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, financing and insurance. At March 26, 2010, we operated eight manufacturing facilities in six states that sell homes through 55 of our company-owned retail sales centers and builder locations and approximately 145 independent retail dealers, builders and developers. Through our subsidiary, CountryPlace Mortgage, Ltd. (CountryPlace), we currently offer conforming mortgages to purchasers of factory-built homes sold by company-owned retail sales centers and certain independent retail dealers, builders and developers. The loans originated through CountryPlace are sold to investors. We provide property and casualty insurance for owners of manufactured homes through our subsidiary, Standard Casualty Company (Standard).
Beginning in 1999, the manufactured housing industry entered a 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 86% over the last ten years to 50,000 in calendar year 2009. During this ten-year period, our manufactured housing shipments declined 87%.
Prior to 2006, 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 caused prices to fall and buyers and sellers began to postpone their home buying decisions. It 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. Industry shipments to Florida, Arizona and California decreased approximately 43%, 41%, and 48% in calendar years 2007, 2008 and 2009, respectively.
With the manufactured housing industry not showing signs of a near term recovery, we directed our focus to new growth opportunities. We entered the modular home business in June 2002 when we acquired Nationwide Custom Homes (Nationwide). We now produce modular homes at seven of our eight factory-built housing facilities. As a result of this planned strategy to grow our modular business, the number of modular homes we sold as a percentage of total factory-built homes sold has increased from 8% in fiscal 2003 (when we acquired Nationwide) to 23% in fiscal 2010. However, the 2007 severe downturn in the overall housing market created by reduced financing options has produced an excess of site-built homes, which are directly competitive with modular housing. Our unit sales of modular homes decreased 12%, 40% and 29% in fiscal years 2008, 2009 and 2010, respectively.
In light of the current economic environment and the ongoing challenges facing the factory-built housing industry, our top priority is to manage our liquidity with a focus on cash generation and cash preservation in every area of our operations. During fiscal 2010, we focused on this priority through the following:
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We reached an agreement with Textron Financial Corporation to amend the terms of our floor plan facility and extend the expiration date until April 2011, and in certain circumstances, further extend through June 2012. The agreement also provides for a gradual step-down of the current total committed amount of $45 million to $25 million between March 2010 and March 2011, favorably adjusts certain financial covenants, and allows for an increased percentage of eligible inventory to be borrowed subject to the total credit line at the lender’s discretion.
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Through CountryPlace, we closed on a four-year, $20 million secured term loan from entities managed by Virgo Investment Group LLC (“Virgo”). Net proceeds of $19.0 million, after fees, will be used for working capital and general corporate purposes.
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We reduced inventories by $36.8 million and receivables by $4.9 million.
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We have continued to reduce our overhead costs (selling, general and administrative expenses decreased $20.2 million in fiscal 2010 despite including $4.4 million for restructuring costs).
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We received $1.8 million from the sale to a third party of a portion of Palm Harbor Insurance Agency’s book of business, including rights to future commissions, profit sharing and renewals.
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We completed a sale leaseback transaction totaling $1.0 million in cash for two of our retail properties.
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CountryPlace was approved to issue Ginnie Mae (GNMA) mortgage-backed securities.
We have also taken additional steps to reduce our manufacturing capacity and distribution channels and realign our operational overhead to meet current and expected demand. During the fourth quarter of fiscal 2010, we closed one factory and 23 underperforming sales centers and now have eight factories in operation and a total of 55 sales locations. We recorded restructuring charges of approximately $9.2 million in connection with these actions. Of this $9.2 million, approximately $4.8 million was recorded in cost of sales and primarily related to the quick selling of retail inventories at reduced margins at the locations we were closing while $4.4 million was recorded in selling, general and administrative expenses and primarily related to sales centers and plants closing costs as well as expenses for legal and financial consultants. No significant additional charges are expected to be incurred in connection with this restructuring.
We continue to pursue ways to both expand our product offering and reach new distribution channels to further drive revenues. The commercial and military markets for modular products represent a new growth opportunity. During fiscal 2009 and 2010, we produced barracks and other housing for three military bases as well as townhouses, apartments, duplexes and condominiums. Commercial projects contributed $10.8 million and $16.7 million to our revenues in fiscal years 2010 and 2009, respectively.
Our amended floor plan financing facility with Textron Financial Corporation continues to include required financial covenants, and beginning in March 2010 through March 2011 will require certain reductions in the overall amounts borrowed under the facility. We believe that the combination of our cash on hand, net proceeds from the Virgo loan, floor plan financing, conforming mortgage sales, and other available borrowing alternatives will be adequate to support working capital, debt servicing and currently planned capital expenditure needs for the foreseeable future. However, because future cash flows and the availability of financing, as well as covenant compliance, is dependent upon a number of factors, including prevailing economic and financial conditions and other factors beyond our control, no assurances can be given in this regard.
Going forward, we will continue to focus on managing our costs, improving gross margin and maintaining adequate liquidity to sustain our business through this cycle. At the same time, we are pursuing ways to both expand our product offering and reach new distribution channels to further drive revenues.
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 17 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 2010, 2009 and 2008.
Factory-Built Housing Segment
Our factory-built housing operations consist of the production and sale of manufactured homes (HUD-code), modular homes, and commercial buildings. 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.
The following table sets forth the total factory-built homes sold, commercial buildings sold and the number of manufacturing facilities we operated for the fiscal years indicated:
(1)
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 single-section homes in fiscal 2006.
The number of operating manufacturing facilities has decreased 55% since March 31, 2006. During the last four fiscal years we idled eight less-than-efficient facilities and had one facility destroyed by fire. During fiscal 2010, we sold one facility. Currently, we have four facilities listed for sale. We recorded $0.3 million and $1.5 million for impairment charges on facilities held for sale in fiscal 2010 and fiscal 2009, respectively. See Note 1 in the notes to the consolidated financial statements for further details on our impairment testing.
Products
We manufacture a broad range of single and multi-section manufactured and modular homes under various brand names and in a variety of floor plans and price ranges. While most of the homes we build are multi-section/modular (78% in fiscal 2010) ranch-style homes, we also build single-section homes, split-level homes, cape cod style homes, two and three story homes and multi-family units such as apartments and duplexes. Most of the single-family homes we produce contain two to five bedrooms, a living room, family room, dining room, kitchen and two or three bathrooms. Approximately 80% of the manufactured homes we produce are structurally or decoratively customized to the homebuyer’s specifications. During fiscal 2010, the average retail sales price (excluding land) of our manufactured and modular homes was approximately $67,000 and $166,000, respectively.
We also produce commercial modular structures including apartment buildings, condominiums, hotels, schools and military barracks and other housing for U.S. military troops. Commercial buildings are constructed in the same factories and using the same assembly lines as the factories where we produce our factory-built homes. These commercial projects are generally engineered to the purchaser’s specifications. The buildings are transported to the customer’s site in the same manner as our homes and are crane set at the site. Commercial projects are finished on site.
We introduced flexible products during fiscal 2009. Flexible products are models that can be built from 1,200-2,400 square feet, built to either HUD-code or modular specifications, all designed with a variety of exterior elevations and available by simply displaying one base model home. This long-term effort has helped us significantly reduce our inventories and our floor plan payable.
Most factory-built homes come with central air conditioning and heating, a range, refrigerator and carpeting. HUD-code homes also typically contain window treatments. Optional amenities, including washers, dryers, furniture packages and specialty cabinets, as well as features usually associated with site-built homes such as stone fireplaces, ceramic tile floors, showers and countertops, computer rooms, master retreats, 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, and which exceeds statutorily-mandated energy efficiency levels. We have been an ENERGY STAR partner since 1997 and 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. In February 2008, we received the U. S. Department of Energy’s (DOE) first Energy Smart label for the green home that we manufactured and displayed at the International Builders Show in Orlando, Florida.
We are constantly introducing new floor plans, decors, exteriors, features and accessories to appeal to changing trends in different regions of the country. Our factory-built 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 principal materials used in the construction of our factory-built homes are of the same quality as those used by conventional site builders. These components 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 construction 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 two suppliers which accounted for more than 5% of our total purchases during the fiscal year ended March 26, 2010 represented 15.4% and 5.3%, respectively, of our total purchases. 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.
Our homes are constructed in indoor facilities, which have approximately 100,000 square feet of floor space and employ an average of 145 associates. Construction of our homes is performed in stages using an assembly-line process. HUD-code homes are constructed in one or more sections that is/are permanently attached to a steel support chassis that allows the section to be moved through the facility and transported upon sale. The sections of many of the modular homes we produce are built on wooden floor systems and transported on carriers that are removed during placement of the homes at the home site. The sections are then moved down a tracked path where various components such as floors, interior and exterior walls, ceiling, roof, and other purchased components are added and function testing is performed. We currently complete a typical HUD-code home in approximately five days and a typical modular home in one to two weeks. We believe the efficiency of our process, protection from the weather, and favorable pricing of materials resulting from our substantial purchasing power enables us to produce homes more quickly and often at a lower cost than a conventional site-built home of similar quality.
The completed homes are transported by independent trucking companies to either the retail sales center (stock orders) or to the customer’s site (retail sold orders). The transportation cost is borne by the independent retailer. At the home site, HUD-code homes are placed on the site, the interior and exterior seams are joined, utility hook-ups are made and installation and finish-out services are provided. The industry practice is to have third parties hired by the retailer provide the installation and finish-out services. Our associates, rather than third parties, perform the installation and finish out services on our homes. 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. Modular homes are typically set by a crane on the foundation, the roof is raised and the final seam of roof shingles along the ridges of the roofline is applied. Modular homes typically require a larger amount of work to be done on-site to complete the homes.
The construction of our factory-built homes is based upon customer orders from retailers and independent dealers, builders and developers. Since orders from retailers may be cancelled prior to production without penalty, we do not consider our order backlog to be a firm indication of future business; however, such cancellations do not often occur. Before scheduling homes for production, customer deposits are received and availability of financing is confirmed with our customer and, with respect to independent dealers, their floor plan lender. As of June 8, 2010, our backlog of manufactured housing orders was approximately $15.9 million, as compared to approximately $8.9 million as of May 26, 2009 and our backlog of modular housing orders as of June 8, 2010 was approximately $10.0 million, as compared to approximately $35.2 million as of May 26, 2009.
