selling prices.
If there is a material increase in inflation in the future, it is unlikely that we will be able to increase our selling prices to completely offset the material increase in inflation and as a result, our operating results may be adversely affected.
The manufactured housing industry is highly competitive and some of our competitors have stronger balance sheets and cash flow, as well as greater access to capital, than we do. As a result of these competitive conditions, we may not be able to sustain past levels of sales or profitability.
The manufactured housing industry is highly competitive, with relatively low barriers to entry. Manufactured and modular homes compete with new and existing site-built homes and to a lesser degree, with apartments, townhouses and condominiums. Competition exists at both the manufacturing and retail levels and is based primarily on price, product features, reputation for service and quality, retailer promotions, merchandising and terms of consumer financing. Some of our competitors have substantially greater financial, manufacturing, distribution and marketing resources than we do. As a result of these competitive conditions, we may not be able to sustain past levels of sales or profitability.
If our retail customers are unable to obtain insurance for factory-built homes, our sales volume and results of operations may be adversely affected.
We sell our factory-built homes to retail customers located throughout the United States including in coastal areas, such as Florida. In fiscal 2007, 21% of our net sales were generated in Florida. Some of our retail customers in these areas have experienced difficulty obtaining insurance for our factory-built homes due to adverse weather-related events in these areas, primarily hurricanes. If our retail customers face continued and increased difficulty in obtaining insurance for the homes we build, our sales volume and results of operations may be adversely affected.
We are concentrated geographically, which could harm our business.
In fiscal 2007, 21% of our net sales were generated in both Florida and Texas. A decline in the demand for factory-built housing in these two states and/or a decline in the economies of these two states could have a material adverse effect on our results of operations.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
We currently own 18 properties upon which our manufacturing facilities are located. We own substantially all of our machinery and equipment. We believe our facilities are adequately maintained and suitable for the purposes for which they are used. Our current utilization rate at our manufacturing facilities is approximately 49%. The following table sets forth certain information with respect to properties at our manufacturing facilities:
(1)
Production line was idled as of March 30, 2007.
(2)
Facility was destroyed by fire on December 2, 2006.
In addition to our production facilities, we currently own properties upon which 29 of our active retail superstores are located. We also lease approximately 48,000 square feet of office space in Addison, Texas for our corporate headquarters. Our corporate headquarters lease expires in 2013.
Item 3.
Item 3. Legal Proceedings
We are subject to various legal proceedings and claims that arise in the ordinary course of business. In the opinion of management, the amount of ultimate liability with respect to these actions will not materially affect our financial position or results of operations.
In late 1992, we removed an underground storage tank formerly used to store gasoline from the site of our Tempe, Arizona manufacturing facility. We are currently working in cooperation with the Arizona Department of Environmental Quality to assess and respond to gasoline related hydrocarbons detected in soil and groundwater at this site. Under certain circumstances, a state fund may be available to compensate responsible parties for petroleum releases from underground storage tanks. Site characterization is complicated by the presence of contaminants associated with the Indian Bend Wash Area Superfund Site described below. The liability is not estimatable due to our inability to project whether any additional remediation is necessary. At this time, we do
not expect that the costs of any corrective action or assessments related to the tank will have a material adverse effect on our financial condition, results of operations or cash flows.
Our Tempe facility is partially located within a large area that has been identified by the EPA as the Indian Bend Wash Area Superfund Site. Under federal law, certain persons known as potentially responsible parties (PRPs) may be held strictly liable on a joint and several basis for all cleanup costs and natural resource damages associated with the release of hazardous substances from a facility. The average cost to clean up a site listed on the National Priorities List is over $30 million. The Indian Bend Superfund Site is listed on the National Priorities List. Groups of PRPs may include current owners and operators of a facility, owners and operators of a facility at the time of disposal of hazardous substances, transporters of hazardous substance and those who arrange for the treatment or disposal of hazardous substances at a site. No government agency, including the EPA, has indicated that we have been or will be named as a PRP or that we are otherwise responsible for the contamination present at the Indian Bend Superfund Site. In general, although no assurance can be given as to the future actions of either the EPA or PRPs who may incur cleanup costs related to this site, we do not believe that our ownership of property partially located within the Indian Bend Superfund Site will have a material adverse effect on our financial condition, results of operations or cash flows.
In 1994, we removed two underground storage tanks used to store petroleum substances from property we own in Georgia. In November 2001, we received a letter from the Georgia Department of Natural Resources indicating no further action was necessary with respect to these storage tanks. The letter, however, did not preclude additional action by the State if contaminants were found in adjoining properties. At this time, we do not expect that the costs of future assessment and corrective action related to the tanks will have a material adverse effect on our financial condition, results of operations or cash flows.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted during the fourth quarter of the fiscal year covered by this Report to a vote of security holders, through the solicitation of proxies or otherwise.
PART II.
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock has been traded on the Nasdaq Stock Market under the symbol “PHHM” since July 31, 1995, the date on which we completed our initial public offering. The following table sets forth, for the periods indicated, the high and low sales information per share of the common stock as reported on the Nasdaq Stock Market.
On May 29, 2007, the last reported sale price of our common stock on the Nasdaq Stock Market was $15.70. As of May 29, 2007, there were approximately 600 record holders of our common stock, and approximately 3,300 holders of the common stock overall based on an estimate of the number of individual participants represented by security position listings.
We have never paid cash dividends on our common stock. Our board of directors intends to retain any future earnings we generate to support operations and to finance expansion and does not intend to pay cash dividends on our common stock for the foreseeable future. The payment of cash dividends in the future will be at the discretion of the board of directors and will depend upon a number of factors such as our earnings levels, capital requirements, financial condition and other factors deemed relevant by the board of directors. Future loan agreements may or may not restrict or prohibit the payment of dividends.
PERFORMANCE GRAPH
The following graph shows a comparison of cumulative total returns for us, the Standard & Poor’s MidCap 400 Composite Stock Index and our peer group, assuming the investment of $100 on March 31, 2002, and the reinvestment of dividends. The companies in our peer group are as follows: Cavalier Homes, Inc., Champion Enterprises, Inc., Fleetwood Enterprises, Inc., Liberty Homes, Inc. and Skyline Corporation.
There can be no assurance that our share performance will continue into the future with the same or similar trends depicted in the graph above. We will not make or endorse any predictions as to future share performance.
Item 6.
Item 6. Selected Financial Data
The following table sets forth selected financial information regarding our financial position and operating results which has been extracted from our audited financial statements for the five fiscal years ended March 30, 2007. The information should be read in conjunction with Item 7
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Executive Overview
We are one of the nation’s leading manufacturers and marketers of factory-built homes. We market nationwide through vertically integrated operations, encompassing manufactured and modular housing, chattel financing and insurance. As of March 30, 2007, we operated 14 manufacturing facilities that sell homes through 107 company-owned retail superstores and builder locations and approximately 350 independent retail dealers, builders and developers. Through our 80% owned subsidiary, CountryPlace, we offer chattel and non-conforming land/home loans to purchasers of factory-built homes sold by company-owned retail superstores and certain independent retail dealers, builders and developers. The loans originated through CountryPlace are held for our own investment portfolio and ultimately securitized. We also provide property and casualty insurance for owners of manufactured homes through our wholly-owned subsidiary, Standard Casualty.
Difficult market conditions have plagued our traditional manufactured housing business since mid-1999 when the industry entered a cyclical downturn as the result of the tightening of credit standards, limited retail and wholesale financing availability, increased levels of repossessions, excessive retail inventory levels and manufacturing capacities. Industry shipments of manufactured homes were approximately 348,700 in calendar year 1999 and have decreased 66% over the last eight years to a 45 year industry low of 117,400 in calendar year 2006. During this eight-year period, our manufactured housing shipments declined 62%.
Prior to 2006, the increases in manufactured housing shipments to Florida, Arizona and California were the main factor in maintaining industry shipments at approximately 130,000 per year. In 2006, however, the dynamics fueling increased manufactured housing demand in these states changed quickly. Site built homes in these states experienced rapid price appreciation driven by high land cost. As such, the increase in speculative building resulted in excess inventory. This has caused prices to fall and buyers and sellers are postponing their home buying decisions. It has also greatly reduced the number of over age 55 buyers of manufactured housing since they typically must sell their site built home to buy a manufactured home. In the last six months of calendar 2006, shipments to Florida, Arizona and California were down approximately 41%.
With the manufactured housing industry not showing signs of a quick recovery, we continue to focus on growth opportunities in our modular housing business. We entered the modular home business in June 2002 when we acquired Nationwide Custom Homes (Nationwide). We have since added modular production to eight of our manufactured housing facilities. Industry shipments of modular homes were approximately 38,300 in calendar year 2006, an 11% decrease over calendar year 2005. However, our modular home sales increased 14% in fiscal 2007 with our net sales for modular products up approximately 34% and now accounting for approximately 32% of our recurring net sales.
During fiscal 2007, we decreased the number of manufacturing facilities from 18 to 14 and the number of company-owned retail superstores from 116 to 107. We closed one manufacturing facility in the first quarter of fiscal 2007 that was previously idled but had been reopened for FEMA production in fiscal 2006. We closed two less-than-efficient manufacturing facilities and 13 company-owned retail superstores in the second and fourth quarters of fiscal 2007 as part of our planned strategy to more effectively balance our manufacturing and distribution capacity with the current needs of the market. One manufacturing facility was destroyed by fire in the third quarter of fiscal 2007.
We continued to execute our plan of expanding our consumer financing capabilities through CountryPlace. On March 22, 2007, through our subsidiary CountryPlace, we successfully completed our second securitization for approximately $116.5 million of loans (including approximately $10.4 million of loans to be originated in the future) which were funded by issuing bonds totaling approximately $101.9 million. Our initial securitization for approximately $141.0 million of loans was funded by issuing bonds totaling approximately $118.4 million on July 12, 2005. The assets are chattel loans originated by company-owned retail locations with the collateral being primarily Palm Harbor manufactured homes built in company-owned factories. See “Liquidity and Capital Resources” for further details on these transactions.
During the second quarter of fiscal 2007, we filed a petition for the dissolution of our partnership with BSM Financial L.P., a conventional real estate mortgage bank of which we were the 50% sole limited partner, and we wrote off our investment in BSM of $4.4 million. Effective May 18, 2007, we have reached an agreement with BSM to terminate the partnership. As part of the agreement, both parties have agreed to mutual releases of all prior claims, counterclaims and causes of action.
Results of Operations
The following table sets forth the items in our Statements of Operations as a percentage of net sales for the periods indicated.
The Company’s fiscal year ends on the last Friday in March. Fiscal years 2007 and 2005 were comprised of 52 weeks while fiscal year 2006 was comprised of 53 weeks. As a result, there was an approximately 1.9% decrease in each of the categories discussed below in the “2007 compared to 2006” section of our results of operations and an approximately 1.9% increase in each of the categories discussed below in the “2006 compared to 2005” section of our results of operations. As this change impacted all the income statement categories in a reasonably consistent manner, no separate discussion of this factor is included in this section, unless the impact of the applicable category varied from the increase described above.
2007 Compared to 2006
Net Sales. Net sales decreased 6.9% to $661.2 million in fiscal 2007 from $710.6 in fiscal 2006. This $49.4 million decrease in net sales is comprised of a $56.0 million decrease in factory-built housing net sales offset by a $6.6 million increase in financial services net sales. The decrease in factory-built housing net sales is the result of $15.9 million, or 583 homes, sold to FEMA in fiscal 2006 and a 19.1% decrease in the number of factory-built homes sold (excluding FEMA business) offset by an increase in the average selling prices of new manufactured and modular homes. The 19.1% decrease in total factory-built homes (excluding FEMA business) is largely due to a decrease in demand for HUD code homes in Florida, California and Arizona, which are typically some of our most profitable states (see Executive Overview section above for more details). The average retail selling price of a new manufactured home increased 6.8% and a new modular home increased 10.7% while the average wholesale selling price of a new manufactured home increased 8.2% and a new modular home increased 3.9%. These increases in average selling prices are the result of customers purchasing larger, more complex homes. The increase in financial services net sales of $6.6 million reflects an increase in interest income resulting from an increase in consumer loans receivable, net from $167.5 million as of March 31, 2006 to $228.3 million as of March 30, 2007.
Gross Profit. In fiscal 2007, gross profit decreased to $157.8 million, or 23.9% of net sales, from $185.6 million, or 26.1% of net sales. Gross profit for the factory-built housing segment decreased from 23.9% of net sales in fiscal 2006 to 20.8% in fiscal 2007. This decrease is partially due to $2.4 million in charges related to closing 13 under-performing sales centers and 2 less than efficient plants in the second and fourth quarters of fiscal 2007. Excluding these charges, gross profit for the factory-built housing segment would have been 21.2%. The reduction in retail and wholesale deliveries in Florida, California and Arizona also contributed to the decrease in factory-built housing gross profit. Gross profit for the financial services segment increased $4.9 million to 73.4% of net sales in fiscal 2007, up slightly from 73.1% of net sales in fiscal 2006. This increase is due to the increase in net sales as explained above.
Selling, General and Administrative Expenses. As a percentage of net sales, selling, general and administrative expenses increased to 24.2% for fiscal 2007 from 22.7% for fiscal 2006. In dollars, selling, general and administrative expenses decreased to $160.0 million in fiscal 2007 as compared to $161.2 million in fiscal 2006. Of this $1.2 million decrease, $4.1 million related to the factory-built housing segment and was offset by increases in general corporate expenses of $2.5 million and increases in financial services expenses of $0.5 million. Factory-built housing expenses also include $3.7 million in charges related to closing 13 under-performing sales centers and 2 less than efficient plants in the second and fourth quarters of fiscal 2007. Excluding these charges, selling, general and administrative expenses for the factory-built housing segment decreased $7.8 million. This decrease is primarily due to a reduction in performance based compensation costs, a reduction of 4 manufacturing facilities and 9 sales centers at March 30, 2007 as compared to March 31, 2006 as well as our ongoing cost savings efforts. The increase in general corporate expenses is due primarily to increases in advertising costs and various other administrative expenses.
Interest Expense. Interest expense increased 33.7% to $15.7 million in fiscal 2007 as compared to $11.7 million in fiscal 2006. This was primarily due to a $2.4 million increase in interest expense on the warehouse revolving debt, a $1.0 million increase in interest expense on the securitized financing and a $0.8 million increase in interest expense on floorplan payable. Both the interest rates on the warehouse revolving debt and the floorplan payable are variable.
Impairment of Limited Partnership and Equity in Earnings (Loss) of Limited Partnership. During the second quarter of fiscal 2007, we filed a petition for dissolution of our partnership with BSM. The investment in BSM of $4.4 million as of September 2006 was written off effective September 29, 2006. Effective May 18, 2007, we have reached an agreement with BSM to terminate the partnership. As part of the agreement, we have both agreed to mutual releases of all prior claims, counterclaims and causes of action. We have not recorded any equity in BSM’s earnings (losses) since the second quarter when we wrote off our investment.
Interest Income and Other. Interest income and other remained relatively flat at $4.9 million in fiscal 2007 as compared to $5.0 million in fiscal 2006. Interest income and other decreased primarily due to $1.5 million earned on a real estate investment in fiscal 2006 and was offset by a $1.0 million increase in interest and dividend income and a $0.3 million gain on the sale of available-for-sale investments in fiscal 2007.
Income Tax Benefit (Expense). Income tax benefit is $6.1 million in fiscal 2007 as compared to expense of $7.2 million in fiscal 2006. This is the result of a pretax loss of $17.7 million in fiscal 2007 versus pretax earnings of $18.3 million in fiscal 2006. The effective tax rate was 34.6% in fiscal 2007 compared to 39.3% in fiscal 2006.
2006 Compared to 2005
Net Sales. Net sales increased 16.4% to $710.6 million in fiscal 2006 from $610.5 million in fiscal 2005. Net sales for the factory-built housing segment increased $15.9 million due to selling 583 homes to FEMA and $80.5 million due to a 4.8% increase in new factory-built homes sold (excluding the 583 homes sold to FEMA), a shift in product mix to modular homes (23.5% of total factory-built net sales, excluding the $15.9 million of net sales to FEMA, in fiscal 2006 as compared to 20.1% in fiscal 2005) and an increase in the average selling price of new manufactured and modular homes. The 4.8% increase in homes sold stemmed from increased market share and the increase in average selling prices resulted from customers purchasing larger, more complex homes as well as the pass through of higher raw material costs. The average retail selling price of a new modular home increased 10.4% (from $135,000 in fiscal 2005 to $149,000 in fiscal 2006), the average wholesale selling price of a new modular home increased 8.5% (from $71,000 in fiscal 2005 to $77,000 in fiscal 2006) and the average wholesale selling price of a new manufactured home increased 10.9% (from $55,000 in fiscal 2005 to $61,000 in fiscal 2006). Financial services net sales increased $3.7 million reflecting an increase in interest income at CountryPlace resulting from an increase in consumer loans receivable from $132.4 million at the end of fiscal 2005 to $163.1 million at the end of fiscal 2006.
Gross Profit. In fiscal 2006, gross profit as a percentage of net sales increased to 26.1%, or $185.6 million, from 25.3%, or $134.5 million, in fiscal 2005. Gross profit for the factory-built housing segment increased $28.1 million from 23.1% of net sales in fiscal 2005 to 23.9% of net sales in fiscal 2006. This improvement reflects a strengthening of gross margin at our retail superstores, reduced availability of repossessed homes at discounted prices and increased sales prices due to customers purchasing larger, more complex homes and our ability to pass through higher raw material costs. In addition, gross margin for fiscal 2005 was reduced $2.7 million due to our closing 12 of our least productive sales centers and streamlining our retail operations. We were able to increase gross margin despite a decline in the internalization rate from 60% in fiscal 2005 to 50% in fiscal 2006. Gross profit for the financial services segment increased $2.9 million due to the increase in net sales as explained above.