Product Distribution
Our homes are sold through a distribution network consisting of retail sales centers we own and independent dealers, builders and developers. Our commercial buildings are sold to the U.S. government, general contractors and developers. The following table sets forth the number of homes and buildings we sold through each of these distribution channels, as well as the number of company-owned retail sales centers and independent dealers, builders and developers during the past three fiscal years:
We currently have 52 company-owned retail sales centers in seven states and three company-owned builder locations in three states. A typical retail sales center consists of a manufactured home finished out as sales offices, and factory-built model homes of various sizes, floor plans, features and prices. Many of our retail sales centers 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. 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 floor plan and various amenities in their new home.
In addition to our company-owned retail sales centers and builder locations, we also distribute our factory-built homes through independent dealers, builders and developers. The number of homes sold through our independent dealers, builders and developers has decreased by 45% over the last three fiscal years. This decline is largely the result of slowdowns in sales to Lifestyle Communities in the three key states of Florida, Arizona and California, which historically were some of our most profitable states. Our independent dealer network consists of approximately 80 local dealers that market to lifestyle communities and on your lot homes. Our builder/developer network consists of approximately 65 builders and developers who typically acquire and develop the land and set a foundation for the home. We transport the home to the site and the builder/developer’s contractors lift the home with a crane onto the foundation and subsequently perform finish-out services. The builder/developer may also construct garages, patios, porches and other such additional add-ons.
Markets Served
During the fiscal year ended March 26, 2010, the percentage of our revenues by region was as follows:
The two states which accounted for greater than 10% of our fiscal 2010 revenues were Texas and Florida with approximately 42% and 12%, respectively, of total revenues.
Because the cost of transporting factory-built homes is significant, there is a practical limit to the distance between a manufacturing facility and our retailers or home sites. 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 20 to 40 retailers, and the facility sales staff maintains personal contact with each retailer, whether company-owned or independent. Our decentralized operations allow us to be more responsive in addressing regional customer preferences of product innovation and home design.
Consumer Financing
Sales of factory-built homes are significantly affected by the availability and cost of consumer financing. There are three 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 (generally HUD-code homes); non-conforming mortgages for purchasers of the home and the land on which the home is placed; and mortgage loans which comply with the requirements of FHA, Fannie Mae or Freddie Mac. The majority of modular homes are financed with conventional real estate mortgages. Beginning in mid-1999, lenient credit standards for chattel loans led to increased numbers of repossessions of manufactured homes and excessive inventory levels. The poor performance of manufactured home loan portfolios made it difficult for consumer finance companies in the industry to obtain long-term capital in the asset-backed securitization market. As a result, many consumer finance companies curtailed their lending or exited the manufactured housing loan industry entirely. Since then, the lenders who remained in the business tightened their credit standards and increased interest rates for chattel loans which reduced lending volumes and lowered 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 purposes.
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 74% 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 2010; (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 $3.0 million as of March 26, 2010. During fiscal years 2010, 2009 and 2008, we did not incur any losses under these repurchase agreements.
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 2010. Since the beginning of the industry downturn, several major floor plan lenders have exited the wholesale financing business for our independent dealers and GE, Textron and 21st Mortgage are all currently in the process of either exiting the business or reducing their lending to the industry. This reduced availability of wholesale financing has resulted in reduced sales to independent dealers, builders and developers during fiscal 2010.
Financial Services Segment
Our financial services subsidiaries’ fiscal year ends on different dates than ours. CountryPlace’s fiscal year ends on March 31 and Standard’s fiscal year ends on the last day of February.
Finance
We provide financing to our customers on competitive terms through our subsidiary, CountryPlace. Through CountryPlace, we currently offer conforming mortgages to purchasers of factory-built homes sold by company-owned retail sales centers and certain independent retail dealers, builders and developers. CountryPlace is an approved seller-servicer with Fannie Mae, is approved by HUD to originate FHA-insured mortgages under its Direct Endorsement program, and is approved to issue Ginnie Mae mortgage-backed securities. The loans originated through CountryPlace are sold to investors. CountryPlace also provides various loan origination and servicing functions for non-affiliated entities under contract. We believe that providing financing alternatives to our customers improves our responsiveness to the financing needs of prospective purchasers and provides us with additional sources of loan origination and servicing revenues.
All of CountryPlace’s loan contracts held are fixed rate and have monthly scheduled payments of principal and interest. The scheduled payments for each contract would, if made on their respective due dates, result in a full amortization of the contract. The following is an analysis of the scheduled repayments of the loans in our portfolio as of March 31, 2010 (in thousands):
CountryPlace’s policy is to place loans on nonaccrual status when either principal or interest is past due and remains unpaid for 120 days or more. In addition, they place loans on nonaccrual status when there is a clear indication that the borrower has the inability or unwillingness to meet payments as they become due. Payments received on nonaccrual loans are accounted for on a cash basis, first to interest and then to principal. Upon determining that a nonaccrual loan is impaired, interest accrued and the uncollected receivable prior to identification of nonaccrual status is charged to the allowance for loan losses. At March 31, 2010, CountryPlace’s management was not aware of any potential problem loans that would have a material effect on loan delinquency or charge-offs. Loans are subject to continual review and are given management’s attention whenever a problem situation appears to be developing. The following table sets forth the amounts and categories of CountryPlace’s non-performing loans and assets as of March 31, 2010 and March 31, 2009 (dollars in thousands):
(1)
As of March 31, 2010 CountryPlace identified $2.4 million of loans in nonaccrual status for which foreclosure is probable. Accordingly, the Company reduced the loans receivable balance and the allowance for loan losses by $1.2 million to reflect the difference between the unpaid balance and the estimated fair market value of the related loans receivable. At March 31, 2009 loans accounted for on a nonaccrual basis were reflected at the unpaid balance of $2.6 million.
(2)
Consists of land and homes acquired through foreclosure, which are carried at the lower of carrying value or fair value less estimated selling expenses.
During fiscal 2010, CountryPlace modified loans to retain borrowers with good payment history. These modifications were considered to represent credit concessions due to borrowers’ loss of income and other repayment matters impacting these borrowers. For the years ended March 31, 2010 and March 31, 2009, CountryPlace modified the payments or rates for approximately $1.6 million and $0.1 million, respectively. These loans are not reflected as non-performing loans but as troubled debt restructurings. As of March 31, 2010, the allowance for loan losses totaled $3.0 million.
Loan contracts secured by collateral that is geographically concentrated could experience higher rates of delinquencies, default and foreclosure losses than loan contracts secured by collateral that is more geographically dispersed. CountryPlace has loan contracts secured by factory-built homes located in the following key states as of March 31, 2010 and March 31, 2009:
The states of California, Florida, Arizona and, to a lesser degree, Texas, have experienced economic weakness resulting from the decline in real estate values. The risks created by these concentrations have been considered by CountryPlace’s management in the determination of the adequacy of the allowance for loan losses. No other states had concentrations in excess of 10% of the principal balance of the consumer loans receivable as of March 31, 2010 or March 31, 2009. Management believes the allowance for loan losses of $3.0 million is adequate to cover estimated losses at March 31, 2010.
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 70 active producing agents.
During fiscal 2010, 85% of homeowners who purchased a home through our own retail superstores purchased extended warranties and 68% purchased property and casualty insurance. At the end of fiscal 2010, Standard Casualty had approximately 11,930 policies in force.
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 regional 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.
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. Although the market is highly fragmented, especially for conforming mortgage products, chattel financing is consolidating among a few remaining national lenders: 21st Mortgage Corporation, an affiliate of Clayton Homes, Inc. and Berkshire Hathaway, Inc.; and US Bank Manufactured Housing Finance. Each of these competitors is larger than CountryPlace and has access to substantially more capital at lower costs than CountryPlace.
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 (including dividend payments to stockholders) 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
Currently, we have approximately 1,700 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 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 a code of conduct. A copy of our code of conduct is available at our website, www.palmharbor.com.
Item 1A.
Item 1A. Forward-Looking Information/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:
Our significant debt obligations, or our incurrence of additional debt, could limit our flexibility in managing our business and could materially and adversely affect our financial performance.
We are highly leveraged. As of March 26, 2010, we had approximately $196 million of long-term indebtedness outstanding. In addition, under the Virgo credit agreement, CountryPlace is permitted to incur up to $4.8 million in additional debt, subject to certain limitations. Being so highly leveraged could have a material adverse effect on our business, financial condition, operating results, and ability to satisfy our obligations under our indebtedness.
Recent turmoil in the credit markets and the financial services industry may reduce the demand for our homes and the availability of home mortgage financing, among other things.
Recently, the credit markets and the financial services industry have been experiencing a period of unprecedented turmoil and upheaval characterized by the bankruptcy, failure, collapse or sale of various financial institutions and an unprecedented level of intervention from the United States federal government. While the ultimate outcome of these events cannot be predicted, it may have a material adverse effect on us, our liquidity, our ability to borrow money to finance our operations from our existing lenders or otherwise, and could also adversely impact the availability of financing to our customers.
We continue to reduce our manufacturing capacity and distribution channels to effectively align with current and expected regional demand to maintain operating profitability. If the economy continues to worsen, our return to operating profitability will be delayed.
Since March 2006, we have decreased the number of operating manufacturing plants by eight and decreased the number of retail sales centers we own by 61 to align current and expected regional demand. If the U.S. economy continues to slow, financial markets continue to decline, and more layoffs occur nationally, our realignment will not allow us to return to operating profitability and further cost savings and other measures will be required.
Deterioration in economic conditions in general could further reduce the demand for homes and impact customers’ ability to repay their loans to CountryPlace and, as a result, could reduce our earnings and adversely affect our financial condition.
Changes in national and local economic conditions could have a negative impact on our business. Adverse changes in employment levels, job growth, consumer confidence and income, interest rates and population growth may further reduce demand, depress prices for our homes and cause homebuyers to cancel their agreements to purchase our homes, thereby possibly reducing earnings and adversely affecting our business and results of operations. These adverse changes may also impact customers’ ability to repay their loans to CountryPlace which could adversely affect the profitability and cash flow from CountryPlace’s loan portfolio and our ability to satisfy our obligations under our indebtedness to Virgo. Recent changes in these economic variables have had an adverse affect on consumer demand for, and the pricing of, our homes, causing our revenues to decline and future deterioration in economic conditions could have further adverse effects.
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 origination 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. Government agencies such as FHA, Fannie Mae and Freddie Mac, which are important insurers or 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. 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.
The factory-built housing industry is currently in a prolonged slump with no recovery in sight.