Selling, General and Administrative Expenses. As a percentage of net sales, selling, general and administrative expenses decreased to 22.7% in fiscal 2006 from 25.4% in fiscal 2005. Selling, general and administrative expenses increased to $161.2 million in fiscal 2006 from $154.9 million in fiscal 2005. Selling, general and administrative expenses increased $3.5 million for general corporate purposes, $1.9 million for factory-built housing and $0.8 million for financial services. The increase in general corporate expenses is due primarily to increases in incentive based compensation as we return to profitability and the increase in factory-built housing expenses is due primarily to costs associated with our site construction operations, costs related to hiring IT consultants as we make system enhancements and an increase in incentive based compensation as we return to profitability offset by a reduction in expenses resulting from operating fewer company-owned retail superstores in fiscal 2006 as compared to fiscal 2005 (average number of open stores was 114 in fiscal 2006 compared to 130 in fiscal 2005).
Interest Expense. Interest expense increased 30.6% to $11.7 million in fiscal 2006 as compared to $9.0 million in fiscal 2005. This increase was primarily due to a $3.7 million increase in fiscal 2006 of interest
expense incurred on the securitized loans offset by a $1.3 million decrease in interest expense incurred on the warehouse revolving debt. The warehouse revolving debt interest decreased due to a significant decline in the warehouse revolving debt balance after $115.7 million of borrowings were repaid with proceeds from the securitization.
Equity in Earnings (Loss) of Limited Partnership. Equity in earnings (loss) of limited partnership increased to $0.6 million of earnings in fiscal 2006 as compared to a $0.8 million loss in fiscal 2005. This increase is primarily due to our share of BSM earnings increasing due to total originations of 15,722 in fiscal 2006 compared to 10,695 in fiscal 2005.
Interest Income and Other. Interest income and other increased 20.2% to $5.0 million in fiscal 2006 as compared to $4.2 million in fiscal 2005 primarily due to a $2.2 million increase in interest and dividend income earned on larger cash and cash equivalents and available-for-sale investment balances as well as higher interest rates, offset by a $1.6 million decrease in income earned on a real estate investment.
Income tax benefit (expense). Income tax expense increased to $7.2 million in fiscal 2006 as compared to a benefit of $2.1 million in fiscal 2005. This increase is the result of pretax earnings of $18.3 million in fiscal 2006 versus a pretax loss of $5.9 million in fiscal 2005. The effective tax rate was 39.3% in fiscal 2006 compared to a credit of 35.6% in fiscal 2005.
Liquidity and Capital Resources
Cash and cash equivalents totaled $44.3 million at March 30, 2007, down from $65.0 million at March 31, 2006. Net cash used in operating activities was $87.7 million in fiscal 2007 compared to $20.0 million in fiscal 2006. The increase is primarily the result of a $64.1 million decrease in accounts payable and accrued liabilities, $27.4 million increase in net consumer loans originated for investment, $5.6 million in restricted cash relating to the securitized financings and customers deposits held in trust accounts, offset by a $32.0 million decrease in inventories and a $16.5 million decrease in trade receivables.
Net cash used in investing activities decreased to $2.4 million in fiscal 2007 from $4.7 million in fiscal 2006. Of this $2.3 million decrease, $6.6 million is due to increased sales of investments offset by a $1.3 million increase in purchases of investments and a $3.1 million increase in purchases of property, plant and equipment.
Net cash provided by financing activities totaled $69.4 million in fiscal 2007 compared to $43.5 million in fiscal 2006. Of this $25.8 million increase, $45.5 million is due to less payments on warehouse revolving debt in fiscal 2007 as compared to fiscal 2006 offset by $16.4 million less in proceeds on the 2007-1 securitized financing in fiscal 2007 as compared to the 2005-1 securitized financing in fiscal 2006.
We have an agreement with a financial institution for a $70.0 million floor plan facility expiring March 30, 2009. The advance rate for the facility is 90% of manufacturer’s invoice. This facility is used to finance a portion of the new home inventory at our retail superstores and is secured by new home inventory and a portion of receivables from financial institutions. The interest rate on the facility is prime (8.25% at March 30, 2007) plus 0.6% or prime plus 1.0% to 3.0% for aged units, of which we have none as of March 30, 2007. The floor plan facility contains certain provisions requiring us to maintain minimum amounts of liquidity, profitability, inventory turns, tangible net worth and annual operating cash flows in order to borrow against the facility. As of March 30, 2007, we were not in compliance with the profitability, tangible net worth and annual operating cash flow covenants. We obtained a waiver from the financial institution for the fiscal year ended March 30, 2007. We have negotiated new covenants, which will be effective beginning with the first quarter of fiscal 2008, and we expect to be in compliance with these covenants during the next fiscal year. In the event we are not in compliance with any of our floor plan facility covenants in future periods, we would seek a waiver of any default from the lending institution and, if no such waiver was obtained, maturities of outstanding debt could be accelerated. We had $43.6 million and $37.9 million outstanding under these floor plan credit facilities at March 30, 2007 and March 31, 2006, respectively.
On May 5, 2004, we issued $65.0 million aggregate principal amount of 3.25% Convertible Senior Notes due 2024 (the “Notes”) in a private, unregistered offering. Interest on the Notes is payable semi-annually in May and November. On June 8, 2004, the initial purchaser of the Notes exercised its option to purchase an additional $10.0 million aggregate principal amount of the Notes. On September 15, 2004, for the benefit of the Note holders, the Company filed a shelf registration statement covering resales of the Notes and the shares of our common stock issuable upon the conversion of the Notes. The Notes are senior, unsecured obligations and rank equal in right of payment to all of our existing and future unsecured and senior indebtedness. Each $1,000 in principal amount of the Notes is convertible, at the option of the holder, at a conversion price of $25.92, or 38.5803 shares of our common stock upon the satisfaction of certain conditions and contingencies. For fiscal years 2007, 2006 and 2005, the effect of converting the senior notes to 2,894,000 shares of common stock was anti-dilutive, and was, therefore, not considered in determining diluted earnings per share.
On July 12, 2005, we, through our 80% owned subsidiary CountryPlace, completed our initial securitization (“2005-1”) for approximately $141.0 million of loans, which was funded by issuing bonds totaling approximately $118.4 million. The bonds were issued in four different classes: Class A-1 totaling $36.3 million with a coupon rate of 4.23%; Class A-2 totaling $27.4 million with a coupon rate of 4.42%; Class A-3 totaling $27.3 million with a coupon rate of 4.80%; and Class A-4 totaling $27.4 million with a coupon rate of 5.20%. Maturity of the bonds is at varying dates beginning in 2006 through 2015 and were issued with a weighted average maturity of 4.66 years. The proceeds from the securitization were used to repay approximately $115.7 million of borrowings on our warehouse revolving debt with the remaining proceeds being used for general corporate purposes, including future origination of new loans. For accounting purposes, this transaction was structured as a securitized borrowing.
On March 22, 2007, we, through our 80% owned subsidiary CountryPlace, completed our second securitization (“2007-1”) for approximately $116.5 million of loans (including approximately $10.4 million of pre-funded loans to be originated in the future) which was funded by issuing bonds totaling approximately $101.9 million. The bonds were issued in four classes: Class A-1 totaling $28.9 million with a coupon rate of 5.484%; Class A-2 totaling $23.4 million with a coupon rate of 5.232%; Class A-3 totaling $24.5 million with a coupon rate of 5.593%; and Class A-4 totaling $25.1 million with a coupon rate of 5.846%. Maturity of the bonds is at varying dates beginning in 2008 through 2017 and were issued with a weighted average maturity of 4.86 years. The proceeds from the securitization were used to repay approximately $91.4 million of borrowings on our warehouse revolving debt with the remaining proceeds being used for general corporate purposes, including future origination of new loans. For accounting purposes, this transaction was also structured as a securitized borrowing.
CountryPlace has an agreement with a financial institution for a warehouse borrowing facility to fund loans originated by CountryPlace. The facility is collateralized by specific consumer loans receivable pledged to the facility. In connection with the renewal of the facility on March 15, 2007, the maximum borrowing amount was increased from $125.0 million to $150.0 million. The facility terminates March 14, 2008; however, amounts outstanding under the facility are effectively settled and re-borrowed on a monthly basis. The advance against the outstanding principle balance of eligible consumer loan receivables is 88% and draws can be made at an 80% advance rate against land-home loans in various stages of completion. The interest rate remains LIBOR (5.375%) plus 1.25%. CountryPlace had outstanding borrowings under the warehouse facility of $12.0 million as of March 30, 2007 and $37.4 million as of March 31, 2006. The facility contains certain requirements relating to the performance and composition of the consumer loans receivable pledged to the facility and financial covenants regarding maintenance of a certain loan delinquency ratio and a minimum capitalization for CountryPlace, which is customary in the industry. As of March 30, 2007, CountryPlace was in compliance with these requirements. As CountryPlace continues to expand and draw down on its warehouse facility, we will fund the difference between the amounts advanced under the warehouse borrowing facility and the balance of any additional loan originations. For CountryPlace to increase its borrowings under the facility to the maximum $150.0 million, CountryPlace would have to originate an additional $159.0 million of new loans, of which $21.9 million would have to be funded through our operations.
Upon completion of the 2007-1 securitization, CountryPlace extinguished its interest rate swap agreement on its variable rate debt which was used to hedge against an increase in variable interest rates. The agreement previously fixed the interest rate on $82.7 million of CountryPlace’s variable rate, long-term warehouse revolving debt to 5.345% per annum. CountryPlace recorded the hedge instrument at fair value as of the end of each fiscal quarter with the effective offsetting portion of the hedge being recorded as a component of accumulated other comprehensive income (loss), net of tax, and the ineffective portion, if any, of the hedge being recorded in our consolidated statement of operations. Upon extinguishment of the hedge, CountryPlace recorded a loss of $1.0 million, net of tax, for the change in fair value to other comprehensive income (loss), which will be amortized to interest expense over the life of the loans. There was no significant ineffectiveness.
CountryPlace currently intends to originate and hold loans for investment on a long-term basis. CountryPlace makes loans to borrowers that it believes are credit worthy based on its credit guidelines. However, originating and holding loans for investment subjects CountryPlace to more credit and interest rate risk than the previous business practice of originating loans for resale. The ability of customers to repay their loans may be affected by a number of factors and if customers do not repay their loans, the profitability and cash flow of the loan portfolio would be adversely affected and we may incur additional loan losses. CountryPlace intends to securitize its loan portfolio on a routine basis. While we believe it will be able to obtain additional liquidity through the securitization of such loans, no assurances can be made that CountryPlace will successfully complete securitization transactions on acceptable terms and conditions, if at all.
We believe that the proceeds from the securitization, floor plan financing, borrowings on the warehouse facility and any other available borrowing alternatives will be adequate to support our working capital needs, currently planned capital expenditure needs and expansion of CountryPlace for the foreseeable future. However, because future cash flows and the availability of financing will depend on a number of factors, including prevailing economic and financial conditions, business, the market for asset-backed securitizations, and other factors beyond our control, no assurances can be given in this regard.
Loan Portfolio
Prior to the third quarter of 2003, CountryPlace originated loans and immediately sold them to other lenders. During the third quarter of 2003, we executed our planned strategy and expanded CountryPlace into a full service chattel lender with originating, servicing and securitization capabilities. In the first quarter of fiscal 2006, CountryPlace completed its initial securitization for $141.0 million of loans. In the fourth quarter of fiscal 2007, CountryPlace completed its second securitization for $116.5 million of loans (including approximately $10.4 million of pre-funded loans to be originated in the future). As a result of the expansion, our loan portfolio has grown at an annual rate of 36.9%, 26.5% and 36.3% in fiscal 2005, 2006 and 2007, respectively, reflecting the build-up of our lending operations.
All loan contracts are fixed rate, simple interest contracts and have monthly scheduled payments of principal and interest. The scheduled payments for each simple interest contract would, if made on their respective due dates, result in a full or nearly full amortization of the contract. The loan contracts have the following maturities as of March 30, 2007 (in thousands):
The “due after five years” category includes $2.0 million of foreclosed assets held for sale, which are included in prepaid expenses and other assets on the consolidated balance sheets at a fair market value of $1.3 million.
Non-performing loan contracts include non-accrual loan contracts and foreclosed assets held for resale. Loan contracts are placed in non-accrual status when CountryPlace determines that foreclosure is imminent as a result of a clear indication that the borrower has the inability or unwillingness to meet payments as they become due. As of March 30, 2007 and March 31, 2006, CountryPlace had non-performing loans totaling $2.7 million and $2.6 million, respectively. As of March 30, 2007 and March 31, 2006, CountryPlace also had $0.1 million and $0.2 million, respectively, of accruing loans past due 90 days or more. The 2007 and 2006 non-performing loans include $2.0 million and $2.1 million of foreclosed assets held for sale, which are included in prepaid expenses and other assets on the consolidated balance sheets at a fair market value of $1.3 million and $0.8 million, respectively.
CountryPlace occasionally restructures troubled loan contracts by deferring or waiving all or part of interest, principal, tax escrow, insurance premium, fees, or other amounts owed to them by their customers. CountryPlace’s policies and guidelines, as well as certain contractual obligations in their securitization transaction, limit the number and the frequency of deferments and waivers that may be granted. A loan contract for which delinquent payments are deferred is classified as current at the time the deferment is granted and therefore is not included as a delinquent account. Loan contracts subject to a payment deferral, as a percentage of the number outstanding loan contracts, were as follows:
Outstanding loan contracts include 35 and 34 foreclosed assets held for sale as of March 30, 2007 and March 31, 2006, respectively. The deferrals in fiscal year 2006 are a direct result of hurricanes Katrina and Rita.
The loan contracts are principally secured by factory-built homes that are geographically concentrated in Texas. Approximately 42.2% and 46.0% of the principal balance of the loan contracts receivable as of March 30, 2007 and March 31, 2006, respectively, were secured by collateral located in Texas. If Texas experiences weaker economic conditions, greater rates of decline in manufactured home values, greater rates of decline in real estate values, or more natural disasters than the United States generally experiences, then the loan contracts may experience higher rates of delinquencies, default and foreclosure losses than manufactured homes that are more geographically dispersed. The risks created by these concentrations have been considered by management in the determination of the adequacy of the allowance for loan losses. Management believes the allowance for loan losses is adequate to cover estimated losses on loans at each balance sheet date. No other states had concentrations in excess of 10% of the loan contracts receivable balance as of March 30, 2007 or March 31, 2006.
Contractual Obligations (dollars in thousands)
The following tables summarize our contractual obligations, including interest, at March 30, 2007. For additional information related to these obligations, see the Notes to Consolidated Financial Statements.
(1)
Interest is calculated by applying contractual interest rates to March 30, 2007 balances.
(2)
We have contingent repurchase obligations outstanding at March 30, 2007 which have a finite life but are replaced as we continue to sell our factory-built homes to dealers under repurchase agreements with financial institutions. Our losses related to these contingent repurchase obligations were $0, $157,000 and $65,000 during fiscal 2007, 2006, and 2005, respectively. For additional information on our repurchase obligations, see critical accounting policies-reserve for repurchase obligations.
(3)
We have provided letters of credit to providers of certain of our insurance policies. While the current letters of credit have a finite life, they are subject to renewal at different amounts based on the requirements of the insurance carriers. We have recorded insurance expense based on anticipated losses related to these policies as is customary in the industry.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Management believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.
Impairment of Intangible Assets (Goodwill) and Other Long-Lived Assets. In assessing the recoverability of our intangible assets and other long-lived assets on an annual basis, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets.
Recovery of Deferred Tax Asset. We believe it is more likely than not we will recover all of our net deferred tax assets. Recovery of our deferred tax assets is dependent upon the generation of future taxable income, which we currently believe will come from future profitable operating results and available tax planning
strategies. Should we operate unprofitably, or otherwise change our estimate of future profitable operations, we may need to record a valuation allowance on all or a part of our deferred tax assets. Net deferred tax assets at March 30, 2007 and March 31, 2006 are $14.6 million and $11.1 million, respectively.
Revenue recognition. Retail sales of manufactured homes and certain single story modular homes, including shipping charges, are recognized when a down payment is received, the customer enters into a legally binding sales contract, title has transferred and the home is accepted by the customer, delivered and permanently located at the customer’s site. Additionally, for retail sales of all multi-story modular homes, Nationwide modular homes, and manufactured homes in which we serve as the general contractor with respect to virtually all aspects of the sale and construction process, sales are not recognized until after final consumer closing. Transportation costs, unless borne by the retail customer or independent retailer, are included in the cost of sales.
Warranties. We provide the retail homebuyer a one-year limited warranty covering defects in material or workmanship in home structure, plumbing and electrical systems. We record a liability for estimated future warranty costs relating to homes sold, based upon our assessment of historical experience factors. Factors we use in the estimation of the warranty liability include historical warranty experience related to the actual number of calls and the average cost per call. Although we maintain reserves for such claims based on our assessments as described above, which to date have been adequate, there can be no assurance that warranty expense levels will remain at current levels or that such reserves will continue to be adequate. A large number of warranty claims exceeding our current warranty expense levels could have a material effect on our results of operations and liquidity.
Reserve for Repurchase Obligations. Factory-built housing companies enter into repurchase agreements with financial institutions which have provided wholesale floor plan financing to independent dealers, builders and developers. These agreements generally provide that in the event of an independent dealer, builder or developer’s default we will repurchase the financed home from the lending institution at declining prices over the term of the repurchase agreement (generally 12-18 months). The risk of loss under such repurchase agreements is mitigated by the fact that (i) approximately 59% of our homes are sold through our company-owned stores for which no repurchase agreement exists; (ii) a majority of the homes we sell to independent dealers, builders and developers are pre-sold to specific retail customers; (iii) we monitor each dealer’s, builder’s and developer’s inventory position on a regular basis; (iv) sales of our manufactured homes are spread over a large number of dealers, builders and developers; (v) none of our independent dealers, builders and developers accounted for more than 5% of our net sales in fiscal 2007; (vi) the price we are obligated to pay declines over time and (vii) we are, in most cases, able to resell homes repurchased from credit sources in the ordinary course of business without incurring significant losses.