Historically, the factory-built housing industry has been highly cyclical and seasonal and has experienced wide fluctuations in aggregate sales. The factory-built housing industry is currently in a prolonged slump with no near-term recovery. We are subject to volatility in operating results due to external factors beyond our control such as:
•
the level and stability of interest rates;
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unemployment trends;
•
the availability of retail home financing;
•
the availability of wholesale financing;
•
the availability of homeowners’ insurance in coastal markets;
•
housing supply and demand;
•
international tensions and hostilities;
•
levels of consumer confidence;
•
inventory levels;
•
severe weather conditions; and
•
regulatory and zoning matters.
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.
If the current crisis continues for an extended period of time, or if the crisis worsens, we could face significant problems caused by a lack of liquidity.
We are currently experiencing an extreme crisis in the national and global economy generally as well as in the housing market specifically. This crisis has materially impacted liquidity in the financial markets, making terms for certain financings less attractive, and in certain cases has resulted in the unavailability of certain types of financing. Continued uncertainty in the credit and equity markets may negatively impact our ability to access additional financing at reasonable terms or at all, which may negatively affect our ability to conduct our operations or refinance our existing debt. Disruptions in the equity markets may also make it more difficult for us to raise capital through the issuance of additional shares of our common stock. In light of this economic crisis and the challenging business conditions that we are currently facing, we are focusing a significant amount of effort on cash generation and preservation. However, there can be no guarantee that these efforts or any other efforts we take to increase our liquidity will be successful. If the current economic crisis continues for an extended period of time, or if the crisis worsens, we may have insufficient liquidity to meet our financial obligations in the future.
Reduced availability of wholesale financing could have a material adverse effect on us.
We have an agreement with Textron Financial Corporation for a floor plan facility. 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 sales centers and is secured by our assets, excluding CountryPlace assets. During the third quarter of fiscal 2009, Textron announced that they wanted to perform an orderly liquidation of certain of their commercial finance businesses, including their housing inventory finance business.
As of December 25, 2009, we were required to reduce the outstanding borrowings under the Textron facility to $40 million by December 31, 2009. However, on December 29, 2009, we agreed with Textron to an amendment to delay the requirement to reduce outstanding borrowings to $40 million until January 31, 2010. Additionally, certain other covenant and condition modifications to the agreement were made at the time. On January 27, 2010, we agreed with Textron to a further amendment that included, among other things, the following modifications:
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Extends the maturity date from June 30, 2010 to the earlier of June 30, 2012 or one month prior to the date of the first repurchase option for the holder of our convertible senior notes;
•
Alters the maximum credit line to $45 million for the fourth quarter of fiscal 2010, $43 million for the first quarter of fiscal 2011, $38 million for the second quarter of fiscal 2011, $32 million for the third quarter of fiscal 2011, $28 million for the fourth quarter of fiscal 2011 and $25 million thereafter;
•
Provides for a maximum loan-to-collateral coverage ratio of 65% through the first quarter of fiscal 2011, 62% for the second quarter of fiscal 2011 and 60% for all quarters thereafter;
•
Allows for an increased percentage of eligible inventory to be borrowed subject to the total credit line at the lender’s discretion;
•
Pledges 100% of the Company’s equity in Standard Casualty Company to Textron; and
•
Alters financial covenants as follows:
•
Maximum quarterly net loss before taxes and restructuring charges-$15 million through the second quarter of fiscal 2011, $10 million for the third and fourth quarters of fiscal 2011 and $1 million of net income for all quarters thereafter;
•
Eliminates the borrowing base requirement in its entirety effective December 29, 2009.
As of March 26, 2010, we were required to comply with a minimum inventory turn of not less than 2.75:1, and a maximum quarterly net loss (before taxes and restructuring charges) not to exceed $15 million, as defined by the agreement. We were in compliance with these financial covenants as of March 26, 2010 and believe that covenant requirements under the amended Textron facility are achievable for the foreseeable future. However, in light of current market conditions, and because covenant compliance is dependent upon a number of factors, including prevailing economic and financial conditions and other factors beyond our control, no assurances can be given in this regard. Textron could also declare a loan violation due to a material adverse change, as defined in the agreement. Should a covenant violation occur, we would seek a waiver from Textron and consider any other available remedies. However, no assurances can be made that Textron would provide us with a waiver or that we will otherwise have available remedies and, if a loan violation were to occur and not be waived or remedied in accordance with the terms of the floor plan facility, Textron could declare an event of default and demand that the full amount of the facility be paid in full prior to maturity. Such a demand would result in, among other things, a cross default on our convertible senior notes described in Note 6.
Additionally, as of March 26, 2010, we had a loan-to-collateral coverage ratio of 82% which exceeded the maximum requirement of 65% and resulted in our having an increased percentage of eligible inventory borrowed subject to the total credit line by $8.9 million. While Textron could demand that the entire $8.9 million be repaid immediately, Textron has approved the coverage ratio to be out of formula and in connection with that waiver, reset the total credit line from $43 million to $38 million effective May 18, 2010.
We are concentrated geographically, which could harm our business.
In fiscal 2010, approximately 42% of our net sales were generated in Texas and approximately 12% of our net sales were generated in Florida. While Texas has lagged the national recession to a certain extent, a further decline in the economy of Texas could have a material adverse effect on our results of operations as well.
We may have insufficient cash available to repurchase our convertible senior notes if a significant portion of the notes are put to us on the repurchase dates.
As of March 26, 2010, we had $53.8 million in principal that remains outstanding under our 3.25% Convertible Senior Notes due 2024 (the Notes). Holders of the 2024 Notes may require us to repurchase all or a portion of their 2024 Notes at 100% of their principal amount plus accrued and unpaid interest for cash on May 15, 2011, May 15, 2014 and May 15, 2019. We cannot guarantee that we will have sufficient funds or will be able to arrange for additional financing to pay the principal amount or purchase price due. In that case, our failure to purchase any tendered notes would constitute an event of default under the indenture, thereby requiring the Notes to become immediately due and payable.
We may not realize our deferred income tax assets.
The ultimate realization of our deferred income tax assets is dependent upon generating future taxable income, executing tax planning strategies, and reversals of existing taxable temporary differences. We have recorded a valuation allowance against our deferred income tax assets. The valuation allowance will fluctuate as conditions change.
Our ability to utilize net operating losses (“NOLs”), built-in losses (“BILs”), and tax credit carryforwards to offset our future taxable income and/or to recover previously paid taxes would be limited if we were to undergo an “ownership change” within the meaning of Section 382 of the Internal Revenue Code (the “IRC”). In general, an “ownership change” occurs whenever the percentage of the stock of a corporation owned by “5-percent shareholders” (within the meaning of Section 382 of the IRC) increases by more than 50 percentage points over the lowest percentage of the stock of such corporation owned by such “5-percent shareholders” at any time over the testing period.
An ownership change under Section 382 of the IRC would establish an annual limitation to the amount of NOLs, BILs, and tax credit carryforwards we could utilize to offset our taxable income in any single year. The application of these limitations might prevent full utilization of the deferred tax assets attributable to our NOLs, BILs, and tax credit carryforwards. We have not experienced an ownership change as defined by Section 382. To preserve our ability to utilize NOLs, BILs, and other tax benefits in the future without a Section 382 limitation, we adopted a shareholder rights plan, which is triggered upon certain transfers of our securities. There can be no assurance that we will not undergo an ownership change within the meaning of Section 382.
Changes in laws or other events that adversely affect liquidity in the secondary mortgage market could hurt our business.
The government-sponsored enterprises, principally Fannie Mae and Freddie Mac, play a significant role in buying home mortgages and creating investment securities that they either sell to investors or hold in their portfolios. These organizations provide liquidity to the secondary mortgage market. Fannie Mae and Freddie Mac have recently experienced financial difficulties. Any new federal laws or regulations that restrict or curtail their activities, or any other events or conditions that prevent or restrict these enterprises from continuing their historic businesses, could affect the ability of our customers to obtain the mortgage loans or could increase mortgage interest rates or credit standards, which could reduce demand for our homes and/or the loans that we originate and adversely affect our results of operations.
Natural disasters and severe weather conditions could delay deliveries, increase costs, and decrease demand for new homes in affected areas.
Our homebuilding operations are located in many areas that are subject to natural disasters and severe weather. The occurrence of natural disasters or severe weather conditions can delay new home deliveries, increase costs by damaging inventories, reduce the availability of materials, and negatively impact the demand for new homes in affected areas. Furthermore, if our insurance does not fully cover business interruptions or losses resulting from these events, our earnings, liquidity, or capital resources could be adversely affected.
We face increased competition from site builders of residential housing, which may reduce our net sales.
Our homes compete with homes that are built on site. The sales of site built homes are declining and new home inventory is increasing, which is resulting in more site built homes being available at lower prices. Appraisal values of site built homes are declining with greater availability of lower priced site built homes in the market. The increase in availability, along with the decreased price of site built homes, 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.
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;
•
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, CountryPlace may repossess or foreclose in order to liquidate its loan collateral and minimize losses. The homes and land securing the loan are subject to fluctuating market values, and proceeds realized from liquidating repossessed or foreclosed property are highly susceptible to adverse movements in collateral values. Recent and continued trends in general house price depreciation and increasing levels of unemployment may result in additional defaults and exacerbate actual loss severities upon collateral liquidation beyond those normally experienced by CountryPlace. CountryPlace has a significant concentration (approximately 43%) of its borrowers in Texas. To date, Texas has experienced less severe house price depreciation and more stable economic conditions than other parts of the country. However, these conditions may change in the future, and a downturn in economic conditions in Texas could severely affect the performance of CountryPlace’s loans. In addition, CountryPlace has loans in several states that are experiencing rapid house price depreciation, such as Florida, Arizona, and California. This may adversely affect the willingness of CountryPlace’s borrowers in these states to repay their loans and result in lower realized proceeds from liquidating repossessed or foreclosed property in these states.
Some of CountryPlace’s loans may be illiquid and their value difficult to determine or realize.
Some of the loans CountryPlace has originated or may originate in the future may not have a liquid market, or the market may contract rapidly in the future and the loans may become illiquid. Although CountryPlace offers loan products and prices its loans at levels that it believes are marketable at the time of credit application approval, market conditions for mortgage-related loans have deteriorated rapidly and significantly recently. CountryPlace’s ability to respond to changing market conditions is bound by
credit approval and funding commitments it makes in advance of loan completion. In this environment, it is difficult to predict the types of loan products and characteristics that may be susceptible to future market curtailments and tailor our loan offerings accordingly. As a result, no assurances can be given that the market value of our loans will not decline in the future, or that a market will continue to exist for all of our loan products.
If CountryPlace is unable to develop sources of long-term funding it may be unable to resume originating chattel and non-conforming mortgage loans.
In the past, CountryPlace securitized loans as its primary source of long-term financing for chattel and non-conforming mortgages. CountryPlace used a warehouse borrowing facility to provide liquidity while aggregating loans prior to securitization. Because of recent significant and continued deterioration in the asset securitization market, CountryPlace is presently unable to rely on warehouse financing for liquidity and can no longer plan to securitize its loans. As a result, CountryPlace has ceased originating chattel and non-conforming mortgage loans for its own portfolio until it determines that a term financing market exists or can be developed for such products. At present, no such market exists, and no assurance can be given that one will develop, or that asset securitization will again be viable term financing method for CountryPlace. Further, no assurance can be given that warehouse financing will be available with economically favorable terms and conditions.
If interest rates increase, the market value of loans held for investment and loans available for sale may be adversely affected.
Fixed rate loans originated by CountryPlace prior to long-term financing or sale to investors are exposed to the risk of increased interest rates between the time of loan origination and term financing or sale. If interest rates for term financings or in the whole-loan market increase after loans are originated, the loans may suffer a decline in market value and our interest margin spreads could be reduced. In the past, CountryPlace entered into interest rate swap agreements to hedge its exposure to such interest rate risk from prior to arranging term-financing such as securitization. However, CountryPlace does not currently hedge the interest rate risk for mortgage loans in various stages of origination prior to sale, except to the extent that it enters into forward delivery commitments with investors for certain mortgages that are executed but for which construction is incomplete.
Loss severities on defaulted loans may increase.
As a result of the Company restructuring its retail operations, there are substantially fewer retail sales centers than in fiscal 2009 to assist CountryPlace in disposing of repossessed homes. The restructurings have resulted in the Company no longer having retail sales centers in several geographic areas in which CountryPlace has loans outstanding. In these areas, CountryPlace must now liquidate repossessed homes through independent manufactured home dealers and brokers at wholesale prices. This is likely to reduce the defaulted loan amounts recovered versus retail sales through the Company’s sales centers. In addition, house prices in general may continue to decline and adversely affect the prices realized by CountryPlace for repossessed homes. We believe that our reserves are adequate to cover these defaulted loans but no assurances can be made.
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 be adversely affected and impair CountryPlace’s ability to continue to originate and sell loans to investors.
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 2010, average prices of our raw materials increased 4% compared to fiscal 2009, and in fiscal 2009, average raw materials prices increased 5% compared to fiscal 2008. 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.
Our repurchase agreements with floor plan lenders could result in increased costs.
In accordance with customary practice in the manufactured 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 retailer in its obligation to these credit sources, to repurchase manufactured 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 manufactured homes 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 manufactured 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 retailers could result in defaults by retailers and consequently repurchase obligations on our part may be higher than has historically been the case. During fiscal 2010, fiscal 2009 and fiscal 2008, we did not incur any significant losses under these repurchase agreements.
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 of the Board 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 three shareholders, who may determine the outcome of all elections.
Approximately 51% of our outstanding common stock is beneficially owned or controlled by Sally Posey Trust, Sally 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.
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. In addition, one of our competitors provides the largest single source of retail financing in our industry and if they were to discontinue providing this financing, our operating results could be adversely affected.
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 2010, approximately 12% 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.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
The following table sets forth certain information with respect to our properties:
(1)
Facility is permanently closed and listed for sale.
We currently own all of our manufacturing facilities (except one building in Siler City, NC which is leased) and substantially all of the machinery and equipment used in the facilities. We believe our facilities are adequately maintained and suitable for the purposes for which they are used. Our capacity utilization rate was approximately 30% as of March 26, 2010.
In addition to our production facilities, we own nine properties upon which two of our active retail centers are located. The remaining active sales centers are leased under operating leases with lease terms generally ranging from monthly to 10 years.
See Note 1 to the consolidated financial statements on our impairment analysis for long-term assets, including property, plant and equipment.
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 worked 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. We have closed the site and completed all the necessary paperwork required by the EPA to settle the claim. 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 estimable 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 or results of operations.
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. We have received a notice of intent from the Arizona Department of Water Resources to abandon the well. In general, although no assurance can be given, 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. [Reserved]
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.
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 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, 2005, and the reinvestment of dividends. The companies in our peer group are as follows: Champion Enterprises, Inc., Fleetwood Enterprises, 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 26, 2010. 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, financing and insurance. As of March 26, 2010, we operated eight manufacturing facilities that sell homes through 55 company-owned retail sales centers and builder locations and approximately 145 independent retail dealers, builders and developers. Through our subsidiary, CountryPlace, we currently offer conforming mortgages to purchasers of factory-built homes sold by company-owned retail sales centers and certain independent retail dealers, builders and developers. The loans originated through CountryPlace are sold to investors. We also provide property and casualty insurance for owners of manufactured homes through our subsidiary, Standard Casualty.
The prevailing economic uncertainties and depressed housing market have continued to challenge the factory-built housing industry and our business during fiscal 2010. Our revenues for the year are indicative of the constrained demand for factory-built housing products resulting from a more restrictive financing environment and an over-supply of discounted site-built homes. Our fiscal year revenues declined 27.1% over the prior year period and our gross margin decreased to 21.4% from 23.7% a year ago. In spite of the decline in sales and gross margin, we have reduced our selling, general and administrative expenses and improved our operating efficiencies in this current sales environment. Our financial services subsidiaries, Standard Casualty and CountryPlace Mortgage, continue to be profitable.
In light of the current economic environment and the ongoing challenges facing the factory-built housing industry, our top priority is to manage our liquidity with a focus on cash generation and cash preservation in every area of our operations. During fiscal 2010, we focused on this priority through the following:
•
We reached an agreement with Textron Financial Corporation to amend the terms of our floor plan facility and extend the expiration date until April 2011, and in certain circumstances, further extend through June 2012. The agreement also provides for a gradual step-down of the current total committed amount of $45 million to $25 million between March 2010 and March 2011, favorably adjusts certain financial covenants, and allows for an increased percentage of eligible inventory to be borrowed subject to the total credit line at the lender’s discretion.
•
Through CountryPlace, we closed on a four-year, $20 million secured term loan from entities managed by Virgo Investment Group LLC (“Virgo”). Net proceeds of $19.0 million, after fees, will be used for working capital and general corporate purposes.
•
We reduced inventories by $36.8 million and receivables by $4.9 million.
•
We have continued to reduce its overhead costs (selling, general and administrative expenses decreased $20.2 million in fiscal 2010 despite including $4.4 million for restructuring costs).
•
We received $1.8 million from the sale to a third party of a portion of Palm Harbor Insurance Agency’s book of business, including rights to future commissions, profit sharing and renewals.
•
We completed a sale leaseback transaction totaling $1.0 million in cash for two of our retail properties.
•
CountryPlace was approved to issue Ginnie Mae (GNMA) mortgage-backed securities.
We have also taken additional steps to reduce our manufacturing capacity and distribution channels and realign our operational overhead to meet current and expected demand. During the fourth quarter of fiscal 2010, we closed one factory and 23 underperforming sales centers and now have eight factories in operation and a total of 55 sales locations. We recorded restructuring charges of approximately $9.2 million in connection with these actions. Of this $9.2 million, approximately $4.8 million was recorded in cost of sales and primarily related to the quick selling of retail inventories at reduced margins at the locations that were closing while $4.4 million was recorded in selling, general and administrative expenses and primarily related to sales centers and plants closing costs as well as expenses for legal and financial consultants. No significant additional charges are expected to be incurred in connection with this restructuring.
We continue to pursue ways to both expand our product offering and reach new distribution channels to further drive revenues. The commercial and military markets for modular products represent a new growth opportunity at higher price points than the residential market. During fiscal 2009 and 2010, we produced barracks and other housing for three military bases as well as townhouses, apartments, duplexes and condominiums. Commercial projects contributed $10.8 million and $16.7 million to our revenues in fiscal years 2010 and 2009, respectively.
Our amended floor plan financing facility with Textron Financial Corporation continues to include required financial covenants, and beginning in March 2010 through March 2011 will require certain reductions in the overall amounts borrowed under the
facility. We believe that the combination of our cash on hand, net proceeds from the Virgo loan, floor plan financing, conforming mortgage sales, and other available borrowing alternatives will be adequate to support working capital, debt servicing and currently planned capital expenditure needs for the foreseeable future. However, because future cash flows and the availability of financing, as well as covenant compliance, is dependent upon a number of factors, including prevailing economic and financial conditions and other factors beyond our control, no assurances can be given in this regard.
Going forward, we will continue to focus on managing our costs, improving gross margin and maintaining adequate liquidity to sustain our business through this cycle. At the same time, we are pursuing ways to both expand our product offering and reach new distribution channels to further drive revenues.
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.
2010 Compared to
Net Sales. Net sales decreased 27.1% to $298.4 million in fiscal 2010 from $409.3 million in fiscal 2009. This decrease is primarily the result of a $108.8 million decrease in factory-built housing net sales. Financial services net revenues decreased $2.1 million in fiscal 2010. The decline in factory-built housing net sales is primarily due to a 22.2% decrease in the total number of factory-built homes sold coupled with decreases in the average selling prices of new manufactured and modular homes. The decrease in the total number of factory-built homes sold reflects the severe state of the factory-built housing industry, the prevailing economic uncertainties, credit crisis and general consumer paralysis that has kept potential homebuyers on the sidelines. Homes sold to independent dealers, builders and developers decreased 30.1% in fiscal 2010 largely due to
slowdowns in sales to lifestyle communities in the three key states of Florida, California and Arizona, which historically were some of our most profitable states. The decrease in the average selling prices is the result of our customers moving down market and buying smaller, less expensive homes. The decrease in financial services net revenues reflects a decline in the average consumer loans balance from $229.6 million for fiscal 2009 to $183.9 million for fiscal 2010, resulting from the sale of approximately $51.3 million of loans in April 2008 and the normal amortization and prepayment of loans.
Gross Profit. In fiscal 2010, gross profit decreased to 21.4% of net sales, or $63.7 million, from 23.7% of net sales, or $96.8 million in fiscal 2009. Gross profit for the factory-built housing segment decreased to 15.0% of net sales in fiscal 2010 from 18.8% in fiscal 2009. The decline in factory-built housing margin is primarily the result of restructuring costs totaling $4.8 million resulting from the restructuring actions taken in the fourth quarter of fiscal 2010 to close one less than efficient plant and 23 under-performing sales centers, offset by an increase in the internalization rate from 69% in fiscal 2009 to 74% in fiscal 2010. Gross profit for the financial services segment decreased $2.8 million in fiscal 2010 due to decreased net revenues as explained above in the net sales section.