Transfers of Financial Assets. CountryPlace has completed two securitizations of manufactured housing loan receivables since the second quarter of fiscal 2006. The securitizations were accounted for as financings, which use the portfolio method of accounting in accordance with FASB Statement of Financial Accounting Standards, or SFAS, No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases,” where (1) loan contracts are securitized and accounted for as borrowings; (2) interest income is recorded over the life of the loans using the interest method; (3) the loan contracts receivable and the securitization debt (asset-backed certificates) remain on CountryPlace’s balance sheet; and (4) the related interest margin is reflected in the income statement. This accounting has been utilized since July 12, 2005, the date of issue of the Company’s initial securitized financing. The securitizations include provisions for removal of accounts by CountryPlace that preclude sale accounting of the securitizations under SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.”
The structure of CountryPlace’s securitizations have no effect on the ultimate amount of profit and cash flow recognized over the life of the loan contracts, except to the extent of surety fees and premiums, trustee fees, backup servicer fees, and securitization issuance costs. However, the structure does affect the timing of cash receipts.
CountryPlace services the loan contracts under pooling and servicing agreements with the securitization trusts. CountryPlace also retains interests in subordinate classes of securitization bonds that provide over-collateralization credit enhancement to senior certificate holders and are subject to risk of loss of interest payments and principal. As is common in securitizations, CountryPlace is also liable for customary representations. We guarantee certain aspects of CountryPlace’s performance as the servicer under the 2005-1 securitization pooling and servicing agreement.
Allowance for Loan Losses. CountryPlace originates and holds for investment purposes loans related primarily to the retail sale of our factory-built homes, with such loans being collateralized primarily by the factory-built home. CountryPlace provides allowances for estimated future loan losses at the time of sale and during the term of the loan. The allowance for loan losses gives consideration to the composition of the loan portfolio, including historical loss experience by static pool, expected probable losses based on industry knowledge of losses for a given range of borrower credit scores, the composition of the portfolio by credit score and seasoning, and recent loss experience. The allowance reflects CountryPlace’s judgment of the probable loss exposure at the end of the reporting period. Although CountryPlace maintains an allowance for loan losses based upon these expectations and other criteria, future differences between CountryPlace’s expectations with respect to loan losses and actual losses incurred in the portfolio could differ, and require CountryPlace to provide additional allowances.
New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement No. 123 (revised 2004), Share-Based Payment (SFAS 123R). SFAS 123R requires that the compensation cost relating to share-based payment transaction, including grants of employee stock options, be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. SFAS 123R permits entities to use any option-pricing model that meets the fair value objective in the statement. We adopted SFAS 123R in the first quarter of fiscal 2007. The adoption of the standard did not have a material impact on our consolidated financial position or results of operations.
In June 2006, the FASB issued Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes-an Interpretation of FASB No. 109, which clarifies the accounting for uncertainty in tax positions. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return and also provides guidance on various related matters such as derecognition, interest, penalties and disclosure. FIN 48 is effective with our fiscal year beginning March 31, 2007. We expect that the financial impact, if any, of applying the provisions of FIN 48 to all tax positions will not be material upon the initial adoption of FIN 48 in the first quarter of fiscal 2008.
In September 2006, the FASB issued Statement 157, Fair Value Measurements (FAS 157). This statement clarifies the definition of fair value; the methods used to measure fair value, and requires expanded financial statement disclosures about fair value measurements for assets and liabilities. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently assessing the impact on our financial statements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
We are exposed to market risks related to fluctuations in interest rates on our variable rate debt, which consists primarily of our liabilities under retail floor plan financing arrangements and warehouse revolving debt. For variable interest rate obligations, changes in interest rates generally do not impact fair market value, but do affect future earnings and cash flows. Assuming our and CountryPlace’s level of variable rate debt as of March 30, 2007 is held constant, each one percentage point increase in interest rates occurring on the first day of the year would result in an increase in interest expense for the coming year of approximately $0.6 million.
CountryPlace is exposed to market risk related to the accessibility and terms of financing in the asset-backed securities market. On July 12, 2005, CountryPlace successfully completed its initial securitized financing of approximately $141.0 million of loans. On March 22, 2007, CountryPlace completed a second securitized financing of approximately $116.5 million of loans (including approximately $10.4 million of pre-funded loans to be originated in the future). CountryPlace intends to continue to securitize its loan originations as a means to obtain long-term fixed interest rate funding. The inability to continue to securitize its loans would require CountryPlace to seek other sources of funding or to reduce or eliminate its loan originations if other sources of funding are not available.
We are also exposed to market risks related to our fixed rate consumer loans receivable balances and our convertible senior notes. For fixed rate loans receivable, changes in interest rates do not change future earnings and cash flows from the receivables. However, changes in interest rates could affect the fair market value of the loan portfolio. Assuming CountryPlace’s level of loans held for investment as of March 30, 2007 is held constant, a 10% increase in average interest rates would decrease the fair value of CountryPlace’s portfolio by approximately $4.0 million. For our fixed rate convertible senior notes, changes in interest rates could affect the fair market value of the related debt. Assuming the amount of convertible senior notes as of March 30, 2007 is held constant, a 10% decrease in interest rates would increase the fair value of the notes by approximately $1.5 million.
Item 8.
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Palm Harbor Homes, Inc.
We have audited the accompanying consolidated balance sheets of Palm Harbor Homes, Inc. and Subsidiaries (the “Company”) as of March 30, 2007 and March 31, 2006 and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three fiscal years in the period ended March 30, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Palm Harbor Homes, Inc. and Subsidiaries at March 30, 2007 and March 31, 2006, and the consolidated results of their operations and their cash flows for each of the three fiscal years in the period ended March 30, 2007, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, in fiscal 2007 the Company changed its method of accounting for share-based compensation as required by Statement of Financial Accounting Standards No. 123 (R), “Share-Based Payment.”
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Palm Harbor Homes, Inc.’s internal control over financial reporting as of March 30, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated May 31, 2007 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Dallas, Texas
May 31, 2007
Palm Harbor Homes, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands)
See accompanying Notes to Consolidated Financial Statements.
Palm Harbor Homes, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share and per share data)
See accompanying Notes to Consolidated Financial Statements.
Palm Harbor Homes, Inc. and Subsidiaries
Consolidated Statements of Operations
(In thousands, except per share data)
See accompanying Notes to Consolidated Financial Statements.
Palm Harbor Homes, Inc. and Subsidiaries
Consolidated Statements of Shareholders’ Equity
(In thousands, except share data)
See accompanying Notes to Consolidated Financial Statements.
Palm Harbor Homes, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
See accompanying Notes to Consolidated Financial Statements.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Principles of consolidation
The consolidated financial statements include the accounts of Palm Harbor Homes, Inc. and its majority-owned and wholly owned subsidiaries (the “Company”). Investments in 50% or less-owned entities are accounted for under the equity method. CountryPlace Mortgage, Ltd. (“CountryPlace”) is 80% owned by the Company. All significant intercompany transactions and balances have been eliminated in consolidation. Headquartered in Addison, Texas, the Company markets factory-built homes nationwide through vertically integrated operations, encompassing factory-built housing, chattel and mortgage bank financing, as well as insurance.
Preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from the estimates and assumptions used by management in preparation of the consolidated financial statements.
General Business Environment
Beginning in 1999, the manufactured housing industry entered a cyclical downturn as the result of the tightening of credit standards, limited retail and wholesale financing availability, increased levels of repossessions, excessive retail inventory levels and manufacturing capacities. Industry shipments of manufactured homes were approximately 348,700 in calendar year 1999 and have decreased 66% over the last eight years to a 45 year industry low of 117,400 in calendar year 2006. During this eight-year period, the Company’s manufactured housing shipments declined 62%.
Prior to 2006, the increases in manufactured housing shipments to Florida, Arizona and California were the main factor in maintaining industry shipments at approximately 130,000 per year. In 2006, however, the dynamics fueling increased manufactured housing demand in these states changed quickly. Site built homes in these states had experienced rapid price appreciation driven by high land cost. As such, the increase in speculative building resulted in excess inventory. This has caused prices to fall and buyers and sellers are postponing their home buying decisions. It has also greatly reduced the number of over age 55 buyers of manufactured housing since they typically must sell their site built home to buy a manufactured home. In the last six months of calendar 2006, shipments to Florida, Arizona and California were down approximately 41%.
With the manufactured housing industry not showing signs of a quick recovery, the Company continues to focus on growth opportunities in its modular housing business. The Company entered the modular home business in June 2002 when it acquired Nationwide Custom Homes (Nationwide). The Company has since added modular production to seven of its manufactured housing facilities. Industry shipments of modular homes were approximately 38,300 in calendar year 2006, an 11% decrease over calendar year 2005. However, the Company’s modular home sales increased 14% in fiscal 2007 with its net sales for modular products up approximately 34% and now accounting for approximately 32% of our recurring net sales.
Year End
The Company’s fiscal year ends on the last Friday in March. Fiscal years 2007 and 2005 were comprised of 52 weeks while fiscal year 2006 was comprised of 53 weeks.