Selling, General and Administrative Expenses. In dollars, selling, general and administrative expenses decreased $20.2 million to $100.2 million in fiscal 2010 from $120.4 million in fiscal 2009. Of this $20.2 million decrease, $22.0 million related to the factory-built housing segment and $1.3 million related to financial services. This decrease was offset by an increase of $3.1 million related to general corporate expenses. The decline in selling, general and administrative expenses related to the factory-built housing segment resulted from a reduction of approximately seven less operating sales centers throughout the majority of the year in addition to a decrease in the fixed expenses of our ongoing operations. This decline was offset by $3.4 million of restructuring costs related to the factory-built housing segment incurred in the fourth quarter of fiscal 2010 related to the closing of 23 retail sales centers and one manufacturing facility. The increase in general corporate expenses was primarily due to $1.0 million of restructuring costs incurred for additional legal and financial advisors to assist us in acquiring the Virgo debt and restructuring our floor plan facility with Textron. As a percentage of net sales, selling, general and administrative expenses increased to 33.6% of net sales in fiscal 2010 as compared to 29.4% of net sales in fiscal 2009.
Interest Expense. Interest expense decreased 4.0% to $17.5 million in fiscal 2010 from $18.3 million in fiscal 2009. Interest expense decreased by $1.0 million, $0.6 million and $0.5 million due to lower principal balances of securitized financings, floor plan payable and convertible senior notes, respectively. This was offset by an increase in interest expense of $0.5 million related to the new Virgo debt and $0.8 million related to the warrants on the fiscal 2010 promissory notes to related parties.
Gain on Repurchase of Convertible Senior Notes. During fiscal 2009, we repurchased $21.2 million principal amount of our convertible senior notes, which had a book value of $18.3 million net of debt discount, for $10.6 million in cash, resulting in a gain of $7.7 million.
Other Income. Other income increased 40.5% to $2.9 million in fiscal 2010 from $2.1 million in fiscal 2009. This increase is primarily due to $1.8 million received from the sale to a third party of a portion of Palm Harbor Insurance Agency’s book of business, including rights to future commissions, profit sharing and renewals and is offset by a decrease in interest income resulting from reduced rates of return coupled with lower average cash and cash equivalent balances.
Income Tax Benefit (Expense). Income tax expense was $41,000 in fiscal 2010 as compared to a benefit of $8,000 in fiscal 2009. The tax benefit in fiscal 2009 resulted from additional benefits for a reduction in Texas margin tax for prior tax years and was offset by taxes payable in various states we do business.
2009 Compared to 2008
Net Sales. Net sales decreased 26.3% to $409.3 million in fiscal 2009 as compared to $555.1 million in fiscal 2008. This decrease is primarily the result of a $140.3 million decrease in factory-built housing net sales and a $5.5 million decrease in financial services net revenues. The decline in factory-built housing net sales is primarily due to a 28.7% decrease in the total number of factory-built homes sold coupled with decreases in the average selling prices of new modular and manufactured homes. The decrease in the total number of factory-built homes sold reflects the severe state of the factory-built housing industry, the prevailing economic uncertainties, credit crisis and general consumer paralysis that has kept potential homebuyers on the sidelines. Also, we were operating 20 fewer retail stores and four less factories than last year. Homes sold to independent dealers, builders and developers decreased 43.4% in fiscal 2009 largely due to slowdowns in sales to Lifestyle Communities in the three key states of Florida, California and Arizona, which historically were some of our most profitable states. The reduction in independent sales was bolstered by $16.7 million in commercial and military modular sales. The decrease in the average selling prices is the result of our lower-priced products. The decrease in financial services net revenues reflects a decline in the average consumer loans balance from $248.0 million for fiscal 2008 to $229.6 million for fiscal 2009, resulting from the sale of approximately $51.3 million of loans in April 2008 and the normal amortization and prepayment of loans.
Gross Profit. In fiscal 2009, gross profit decreased to 23.7% of net sales, or $96.8 million, from 24.1% of net sales, or $133.7 million in fiscal 2008. Gross profit for the factory-built housing segment decreased to 18.8% of net sales in fiscal 2009 from 19.7% in fiscal 2008. The decline in factory-built housing margin is primarily the result of increased manufacturing costs driven by rapidly rising material costs. This decline is partially offset by an increase in margin resulting from the impact of the restructuring actions taken in the fourth quarter of fiscal 2008 to close 18 under-performing sales centers and three less than efficient plants coupled with an increase in the internalization rate (the percentage of factory-built homes we manufactured and sold through our company-owned retail stores and builder locations) from 64% in fiscal 2008 to 69% in fiscal 2009. Gross profit for the financial services segment decreased $5.8 million in fiscal 2009 due to decreased net revenues as explained above in the net sales section. However, the financial services segment produced gross profit of $27.1 million in fiscal 2009 and positively contributed to our cash flow.
Selling, General and Administrative Expenses. As a percentage of net sales, selling, general and administrative expenses increased to 29.4% of net sales in fiscal 2009 from 27.1% of net sales in fiscal 2008. This increase resulted from the larger percentage decline in net sales. In dollars, selling, general and administrative expenses decreased $30.2 million to $120.4 million in fiscal 2009 from $150.6 million in fiscal 2008. Of this $30.2 million decrease, $21.5 million related to the factory-built housing segment, $1.9 million related to the financial services segment and $6.8 million related to general corporate expenses. The majority of the reductions in selling, general and administrative expenses related to the factory-built housing segment and general corporate expenses resulted from the restructuring actions taken in the fourth quarter of fiscal 2008 to close 18 under-performing sales centers and three less than efficient plants, plus a reduction in performance based compensation expense. The decrease in selling, general and administrative expenses for the financial services segment relates to a $1.5 million one-time performance-based compensation payment in fiscal 2008. The payment was based on CountryPlace profitability from inception (2002) through 2007.
Goodwill Impairment. Goodwill impairment was $78.5 million for fiscal 2008. Due to the difficult market environment and our operating losses, we determined that an interim test to assess the recoverability of goodwill was necessary. With the assistance of an independent valuation firm, we performed an interim goodwill impairment analysis and concluded that the goodwill relating to our factory-built housing reporting unit was impaired. As a result, during the second quarter of fiscal 2008, we recorded a non-cash impairment charge of $78.5 million to fully impair the goodwill related to our factory-built housing segment.
Interest Expense. Interest expense decreased 16.4% to $18.3 million in fiscal 2009 as compared to $21.9 million in fiscal 2008. Of this decrease, $1.7 million related to decreased interest expense on the average balance of the warehouse facility which was terminated April 30, 2008 and $1.4 million related to decreased interest expense on the average balance of the securitized loans resulting from reduced securitization financing balances in fiscal 2009 as compared to fiscal 2008.
Gain on Repurchase of Convertible Senior Notes. During fiscal 2009, we repurchased $21.2 million principal amount of our convertible senior notes, which had a book value of $18.3 million net of debt discount, for $10.6 million in cash, resulting in a gain of $7.7 million.
Other Income. Other income decreased 42.2% to $2.1 million in fiscal 2009 from $3.6 million in fiscal 2008 primarily due to a $2.2 million decrease in interest and dividend income resulting from reduced rates of return coupled with lower average cash and cash equivalent balances. This is offset by a $0.4 million increase on income earned on a real estate investment.
Income Tax Benefit (Expense). Income tax benefit was $8,000 in fiscal 2009 as compared to expense of $8.4 million in fiscal 2008. The $8.4 million of income tax expense for fiscal 2008 related to our recording a valuation allowance against all of our net deferred tax assets due to the uncertainty of realizing the tax benefits associated with these assets.
Liquidity and Capital Resources
Cash and cash equivalents totaled $26.7 million at March 26, 2010, up from $12.4 million at March 27, 2009. Net cash provided by operating activities was $15.6 million in fiscal 2010 as compared to $57.3 million in fiscal 2009. The decrease in net cash provided by operating activities is primarily attributable to a larger net loss in fiscal 2010 as well as $69.8 million of consumer loans sold in fiscal 2009 as compared to $36.0 million sold in fiscal 2010.
Net cash provided by investing activities was $3.6 million in fiscal 2010 as compared to $4.7 million in fiscal 2009. Net cash provided by investing activities in fiscal 2010 was primarily the result of $2.7 million in net cash received from the sale of investments and $0.9 million resulting from net disposals of property, plant and equipment. Net cash provided by investing activities in fiscal 2009 was primarily the result of $4.1 million in net cash received from the sale of investments and $0.6 million resulting from net disposals of property, plant and equipment.
Net cash used in financing activities was $4.9 million in fiscal 2010 as compared to $77.8 million in fiscal 2009. Net cash used in financing activities in fiscal 2010 was primarily the result of $7.2 million used to pay down the floor plan facility and $17.8 million used for payments on securitized financings, offset by $19.0 million provided by proceeds from the Virgo debt. Net cash used in financing activities in fiscal 2009 was primarily attributable to $42.2 million used to repay in full and terminate the warehouse borrowing facility, $25.1 million used for payments on securitized financings, $10.6 million used to repurchase $21.2 million principal amount of our convertible senior notes, and $10.0 million used for payments on the floor plan facility, offset by $3.6 million in proceeds from the construction lending line and $6.5 million in proceeds from sale-leaseback transactions.
We have an agreement with Textron Financial Corporation for a floor plan facility. 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 sales centers and is secured by our assets, excluding CountryPlace assets. During the third quarter of fiscal 2009, Textron announced that they wanted to perform an orderly liquidation of certain of their commercial finance businesses, including their housing inventory finance business.
As of December 25, 2009, we were required to reduce the outstanding borrowings under the Textron facility to $40 million by December 31, 2009. However, on December 29, 2009, we agreed with Textron to an amendment to delay the requirement to reduce outstanding borrowings to $40 million until January 31, 2010. Additionally, certain other covenant and condition modifications to the agreement were made at the time. On January 27, 2010, we agreed with Textron to a further amendment that included, among other things, the following modifications:
•
Extends the maturity date from June 30, 2010 to the earlier of June 30, 2012 or one month prior to the date of the first repurchase option for the holder of our convertible senior notes;
•
Alters the maximum credit line to $45 million for the fourth quarter of fiscal 2010, $43 million for the first quarter of fiscal 2011, $38 million for the second quarter of fiscal 2011, $32 million for the third quarter of fiscal 2011, $28 million for the fourth quarter of fiscal 2011 and $25 million thereafter;
•
Provides for a maximum loan-to-collateral coverage ratio of 65% through the first quarter of fiscal 2011, 62% for the second quarter of fiscal 2011 and 60% for all quarters thereafter;
•
Allows for an increased percentage of eligible inventory to be borrowed subject to the total credit line at the lender’s discretion;
•
Pledges 100% of the Company’s equity in Standard Casualty Company to Textron; and
•
Alters financial covenants as follows:
•
Maximum quarterly net loss before taxes and restructuring charges-$15 million through the second quarter of fiscal 2011, $10 million for the third and fourth quarters of fiscal 2011 and $1 million of net income for all quarters thereafter;
•
Eliminates the borrowing base requirement in its entirety effective December 29, 2009.
As of March 26, 2010, we were required to comply with a minimum inventory turn of not less than 2.75:1, and a maximum quarterly net loss (before taxes and restructuring charges) not to exceed $15 million, as defined by the agreement. We were in compliance with these financial covenants as of March 26, 2010 and believe that covenant requirements under the amended Textron facility are achievable for the foreseeable future. However, in light of current market conditions, and because covenant compliance is dependent upon a number of factors, including prevailing economic and financial conditions and other factors beyond our control, no assurances can be given in this regard. Textron could also declare a loan violation due to a material adverse change, as defined in the agreement. Should a covenant violation occur, we would seek a waiver from Textron and consider any other available remedies. However, no assurances can be made that Textron would provide us with a waiver or that we will otherwise have available remedies and, if a loan violation were to occur and not be waived or remedied in accordance with the terms of the floor plan facility, Textron could declare an event of default and demand that the full amount of the facility be paid in full prior to maturity. Such a demand would result in, among other things, a cross default on our convertible senior notes described in Note 6.
Additionally, as of March 26, 2010, we had a loan-to-collateral coverage ratio of 82% which exceeded the maximum requirement of 65% and resulted in our having an increased percentage of eligible inventory borrowed subject to the total credit line by $8.9 million. While Textron could demand that the entire $8.9 million be repaid immediately, Textron has approved the coverage ratio to be out of formula and in connection with that waiver, reset the total credit line from $43 million to $38 million effective May 18, 2010.
In fiscal 2005, we issued $75.0 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. The Notes are senior, unsecured obligations and rank equal in right of payment to all of our existing and future unsecured and senior indebtedness.
The note holders may require us to repurchase all or a portion of their notes for cash on May 15, 2011, May 15, 2014 and May 15, 2019 at a repurchase price equal to 100% of the principal amount of the notes to be repurchased plus accrued and unpaid interest, if any. 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 2010, 2009 and 2008, the effect of converting the senior notes to 2.1 million, 2.1 million and 2.9 million shares of common stock, respectively, was anti-dilutive, and, therefore, was not considered in determining diluted earnings per share. During fiscal 2009, we repurchased $21.2 million of the Notes, which had a book value of $18.3 million net of debt discount, for $10.6 million in cash, resulting in a gain of $7.7 million. We did not repurchase any Notes during fiscal 2010.
On July 12, 2005, we, through 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 an expected 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. CountryPlace’s servicing obligation under this securitized financing is guaranteed by us.
On March 22, 2007, we, through CountryPlace, completed our second securitization (“2007-1”) for approximately $116.5 million of loans, 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 an expected weighted average maturity of 4.86 years. The proceeds from the securitization were used to repay approximately $97.1 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.
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. 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 is amortized to interest expense over the life of the loans.
CountryPlace currently originates conforming mortgage loans for sale to Fannie Mae and other investors. CountryPlace plans to retain the associated servicing rights. In addition, CountryPlace plans to continue holding its remaining portfolio of chattel, non-conforming mortgages 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 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.
At present, asset-backed and mortgage-backed securitization markets are effectively closed to CountryPlace and other manufactured housing lenders, and no assurances can be made that a securitization or other term financing market will be available to CountryPlace in the future. At such time in the future that any securitization or other term financing market re-emerges, CountryPlace intends to resume originating chattel and non-conforming mortgages for its investment portfolio. While we believe CountryPlace will be able to obtain liquidity through sales of conforming mortgages to Fannie Mae and other investors, no assurances can be made that these investors will continue to purchase loans secured by factory-built homes, or that CountryPlace will successfully complete transactions on acceptable terms and conditions, if at all.
On January 29, 2010, through our subsidiary CountryPlace, we entered into an agreement for a $20 million secured term loan from entities managed by Virgo Investment Group LLC. The agreement provides an option for CountryPlace to exercise a subsequent commitment to borrow an additional $5.0 million, which expires on August 1, 2010. Currently, the Company does not expect CountryPlace to exercise the secondary commitment. The facility has a maturity date of January 29, 2014 and bears interest at an annual rate of the Eurodollar Rate plus 12%. The Eurodollar Rate cannot be less than 3.0% nor greater than 4.5%. The proceeds will be used by CountryPlace to repay the intercompany indebtedness to us and we expect to use the proceeds for working capital and general corporate purposes.
The agreement also contains financial covenants that CountryPlace must comply with. CountryPlace shall not incur capital expenditures exceeding $300K in any fiscal year; and the maximum amount of the Virgo loan divided by the value of the collateral securing the loan shall not exceed the ratios below for more than three consecutive months during the applicable periods:
For the year ended March 31, 2010, CountryPlace was in compliance with the financial covenants with a loan-to-value ratio of 0.34:1.
As a precedent to Virgo making the loan, the parties also agreed to create a special purpose vehicle (SPV) to hold certain mortgage loans as collateral. Under the agreement, CountryPlace transferred its right, title, and interest to certain manufactured housing installment sales contracts and mortgages, along with certain related property, to a newly created subsidiary, CountryPlace Mortgage Holdings, LLC (“Mortgage SPV”). The transferred sales contracts and mortgages consist of $39.4 million of the overcollateralization on the 2005-1 and 2007-1 securitizations (Class X and R certificates), and $19.8 million of certain other mortgage loans held for investment that were not previously securitized.
The Mortgage SPV is consolidated on our financial statements as CountryPlace will continue to service the mortgage loans and collect the related service fee and residual income even after the termination of the loan facility, is obligated to repurchase or substitute contracts that materially adversely affect the Mortgage SPV’s interest, and will be solely liable for losses incurred by the Mortgage SPV.
As partial consideration for the loan with Virgo, we issued warrants to purchase up to an aggregate of 1,296,634 shares of our common stock at a purchase price of $2.1594 per share. These warrants contain an anti-dilution provision that prevents the warrant holder’s fully-diluted percentage interest in the Company from being diluted in the event that any of our convertible securities are converted into any other of our securities. The warrants also contain an anti-dilution provision that prevents the warrant holder from having its percentage ownership in our company diminished by more than 10% in the event that we issue additional securities, subject to certain exceptions. These anti-dilution provisions expire four years after the issuance of the warrants.
Typically our wholesale customers pay within 15 days. During fiscal 2009, we began building barracks and other housing for the U.S. Government. These government contracts have longer payment periods, which have put pressure on our cash balance. In response to these cash pressures, on April 27, 2009, we issued warrants to each of Capital Southwest Venture Corporation, Sally Posey and the Estate of Lee Posey (collectively, the lenders) to purchase up to an aggregate of 429,939 shares of our common stock at a price of $3.14 per share, which was the closing price of the stock on April 24, 2009. The Black-Scholes-Merton method was used to value the warrants, which resulted in us recording $0.8 million in non-cash interest expense in the first quarter of fiscal 2010. The warrants were granted in connection with a loan made by the lenders to us of an aggregate of $4.5 million pursuant to senior subordinated secured promissory notes between us and each of the lenders (collectively, the Promissory Notes). The proceeds were used for working capital purposes. The Promissory Notes were repaid in full on June 29, 2009. The warrants, which expire on April 24, 2019, contain anti-dilution provisions and other customary provisions. The Promissory Notes bore interest at the rate of LIBOR plus 2.0% and were secured by 150,000 shares of Standard’s common stock, which was later released upon repayment of the Promissory Notes.
Property and casualty insurance companies are subject to certain Risk-Based Capital (RBC) requirements as specified by the National Association of Insurance Commissioners (NAIC). Under those requirements, the amount of capital and surplus maintained by a property and casualty insurance company is to be determined based on the various risk factors related to it. At December 31, 2009 and 2008, Standard meets the RBC requirements.
The payment of dividends by Standard to us is limited and can only be made from earned profits unless prior approval is received from the Texas Department of Insurance (TDI). The maximum amount of dividends that may be paid by property and casualty insurance companies without prior approval of the Texas Insurance Commissioner is the greater of 10% of statutory surplus or net income for the preceding year. In calendar 2009, Standard could pay dividends of approximately $1.5 million without prior approval of the Texas Insurance Commissioner. In calendar 2009, Standard filed an application with the TDI and received approval to declare and pay $6.2 million extraordinary dividends to us. In calendar 2008, Standard paid a $2 million dividend to us, which was within the statutory limits.
We believe that the combination of our cash on hand, net proceeds from the Virgo loan, floor plan financing, conforming mortgage sales, and other available borrowing alternatives will be adequate to support working capital, debt servicing and currently planned capital expenditure needs for the foreseeable future. However, because future cash flows and the availability of financing, as well as covenant compliance, is dependent upon a number of factors, including prevailing economic and financial conditions and other factors beyond our control, no assurances can be given in this regard.
Inflation
We, and the homebuilding industry in general, may be adversely affected during periods of high inflation because of higher land and construction costs. Inflation may also increase our financing, labor, and material costs. In addition, higher mortgage interest rates significantly affect the affordability of permanent mortgage financing to prospective homebuyers. While we attempt to pass to our customers increases in our costs through increased sales prices, the current industry conditions have resulted in lower
sales prices in substantially all of our markets. If we are unable to raise sales prices enough to compensate for higher costs, or if mortgage interest rates increase significantly, affecting our prospective homebuyers’ ability to adequately finance home purchases, our revenues, gross margins, and net income would be adversely affected.
Contractual Obligations (dollars in thousands)
The following tables summarize our contractual obligations, including interest, at March 26, 2010. For additional information related to these obligations, see the Notes to Consolidated Financial Statements.
(1)
Interest is calculated by applying contractual interest rates to 2010 fiscal year-end balances.
(2)
We have contingent repurchase obligations outstanding at March 26, 2010 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. We did not incur any significant losses related to these contingent repurchase obligations during fiscal 2010, 2009 and 2008.
(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.