Revenue recognition
Retail sales of manufactured homes and certain single story modular homes, including shipping charges, are recognized when a down payment is received, the customer enters into a legally binding sales contract, title has
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
transferred and the home is accepted by the customer, delivered and permanently located at the customer’s site. Additionally, for retail sales of all multi-story modular homes, Nationwide modular homes, and manufactured homes in which the Company serves as the general contractor with respect to virtually all aspects of the sale and construction process, sales are not recognized until after final consumer closing. Transportation costs, unless borne by the retail customer or independent retailer, are included in cost of sales.
Interest income on consumer loans receivable is recognized as net sales on an accrual basis. When CountryPlace determines that a loan held for investment is partially or fully uncollectible, the estimated loss is charged against the allowance for loan losses. Recoveries on losses previously charged to the allowance are credited to the allowance at the time the recovery is collected. Loan origination fees and certain direct loan origination costs are deferred and amortized into net sales over the contractual life of the loan using the interest method.
Most of the homes sold to independent retailers are financed through standard industry arrangements which include repurchase agreements (see Note 13). The Company extends credit in the normal course of business under normal trade terms and its receivables are subject to normal industry risk.
Premium income from insurance policies is recognized on an as earned basis. Premium amounts collected are amortized into net sales over the life of the policy. Policy acquisition costs are also amortized as cost of sales over the life of the policy.
Fair value of financial instruments
Cash and cash equivalents, restricted cash, trade receivables, accounts payable, accrued liabilities, floor plan payable and warehouse revolving debt are stated at expected settlement amounts and approximate fair value. Additional information concerning the fair value of the Company’s investments, consumer loans receivable, convertible senior notes and securitized financings is disclosed in notes 4, 5 and 7, respectively.
Cash and cash equivalents
Cash and cash equivalents are all liquid investments with maturities of three months or less when purchased.
Restricted cash
At March 30, 2007 and March 31, 2006, restricted cash consists of $15.5 million and $15.3 million, respectively, of cash pledged as collateral for outstanding insurance programs and surety bonds, $10.8 million and $8.4 million, respectively, of cash relating to customer deposits held in trust accounts, and $17.2 million and $2.9 million, respectively, of cash relating primarily to CountryPlace customers’ principal and interest payments on the loans that are in the warehouse or securitized. In the event of default on the warehouse facility or the securitized borrowing, this amount would be paid to the financial institution as payment of outstanding principal and interest on the facility.
Consumer loans receivable
Consumer loans receivable consists of loans held for investment and securitized loans, which are both stated at the aggregate remaining unpaid principal balances, and land/home loan advances less allowances for loan losses and deferred financing costs, net of amortization.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Allowance for loan losses
CountryPlace originates and holds for investment purposes loans related primarily to the retail sale of factory-built Palm Harbor Homes, with such loans being collateralized primarily by the factory-built home. CountryPlace provides allowances for estimated future loan losses at the time of sale and during the term of the loan. The allowance for loan losses gives consideration to, among other things, the composition of the loan portfolio, including historical loss experience by static pool, expected probable losses based on industry knowledge of losses for a given range of borrower credit scores, the composition of the portfolio by credit score and seasoning, and recent loss experience. The allowance reflects CountryPlace’s judgment of the probable loss exposure at the end of the reporting period. Although CountryPlace maintains an allowance for loan losses based upon these expectations and other criteria, future differences between CountryPlace’s expectations with respect to loan losses and actual losses incurred in the portfolio could differ, and require CountryPlace to provide additional allowances.
Concentration of loans
Approximately 42.2% and 46.0% of the principal balance of the loan contracts receivable as of March 30, 2007 and March 31, 2006, respectively, were secured by collateral located in Texas. If Texas experiences weaker economic conditions, greater rates of decline in manufactured home values, greater rates of decline in real estate values, or more natural disasters than the United States generally experiences, then the loan contracts may experience higher rates of delinquencies, default and foreclosure losses than manufactured home loans that are more geographically dispersed. The risks created by these concentrations have been considered by management in the determination of the adequacy of the allowance for loan losses.
Investments
The Company holds investments as available-for-sale. The available-for-sale investments include marketable debt and equity securities and are stated at fair value with unrealized gains and losses, net of tax, reported as a component of shareholders’ equity.
Inventories
Raw materials inventories are valued at the lower of cost (first-in, first-out method which approximates actual cost) or market. Finished goods are valued at the lower of cost or market, using the specific identification method.
Property, plant and equipment
Property, plant and equipment are carried at cost. Depreciation is calculated using the straight-line method over the assets’ estimated useful lives. Leasehold improvements are amortized using the straight-line method over the shorter of the lease period or the improvements’ useful lives. Estimated useful lives for significant classes of assets are as follows: Land Improvements 10-15 years, Buildings and Improvements 3-30 years, and Machinery and Equipment 2-10 years. The Company had depreciation expense of $8.4 million, $9.7 million and $11.4 million in fiscal 2007, 2006 and 2005, respectively. Repairs and maintenance are expensed as incurred. The recoverability of property, plant and equipment is evaluated whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable, primarily based on estimated selling price, appraised value or projected undiscounted cash flows. The Company has not recorded any impairment charges in fiscal 2007, 2006 or 2005.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Goodwill
Goodwill is the excess of cost over fair value of net assets of businesses acquired. Goodwill is no longer amortized. The Company tests goodwill annually for impairment by reporting unit and records an impairment charge when the implied fair value of goodwill is less than its carrying value. The Company’s two reporting units are factory-built housing and financial services. All of the Company’s goodwill relates to its factory-built housing reporting unit. The Company performed its annual goodwill impairment test for fiscal year 2007 and 2006 as of December 30, 2006 and December 31, 2005, respectively, the first day of its fourth fiscal quarter, and noted no implied impairment of goodwill.
Warranties
Products are warranted against manufacturing defects for a period of one year commencing at the time of sale to the retail customer. Estimated costs relating to product warranties are provided at the date of sale.
Start-up costs
Costs incurred in connection with the start-up of manufacturing facilities and retail superstores are expensed as incurred.
Income taxes
Deferred income taxes are determined by the liability method and reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The Company evaluates the recoverability of its net deferred tax assets and establishes valuation allowances, if needed, when it is not more likely then not that such assets are recoverable.
Accumulated other comprehensive income (loss)
Accumulated other comprehensive income (loss) is presented net of income taxes and is comprised of unrealized gains and losses on available-for-sale investments and changes in fair value of an interest rate hedge.
Reclassifications
Certain accounts in the prior year’s financial statements were reclassified to consumer loans receivable, net from trade receivables, prepaid expenses and other assets and accrued liabilities to conform to the current year presentation. Also, the cash accounts relating to customer deposits held in trust accounts were reclassified from cash and cash equivalents in the prior year’s financial statements to restricted cash to conform to the current year presentation. Finally, certain job cost accounts in prepaid expenses and other assets in the prior year’s financial statements were reclassified to inventories to conform to the current year presentation. These reclassifications had no effect on previously reported operating income, net earnings or shareholders’ equity.
New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”). SFAS 123R requires that the compensation cost relating to share-based payment transactions, including grants of employee stock options, be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. SFAS 123R
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
permits entities to use any option-pricing model that meets the fair value objective in the statement. The Company adopted SFAS 123R in the first quarter of fiscal 2007. The adoption of the standard did not have a material impact on its consolidated financial position or results of operations.
In June 2006, the FASB issued Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes-an Interpretation of FASB No. 109, which clarifies the accounting for uncertainty in tax positions. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return and also provides guidance on various related matters such as derecognition, interest, penalties and disclosure. FIN 48 is effective with the Company’s fiscal year beginning March 31, 2007. The Company expects that the financial impact, if any, of applying the provisions of FIN 48 to all tax positions will not be material upon the initial adoption of FIN 48 in the first quarter of fiscal 2008.
In September 2006, the FASB issued Statement 157, Fair Value Measurements (“FAS 157”). This statement clarifies the definition of fair value; the methods used to measure fair value, and requires expanded financial statement disclosures about fair value measurements for assets and liabilities. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently assessing the impact on its financial statements.
2. Investment in limited partnership
In June 2002, the Company invested $3.0 million to become the sole limited partner and 50% owner of an existing mortgage banking firm, BSM Financial L. P. (“BSM”) which is accounted for using the equity method of accounting. During the second quarter of fiscal 2007, the Company filed a petition for the dissolution of its partnership with BSM. The investment of $4.4 million was written off effective September 29, 2006. Effective May 18, 2007, the Company has reached an agreement with BSM to terminate the partnership. As part of the agreement, both parties have agreed to mutual releases of all prior claims, counterclaims and causes of action. The revenues and net income (loss) of the limited partnership for the six months ended September 29, 2006 and the fiscal years ended March 31, 2006 and March 25, 2005 are as follows (in thousands):
3. Inventories
Inventories consist of the following (in thousands):
4. Investments
The Company’s investments, which are classified as available-for-sale, totaled $22.1 million and $24.7 million at March 30, 2007 and March 31, 2006, respectively. The investments consist primarily of U.S.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
government related obligations and other debt obligations with contractual maturities of generally 2 to 11 years and common and preferred stocks of U.S. companies. As of March 30, 2007 and March 31, 2006, the fair value of the securities approximated their book value. For the years ended March 30, 2007 and March 31, 2006, the Company has a net unrealized loss of $0.5 million and a net unrealized gain of $0.1 million included in shareholders’ equity, net of tax.
The following table shows the gross unrealized losses and fair value of the Company’s investments, with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous loss position at March 30, 2007 (in thousands):
The Company’s investments in marketable equity securities consist primarily of common and preferred stocks of U.S. companies. Within the Company’s portfolio of marketable equity securities, approximately 81% of the total fair value and 97% of the Company’s total unrealized losses are in one company. The remaining fair value and unrealized losses relate to the common stock of four companies and the preferred stock of three companies. The Company evaluated the near-term prospects of the issuer in relation to the severity and duration of the impairment. Based on that evaluation and the Company’s ability and intent to hold those investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider those investments to be other-than-temporarily impaired at March 30, 2007.
The Company’s investments in marketable debt securities consist primarily of U.S. government related obligations and other debt obligations. The unrealized losses on these securities were caused by interest rate increases. Because the Company has the ability and intent to hold those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at March 30, 2007.
5. Consumer loans receivable and allowance for loans losses
Consumer loans receivable, net of allowance for loan losses, consist of the following (in thousands):
As of March 30, 2007 and March 31, 2006, the fair value of the consumer loans receivable, net, was $228.0 million and $167.9 million, respectively.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
The allowance for loan losses and related additions and deductions to the allowance during the fiscal years ended March 30, 2007, March 31, 2006 and March 25, 2005 are as follows (in thousands):
6. Floor plan payable
The Company has an agreement with a financial institution for a $70.0 million floor plan facility, expiring March 30, 2009. The advance rate for the facility is 90% of manufacturer’s invoice. This facility is used to finance a portion of the new home inventory at the Company’s retail superstores and is secured by new home inventory and a portion of receivables from financial institutions. The interest rate on the facility is prime (8.25% at March 30, 2007) plus 0.6% or prime plus 1.0% to 3.0% for aged units, of which the Company has none as of March 30, 2007. The floor plan facility contains certain provisions requiring the Company to maintain minimum amounts of liquidity, profitability, inventory turns, tangible net worth and annual operating cash flow in order to borrow against the facility. As of March 30, 2007, the Company was not in compliance with the profitability, tangible net worth and annual operating cash flow covenants. The Company obtained a waiver from the financial institution for the fiscal year ended March 30, 2007. The Company has negotiated new covenants, which will be effective beginning with the first quarter of fiscal 2008, and it expects to be in compliance with these covenants during the next fiscal year. In the event the Company is not in compliance with any of its floor plan facility covenants in the future, it would again seek a waiver of any default from the lending institution and, if no such waiver was obtained, maturities of outstanding debt could be accelerated. The Company had $43.6 million and $37.9 million outstanding under these floor plan credit facilities at March 30, 2007 and March 31, 2006, respectively.
7. Debt obligations
Debt obligations consist of the following (in thousands):
On May 5, 2004, the Company issued $65.0 million aggregate principal amount of 3.25% Convertible Senior Notes due 2024 (the “Notes”) in a private, unregistered offering. Interest on the Notes is payable semi-annually in May and November. On June 8, 2004, the initial purchaser of the Notes exercised its option to purchase an additional $10.0 million aggregate principal amount of the Notes. On September 15, 2004, for the benefit of the Note holders, the Company filed a shelf registration statement covering resales of the Notes and the shares of the Company’s common stock issuable upon the conversion of the Notes. The Notes are senior, unsecured obligations and rank equal in right of payment to all of the Company’s existing and future unsecured and senior indebtedness. Each $1,000 in principal amount of the Notes is convertible, at the option of the holder, at a conversion price of $25.92, or 38.5803 shares of the Company’s common stock upon the satisfaction of
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
certain conditions and contingencies. For fiscal years 2007, 2006 and 2005, the effect of converting the senior notes to 2,894,000 shares of common stock was anti-dilutive, and was, therefore, not considered in determining diluted earnings per share. At March 30, 2007 and March 31, 2006, the fair market value of the convertible senior notes is estimated at $63.6 and $71.5 million based on quoted market prices.
On July 12, 2005, the Company, through its subsidiary CountryPlace, completed its initial securitization (“2005-1”) for approximately $141.0 million of loans, which was funded by issuing bonds totaling approximately $118.4 million. The bonds were issued in four different classes: Class A-1 totaling $36.3 million with a coupon rate of 4.23%; Class A-2 totaling $27.4 million with a coupon rate of 4.42%; Class A-3 totaling $27.3 million with a coupon rate of 4.80%; and Class A-4 totaling $27.4 million with a coupon rate of 5.20%. Maturity of the bonds is at varying dates beginning in 2006 through 2015 and were issued with a weighted average maturity of 4.66 years. The proceeds from the securitization were used to repay approximately $115.7 million of borrowings on the Company’s warehouse revolving debt with the remaining proceeds being used for general corporate purposes, including future origination of new loans. For accounting purposes, this transaction was structured as a securitized borrowing. At March 30, 2007, the fair market value of the securitized financing was $89.8 million.
On March 22, 2007, the Company, through its subsidiary CountryPlace, completed its second securitization (“2007-1”) for approximately $116.5 million of loans (including approximately $10.4 million of pre-funded loans to be originated in the future), which was funded by issuing bonds totaling approximately $101.9 million. The bonds were issued in four classes: Class A-1 totaling $28.9 million with a coupon rate of 5.484%; Class A-2 totaling $23.4 million with a coupon rate of 5.232%; Class A-3 totaling $24.5 million with a coupon rate of 5.593%; and Class A-4 totaling $25.1 million with a coupon rate of 5.846%. Maturity of the bonds is at varying dates beginning in 2008 through 2017 and were issued with a weighted average maturity of 4.86 years. The proceeds from the securitization were used to repay approximately $91.4 million of borrowings on the Company’s warehouse revolving debt with the remaining proceeds being used for general corporate purposes, including future origination of new loans. For accounting purposes, this transaction was also structured as a securitized borrowing. At March 30, 2007, the fair market value of the securitized financing was $101.7 million.
The Company, through its subsidiary CountryPlace, has an agreement with a financial institution for a warehouse borrowing facility to fund loans originated by CountryPlace. The facility is collateralized by specific consumer loans receivable pledged to the facility. In connection with the renewal of the facility on March 15, 2007, the maximum borrowing amount was increased from $125.0 million to $150.0 million. The facility terminates March 14, 2008; however, amounts outstanding under the facility are effectively settled and re-borrowed on a monthly basis. The advance against the outstanding principle balance of eligible consumer loan receivables is 88% and draws can be at an 80% advance rate against land-home loans in various stages of completion. The interest rate is LIBOR (5.375%) plus 1.25%. CountryPlace had outstanding borrowings under the warehouse facility of $12.0 million as of March 30, 2007 and $37.4 million as of March 31, 2006. The facility contains certain requirements relating to the performance and composition of the consumer loans receivable pledged to the facility and financial covenants regarding maintenance of a certain loan delinquency ratio and a minimum capitalization for CountryPlace, which is customary in the industry. As of March 30, 2007, CountryPlace was in compliance with these requirements. As CountryPlace continues to expand and draw down on its warehouse facility, the Company will fund the difference between the amounts advanced under the warehouse borrowing facility and the balance of any additional loan originations. For CountryPlace to increase its borrowings under the facility to the maximum $150.0 million, CountryPlace would have to originate an additional $159.0 million of new loans, of which $21.9 million would have to be funded through the Company’s operations.
Upon completion of the 2007-1 securitization, CountryPlace extinguished its interest rate swap agreement on its variable rate debt which was used to hedge against an increase in variable interest rates. The agreement previously fixed the interest rate on $82.7 million of CountryPlace’s variable rate, long-term warehouse
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
revolving debt to 5.345% per annum. CountryPlace recorded the hedge instrument at fair value as of the end of each fiscal quarter with the effective offsetting portion of the hedge being recorded as a component of accumulated other comprehensive income (loss) and the ineffective portion, if any, of the hedge being recorded in the Company’s consolidated statement of operations. Upon extinguishment of the hedge, CountryPlace recorded a loss of $1.0 million, net of tax, for the change in fair value to other comprehensive income (loss), which will be amortized to interest expense over the life of the loans. There was no significant ineffectiveness.
8. Accrued liabilities
Accrued liabilities consist of the following (in thousands):
9. Income taxes
Income tax expense (benefit) for fiscal years 2007, 2006 and 2005 is as follows (in thousands):
Significant components of deferred tax assets and liabilities are as follows (in thousands):
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
The Company believes it is more likely than not it will recover all of its net deferred tax assets. Recovery of the Company’s deferred tax assets is dependent upon the generation of future taxable income, which it currently believes will come from future profitable operating results and available tax planning strategies. Should the Company continue to operate unprofitably, or otherwise change its estimate of future profitable operations, it may need to record a valuation allowance on all or a part of its deferred tax assets. Net deferred tax assets at March 30, 2007 and March 31, 2006 are $14.6 million and $11.1 million, respectively.
The Company has state net operating loss carryforwards of approximately $0.9 million available to offset future state income tax and which expire between 2009 and 2027.