(4)
The note holders may require us to repurchase all or a portion of their notes for cash on May 15, 2011, May 15, 2014 and May 15, 2019 at a repurchase price equal to 100% of the principal amount of the notes to be repurchased plus accrued and unpaid interest, if any.
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.
Recovery of Deferred Tax Asset. Deferred tax assets and liabilities are determined based on temporary differences between the financial statement amounts and the tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. To the extent we believe it is more likely than not that some portion or all of our deferred tax assets will not be realized prior to expiration, we are required to establish a valuation allowance against that portion of our deferred tax assets. The determination of valuation allowances involves significant management judgment and is based upon the evaluation of both positive and negative evidence, including our best estimates of anticipated taxable profits in the various jurisdictions with which the deferred tax assets are associated. Changes in events or expectations could result in significant adjustments to the valuation allowances and material changes to our provision for income taxes.
In fiscal 2008 we recognized in income tax expense a $27.6 million valuation allowance against all of our net deferred tax assets which resulted in us recording a net income tax provision of approximately $8.4 million. In fiscal 2009, we recorded an additional $17.0 million valuation allowance and an income tax benefit of $8,000. In fiscal 2010, we recorded an additional $20.2 million valuation allowance and income tax expense of $41,000. The tax expense related to taxes payable in various states we do business. If, after future considerations of positive and negative evidence related to the recoverability of our deferred tax assets, we determine a lesser allowance is required, we would record a reduction to income tax expense and the valuation allowance in the period of such determination.
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. Sales of our commercial buildings, including shipping charges, are recognized when the customer enters into a legally binding sales contract, title has transferred and the home is substantially completed and accepted by the customer. 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.
Transfers of Financial Assets. CountryPlace completed two securitizations of factory-built housing loan receivables, both of which were accounted for as financings, which use the portfolio method of accounting in accordance with the guidance in ASC Topic 310 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. The securitizations include provisions for removal of accounts by CountryPlace and other factors that preclude sale accounting of the securitizations under the guidance in ASC Topic 860.
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. The allowance for loan losses reflects CountryPlace’s judgment of the probable loss exposure on their loans held for investment portfolio as of the end of the reporting period. CountryPlace’s loan portfolio is comprised of loans related primarily to factory-built Palm Harbor homes. The allowance for loan losses is developed at a portfolio level, as pools of homogeneous loans, and not allocated to specific individual loans or to impaired loans. A range of probable losses is calculated after giving 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, loan type characteristics, and recent loss experience. CountryPlace then makes a determination of the best estimate within the range of loan losses.
The accrual of interest is discontinued when either principal or interest is more than 120 days past due. In addition, loans are placed on nonaccrual status when there is a clear indication that the borrower has the inability or unwillingness to meet payments as they become due. Payments received on nonaccrual loans are accounted for on a cash basis, first to interest and then to principal. Impaired loans, or portions thereof, are charged off when deemed uncollectible. Upon determining that a nonaccrual loan is impaired, interest accrued prior to identification of nonaccrual status is charged to the allowance for loan losses. As of March 31, 2010, CountryPlace management was not aware of any potential problem loans that would have a material effect on loan delinquency or charge-offs.
The portion of the loan portfolio with payments delinquent sixty-one or more days has decreased to 1.37% at March 31, 2010 from 2.09% at March 31, 2009. Based on prior experience with factory-built home loan performance, CountryPlace management expects the incidence of defaults to increase as loans age for the first three to six years of a portfolio life, and then decrease in later years, under normal economic conditions. The weighted average remaining contractual life of the portfolio increased from 46 months at March 31, 2009 to 57 months at March 31, 2010. The weighted average remaining contractual life for chattel and mortgages was 62 and 42 months, respectively, as of March 31, 2010.
The average unpaid balance of defaulted loans increased in 2010, due primarily to the increase in percentage of mortgage loan defaults. The portion of CountryPlace’s defaulted loans attributable to mortgage loans increased to 31.3% in 2010 from 13.4% in 2009. The average unpaid balance of defaulted mortgage loans was $146,000 in 2010 versus $94,000 in 2009. The average unpaid balance of chattel loans was $67,000 in 2010 versus $58,000 in 2009. During 2010, recovery rates for chattel and mortgage loans were 29.7% and 51.6%, respectively, versus 36.1% and 57.6% respectively in 2009.
House price depreciation, elevated unemployment, and general economic weakness continue to adversely affect the rates of delinquency and default in mortgage loan portfolios. California, Florida, and Arizona have been especially affected. With the exception of a 43.2% concentration of loans receivable in Texas, CountryPlace’s loan portfolio is well diversified across 26 states. Accordingly, CountryPlace’s exposure to isolated local or regional economic downturns is, in normal conditions, offset by more favorable economic conditions in other states. Texas continues to perform better than other states in the current economic downturn and CountryPlace’s loans receivable concentration in Texas has offset the effects of economic weakness in other states. The portion of CountryPlace’s total defaulted loans located in Texas decreased during fiscal 2010 to 37.9% from 52.8% in fiscal 2009. The portion of CountryPlace’s loans receivable located in Texas that were 61 days or more past due at March 31, 2010 was 0.71%, or 0.66% lower than the delinquency rate for the total loans receivable portfolio of 1.37%. The portion of CountryPlace’s total defaulted loans located in Florida increased to 10.5% in 2010 from 0.4% in 2009. Florida loans receivable past due 61 days or more represented 0.08% of total loans receivable at March 31, 2010, down from 0.25% at March 31, 2009. The portion of CountryPlace’s total defaulted loans located in Arizona decreased to 5.2% in 2010 from 8.5% in 2009. The portion of total loans receivable past due 61 days or more located in Arizona at March 31, 2010 increased to 0.20% from 0.14% at March 31, 2009. The portion of defaulted loans located in California in 2010 increased to 9.6% from 2.5% in 2009. However, delinquent accounts in California represent less than 0.1% of the total loans receivable balance at March 31, 2010.
In addition to declining economic growth and elevated unemployment, deteriorating performance of mortgage loans in general has been driven, in large part, by product features (such as adjustable rates, interest-only payments, payment options, etc.) that have a high propensity to induce payment shock or negative equity, and underwriting practices which relied on the expectation of continuous house price appreciation. CountryPlace’s portfolio is comprised entirely of fixed-rate, full-amortizing loans. CountryPlace’s underwriting practices and risk management policies have been based on an assumption that the manufactured home collateral would depreciate, rather than appreciate, in value over the life of the loan. Accordingly, its credit standards are based on both the borrowers’ capacity to repay the loan as scheduled, and the borrowers’ history of satisfying repayment obligations. As a result, CountryPlace management believes the portfolio is less susceptible to defaults due to adjustable interest rate resets and default losses, since house price depreciation has always been considered in determining CountryPlace’s allowance for loan losses.
Allowance for loan losses as of March 31, 2010 was $3.0 million, or approximately 1.6% of the $184.3 million total consumer loans receivable and construction advances balance. The Company believes this allowance is adequate for expected loan losses, considering the geographic and loan-type concentrations of the portfolio, the age and remaining life of the portfolio, expected overall future credit losses, collection history, and recent delinquency experience by geographic area and type of loan collateral.
Property, Plant and Equipment Valuation. We record impairment losses on long-lived assets used in operations when events and circumstances indicate that long-lived assets might be impaired, the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets, and the net book value of the assets exceeds their estimated fair value. In making these determinations, we use certain assumptions, including, but not limited to: (i) estimated future cash flows expected to be generated by the assets, generally evaluated at the regional level, which are based on additional assumptions such as asset utilization, length of service, and estimated salvage values; and (ii) estimated fair value of the assets, which are generally based on third-party appraisals. Given the difficult business environment in fiscal 2010, indicators of impairment exist with respect to approximately $25.0 million of long-lived assets in the factory-built housing segment. However, based upon events, circumstances and information available at March 26, 2010, our estimates of undiscounted future cash flows related to these long-lived assets in the normal course of business indicate that such amounts would be recoverable. Nonetheless, it is reasonably possible that estimates of undiscounted cash flows could change in the near term and could result in impairment charges necessary to record the assets at fair value. Our estimates of undiscounted future cash flows could change, for example, based upon changes in events, circumstances and information related to the long-lived assets or the factory-built housing segment generally, changes in overall business conditions, or changes resulting from our realignments responsive to liquidity needs or consumer demand.
We recorded no impairment charges in fiscal 2010 and fiscal 2009, and $0.6 million for fiscal 2008 related to our assets held and used. We recorded approximately $0.3 million and $1.5 million for impairment charges in fiscal 2010 and fiscal 2009, respectively, and none for fiscal 2008 related to our assets held for sale.
Inventory Valuation. Inventory consists of raw material and finished goods (factory-built homes). We carry very little land held for development and we do not purchase options to acquire land inventory.
Each quarter we assess the recoverability of our inventory by comparing the carrying amount to its estimated net realizable value. Our raw materials consist of home building materials and supplies and turn approximately 3 times per month. Our finished goods consist of homes completed under customer order and homes available for purchase at our retail sales centers. We evaluate the recoverability of our finished homes by comparing our inventory cost to our estimated sales price, less costs to sell. We estimate our sales price by product type (HUD code and modular). During fiscal 2010, we impaired approximately $1.9 million of retail finished goods inventories. Management is not aware of any other factors that are reasonably likely to result in valuation adjustments in future periods. These valuations are significantly impacted by estimated average selling prices, average sales rates and product type. The quarterly assessments reflect management’s estimates, which management believes are reasonable. However, based on the general economic conditions, future results could differ materially from management’s judgments and estimates.
New Accounting Pronouncements
We adopted new accounting guidance related to our accounting for convertible debt instruments as of March 28, 2009. The adoption impacted the historical accounting of certain senior convertible notes. We filed a Current Report on Form 8-K on March 18, 2010 to reflect the retrospective adoption of the new accounting guidance on the fiscal 2009, 2008 and 2007 financial statements.
In accordance with U.S. GAAP, we have adopted new fair value measurements guidance as it applies to non-financial assets and liabilities. U.S. GAAP defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measurements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The guidance was applied in the fourth quarter of 2010, in conjunction with a reclassification of two facilities as held for sale, at which time the net carrying value of the facilities were measured at their fair value less costs to sell. It was determined through third-party appraisals that the fair value of one facility was less than the carrying value, and we adjusted the value of the facility to its fair value less cost to sell.