The effective income tax rate on pretax earnings differed from the U.S. federal statutory rate for the following reasons (in thousands):
In October 2004, the American Jobs Creation Act of 2004 (“the Act”) was passed, which provides a deduction for income from qualified domestic production activities which generally will be phased in from 2005 through 2010. Subsequently, the FASB passed FSP FAS 109-1, which indicates that the available qualified domestic production activity deduction will be treated as a “special deduction” as described in SFAS No. 109. As such, there is no impact to the Company’s deferred tax assets or liabilities existing as of the enactment date. Rather, the impact of any deduction will be reported in the period in which the deduction is claimed on the Company’s tax return.
10. Shareholders’ equity
The Board of Directors may, without further action by the Company’s shareholders, from time to time, authorize the issuance of shares of preferred stock in series and may, at the time of issuance, determine the powers, rights, preferences and limitations, including the dividend rate, conversion rights, voting rights, redemption price and liquidation preference, and the number of shares to be included in any such series. Any preferred stock so issued may rank senior to the common stock with respect to the payment of dividends or amounts upon liquidation, dissolution or winding up, or both. In addition, any such shares of preferred stock may have class or series voting rights.
11. Long-Term Incentive Plan
Beginning fiscal 2000 through fiscal 2003, the Board of Directors approved the Long-Term Incentive Plan (the “Plan”) whereby certain key associates received awards of restricted common stock. The Company’s Chairman and Chief Executive Officer does not participate in the Plan. Shares awarded under the Plan are either purchased by the Company in the open market or transferred from the Company’s treasury stock account. These restricted stock awards give the associate the right to receive a specific number of shares of common stock
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
contingent upon remaining an associate of the Company for a specified period. Beginning in fiscal 2004, the Plan was modified until certain earnings levels are achieved.
The unamortized cost of the common stock acquired by the Company for the participants in the plan is included in “Additional paid-in capital” in the accompanying consolidated balance sheets. The Plan is administered by a committee authorized by the Board of Directors.
12. Employee plan
The Company sponsors an employee savings plan (the “401k Plan”) that is intended to provide participating employees with additional income upon retirement. Employees may contribute between 1% and 18% of eligible compensation to the 401k Plan. The Company matches 25% of the first 6% deferred by employees. Employees are immediately eligible to participate and employer contributions, which begin one year after employment, are vested at the rate of 20% per year and are fully vested after five years of employment. Contribution expense was $0.8, $1.0 million and $1.1 million in fiscal years 2007, 2006 and 2005, respectively.
13. Commitments and contingencies
Future minimum lease payments for all noncancelable operating leases having a remaining term in excess of one year at March 30, 2007, are as follows (in thousands):
Rent expense (net of sublease income) was $10.1 million, $9.0 million and $8.9 million for fiscal years 2007, 2006 and 2005, respectively.
The Company is contingently liable under the terms of repurchase agreements covering independent dealers’, builders’ and developers’ floor plan financing. Under such agreements, the Company agrees to repurchase homes at declining prices over the term of the agreement, generally 12 to 18 months. At March 30, 2007, the Company estimates that its potential obligations under all repurchase agreements were approximately $22.7 million. However, it is management’s opinion that no material loss will occur from the repurchase agreements. During fiscal years 2007, 2006 and 2005, net losses incurred by the Company under these repurchase agreements totaled $0, $157,000 and $65,000, respectively.
The Company is subject to various legal proceedings and claims that arise in the ordinary course of business. In the opinion of management, the amount of ultimate liability with respect to these actions will not materially affect the financial position or results of operations of the Company.
14. Interest income and other
During fiscal years 2007, 2006 and 2005, the Company recorded interest income of $4.4 million, $3.4 million and $1.1 million, respectively and other income of $0.5 million, $1.7 million and $3.1 million,
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
respectively. Other income consists primarily of a gain on the sale of available-for-sale investments of $0.3 million in fiscal 2007 and income earned on a real estate investment of $1.5 million and $3.3 million in fiscal years 2006 and 2005, respectively.
15. Losses from natural disaster
During the third quarter of fiscal 2007, the Company’s Burleson, Texas manufacturing facility was destroyed by fire. The Company has business interruption and general liability insurance that will cover the losses. As of March 30, 2007, the Company has recorded $2.5 million of losses and $2.0 million of recoveries. Subsequent to March 30, 2007, the Company received another $1.0 million of recoveries from the insurance company.
16. Business segment information
The Company operates principally in two segments: (1) factory-built housing, which includes manufactured housing, modular housing and retail operations and (2) financial services, which includes finance and insurance. The following table details net sales, income (loss) from operations, identifiable assets, depreciation and amortization expense and capital expenditures by segment for fiscal 2007, 2006 and 2005 (in thousands):
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
17. Accrued product warranty obligations
The Company provides the retail homebuyer a one-year limited warranty covering defects in material or workmanship in home structure, plumbing and electrical systems. The amount of warranty reserves recorded are estimated future warranty costs relating to homes sold, based upon the Company’s assessment of historical experience factors, such as actual number of warranty calls and the average cost per warranty call.
Accrued product warranty obligations are classified as accrued liabilities in the consolidated balance sheets. The following table summarizes the accrued product warranty obligations at March 30, 2007, March 31, 2006 and March 25, 2005 (in thousands).
18. Quarterly financial data (unaudited)
The following table sets forth certain unaudited quarterly financial information for the fiscal years 2007 and 2006.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Management’s Evaluation of Disclosure Controls and Procedures
The term “disclosure controls and procedures” is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, or the Exchange Act. This term refers to the controls and procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission. An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of the Company’s disclosure controls and procedures as of March 30, 2007. Based on that evaluation, the Company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures were effective as of March 30, 2007. During the quarter ending on March 30, 2007, there was no change in the Company’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining effective internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of March 30, 2007 using the criteria set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that, as of March 30, 2007, the Company’s internal control over financial reporting was effective based on those criteria.
Management’s assessment of the effectiveness of internal control over financial reporting as of March 30, 2007, has been audited by Ernst & Young LLP, the independent registered public accounting firm who also audited the Company’s consolidated financial statements. Ernst & Young LLP’s attestation report on management’s assessment of the Company’s internal control over financial reporting appears on the next page.
/s/ LARRY H. KEENER
Larry H. Keener
Chairman and Chief Executive Officer
/s/ KELLY TACKE
Kelly Tacke
Executive Vice President, Chief Financial
Officer and Secretary
Report of Independent Registered Public Accounting Firm on
Internal Control over Financial Reporting
Board of Directors and Shareholders
Palm Harbor Homes, Inc.
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Palm Harbor Homes, Inc. maintained effective internal control over financial reporting as of March 30, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Palm Harbor Homes, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Palm Harbor Homes, Inc. maintained effective internal control over financial reporting as of March 30, 2007, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Palm Harbor Homes, Inc. maintained, in all material respects, effective internal control over financial reporting as of March 30, 2007, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Palm Harbor Homes, Inc. and Subsidiaries as of March 30, 2007 and March 31, 2006 and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three fiscal years in the period ended March 30, 2007. Our report dated May 31, 2007 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Dallas, Texas
May 31, 2007
PART III.
Item 10.
Item 10. Directors and Executive Officers of the Registrant
(a) Information set forth in the sections entitled “Proposal One: Election of Directors” and “Executive Officers” in the Company’s proxy statement for the annual meeting of shareholders to be held July 25, 2007 is incorporated herein by reference.
(b) The information set forth under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s proxy statement for the annual meeting of shareholders to be held July 25, 2007 is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
The information set forth in the sections entitled “Executive Officers” and “Report of the Compensation Committee” in the Company’s proxy statement for the annual meeting of shareholders to be held July 25, 2007 is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information set forth in the section entitled “Share ownership of principal shareholders, directors and management” in the Company’s proxy statement for the annual meeting of shareholders to be held July 25, 2007 is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
None.
Item 14.
Item 14. Principal Accountant Fees and Services
The information set forth in the section entitled “Proposal Two: Ratification of Independent Auditors” in the Company’s proxy statement for the annual meeting of shareholders to be held July 25, 2007 is incorporated herein by reference.
PART IV.
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) (1) Financial Statements
Our Consolidated Financial Statements for the year ended March 30, 2007 are included on pages 31 through 49 of this report.
(2) Financial Statement Schedules
None
(3) Index to Exhibits
* Filed herewith
(b) None.
(c) See Item 14(a)(3) above.
(d) None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on our behalf by the undersigned, thereunto duly authorized on June 4, 2007.
PALM HARBOR HOMES, INC.
/s/ LARRY H. KEENER
Larry H. Keener, Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
KNOW ALL MEN BY THESE PRESENTS, that the undersigned do hereby constitute and appoint Larry H. Keener and Kelly Tacke, and each of them, each with full power to act without the other, his true and lawful attorneys-in-fact and agents, each with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to the annual report on Form 10-K for the year ended March 30, 2007 of Palm Harbor Homes, Inc., and to file the same, with any and all exhibits thereto, and all other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, full power and authority to do and perform each and every act and thing requisite and necessary to be done as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all of each of said attorneys-in-fact and agents or any of them may lawfully do or cause to be done by virtue thereof.
INDEX TO EXHIBITS
* Filed herewith