In June 2009, the FASB issued guidance to change financial reporting by enterprises involved with variable interest entities (VIEs). The standard replaces the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a VIE with an approach focused on identifying which enterprise has the power to direct the activities of a VIE and the obligation to absorb losses of the entity or the right to receive the entity’s residual returns. This accounting standard is effective for fiscal years beginning after November 15, 2009. We have evaluated the impact of the adoption of this pronouncement on our consolidated financial statements and have determined the impact of adoption to be immaterial based on our current structures with VIEs.
In June 2009, the FASB issued guidance to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. The standard modifies existing guidance by removing the concept of a qualifying special purpose entity (QSPE) and removing the special provisions for guaranteed mortgage securitizations, requiring those securitizations to be treated the same as any other transfer of financial assets. Therefore, formerly qualifying special-purpose entities (as defined under previous
accounting standards) and guaranteed mortgage securitizations should be evaluated for consolidation by reporting entities on and after the effective date in accordance with the applicable consolidation guidance. The standard also limits the unit of account eligible for sale accounting, and clarifies the control and legal isolation criteria to qualify for sale accounting. This accounting standard is effective for fiscal years beginning after November 15, 2009. We have evaluated the impact of the adoption of this pronouncement on our consolidated financial statements and have determined the impact of adoption to be immaterial as our securitizations and other financial assets transfers as described in Note 6 are currently consolidated.
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 of our liabilities under retail floor plan financing arrangements and the Virgo 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 level of floor plan payable as of March 26, 2010 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 $0.4 million. Assuming our level of Virgo debt as of March 31, 2010 is held constant, increasing the interest rate to the maximum level allowable per the agreement on the first day of the year would result in an increase in interest expense for the coming year of approximately $0.3 million.
CountryPlace is exposed to market risk related to the accessibility and terms of long-term financing of its loans. In the past, CountryPlace accessed the asset-backed securities market to provide term financing of its chattel and non-conforming mortgage originations. At present, asset-backed and mortgage-backed securitization markets are effectively closed to CountryPlace and other manufactured housing lenders. Accordingly, it is unlikely that CountryPlace can continue to securitize its loan originations as a means to obtain long-term funding. This inability to continue to securitize its loans caused CountryPlace to discontinue origination of chattel loans and non-conforming mortgages until other sources of funding are 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 31, 2010 is held constant, a 10% increase in average interest rates would increase the fair value of CountryPlace’s portfolio by approximately $2.3 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 26, 2010 is held constant, a 10% decrease in interest rates would increase the fair value of the notes by approximately $0.5 million.
Item 8.
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of Palm Harbor Homes, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Palm Harbor Homes, Inc. and subsidiaries as of March 26, 2010 and March 27, 2009, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended March 26, 2010. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(2). 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 26, 2010 and March 27, 2009, and the consolidated results of its operations and its cash flows for each of the three years in the period ended March 26, 2010, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Palm Harbor Homes, Inc.’s internal control over financial reporting as of March 26, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 15, 2010 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Dallas, Texas
June 15, 2010
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, except per share data)
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 wholly owned subsidiaries (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, financing and 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
The prevailing economic uncertainties and depressed housing market have continued to challenge the factory-built housing industry and the Company’s business during fiscal 2010. The Company’s revenues for the year are indicative of the constrained demand for factory-built housing products resulting from a more restrictive financing environment and an over-supply of discounted site-built homes. The Company’s fiscal year revenues declined 27.1% over the prior year period and its gross margin decreased to 21.4% from 23.7% a year ago. In spite of the decline in sales and gross margin, the Company has reduced its selling, general and administrative expenses and improved its operating efficiencies in this current sales environment. The Company’s financial services subsidiaries, Standard Casualty and CountryPlace Mortgage, continue to be profitable.
In light of the current economic environment and the ongoing challenges facing the factory-built housing industry, the Company’s top priority is to manage its liquidity with a tight focus on cash generation and cash preservation in every area of its operations. During fiscal 2010, the Company focused on this priority through the following:
•
The Company reached an agreement with Textron Financial Corporation to amend the terms of its floor plan facility and extend the expiration date until April 2011, and in certain circumstances, further extend through June 2012. The agreement also provides for a gradual step-down of the current total committed amount of $45 million to $25 million between March 2010 and March 2011, favorably adjusts certain financial covenants, and allows for an increased percentage of eligible inventory to be borrowed subject to the total credit line at the lender’s discretion.
•
Through CountryPlace, the Company closed on a four-year, $20 million secured term loan from entities managed by Virgo Investment Group LLC (“Virgo”). Net proceeds of $19.0 million, after fees, will be used for working capital and general corporate purposes.
•
The Company reduced inventories by $36.8 million and receivables by $4.9 million.
•
The Company has continued to reduce its overhead costs (selling, general and administrative expenses decreased $20.2 million in fiscal 2010 despite including $4.4 million for restructuring costs).
•
The Company received $1.8 million from the sale to a third party of a portion of Palm Harbor Insurance Agency’s book of business, including rights to future commissions, profit sharing and renewals.
•
The Company completed a sale leaseback transaction totaling $1.0 million in cash for two of its retail properties.
•
CountryPlace was approved to issue Ginnie Mae mortgage-backed securities.
The Company has also taken additional steps to reduce its manufacturing capacity and distribution channels and realign its operational overhead to meet current and expected demand. During the fourth quarter of fiscal 2010, the Company closed one factory and 23 underperforming sales centers and now has eight factories in operation and a total of 55 sales locations. The Company recorded restructuring charges of approximately $9.2 million in connection with these actions. Additionally, the Company continues to identify ways to lower its quarterly selling, general and administrative expenses, increase margins and further reduce its receivables and inventory levels.
The Company continues to pursue ways to both expand its product offering and reach new distribution channels to further drive revenues. The commercial and military markets for modular products represent a new growth opportunity at higher price points than the residential market. During fiscal 2009 and 2010, the Company produced barracks and other housing for three military bases as well as townhouses, apartments, duplexes and condominiums. Commercial projects contributed $10.8 million and $16.7 million to its revenues in fiscal years 2010 and 2009, respectively.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
The Company’s amended floor plan financing facility with Textron Financial Corporation continues to include required financial covenants, and beginning in March 2010 through March 2011 will require certain reductions in the overall amounts borrowed under the facility. The Company believes that the combination of its cash on hand, net proceeds from the Virgo loan, floor plan financing, conforming mortgage sales, and other available borrowing alternatives will be adequate to support working capital, debt servicing and currently planned capital expenditure needs for the foreseeable future. However, because future cash flows and the availability of financing, as well as covenant compliance, is dependent upon a number of factors, including prevailing economic and financial conditions and other factors beyond the Company’s control, no assurances can be given in this regard.
Going forward, the Company will continue to focus on managing its costs, improving gross margin and maintaining adequate liquidity to sustain its business through this cycle. At the same time, the Company is pursuing ways to both expand its product offering and reach new distribution channels to further drive revenues.
Year End
The Company’s fiscal year ends on the last Friday in March. The Company’s financial services subsidiaries’ fiscal year ends on different dates than the Company’s. Country Place’s fiscal year ends on March 31 and Standard Casualty’s (Standard) fiscal year ends on the last day of February.
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. Sales of the Company’s commercial buildings, including shipping charges, are recognized when the customer enters into a legally binding sales contract, title has transferred and the home is substantially complete and accepted by the customer. 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. For loans held for investment, loan origination fees are deferred and amortized into net sales over the contractual life of the loan using the interest method. For loans held for sale, loan origination fees and gains or losses on sales are recognized upon sale of the loans.
Country Place’s policy is to place loans on nonaccrual status when either principal or interest is past due and remains unpaid for 120 days or more. In addition, they place loans on nonaccrual status when there is a clear indication that the borrower has the inability or unwillingness to meet payments as they become due. Payments received on nonaccrual loans are accounted for on a cash basis, first to interest and then to principal. Upon determining that a nonaccrual loan is impaired, interest accrued and the uncollected receivable prior to identification of nonaccrual status is charged to the allowance for loan losses.
Most of the homes sold to independent retailers are financed through standard industry arrangements which include repurchase agreements (see Note 12). 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.
Cash and cash equivalents
Cash and cash equivalents are all liquid investments with maturities of three months or less when purchased.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
Restricted cash
Restricted cash consists of the following (in thousands):
Consumer loans receivable
Consumer loans receivable consists of manufactured housing loans (held for investment, held for sale or securitized) and construction advances on non-conforming mortgages less allowances for loan losses and deferred financing costs, net of amortization. Loans held for investment and loans securitized are stated at the aggregate remaining unpaid principal balances. Loans held for sale are recorded at the lower of cost or market on an aggregate basis. Interest income is recognized based upon the unpaid principal amount outstanding.
As of March 31, 2010 and March 31, 2009, the Company had $0.6 million and $1.1 million of loans held for sale, respectively. These loans were transferred from loans held for investment to loans held for sale at the lower of cost or estimated fair market value. See Note 4 for more information.
Certain direct loan origination costs for loans held for investment are deferred and amortized over the estimated life of the portfolio and amortized using the effective interest method. Certain direct loan origination costs for loans held for sale are expensed as incurred.
Allowance for loan losses
The allowance for loan losses reflects Country Place’s judgment of the probable loss exposure on their loans held for investment portfolio as of the end of the reporting period. Country Place’s loan portfolio is comprised of loans related primarily to factory-built Palm Harbor homes. The allowance for loan losses is developed at a portfolio level, as pools of homogeneous loans, and not allocated to specific individual loans or to impaired loans. A range of probable losses is calculated after giving 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, loan type characteristics, and recent loss experience. CountryPlace then makes a determination of the best estimate within the range of loan losses.
The accrual of interest is discontinued when either principal or interest is more than 120 days past due. In addition, loans are placed on nonaccrual status when there is a clear indication that the borrower has the inability or unwillingness to meet payments as they become due. Payments received on nonaccrual loans are accounted for on a cash basis, first to interest and then to principal. Impaired loans, or portions thereof, are charged off when deemed uncollectible. Upon determining that a nonaccrual loan is impaired, interest accrued prior to identification of nonaccrual status is charged to the allowance for loan losses. As of March 31, 2010, CountryPlace management was not aware of any potential problem loans that would have a material effect on loan delinquency or charge-offs.
The portion of the loan portfolio with payments delinquent sixty-one or more days has decreased to 1.37% at March 31, 2010 from 2.09% at March 31, 2009. Based on prior experience with factory-built home loan performance, CountryPlace management expects the incidence of defaults to increase as loans age for the first three to six years of a portfolio life, and then decrease in later years, under normal economic conditions. The weighted average remaining contractual life of the portfolio increased from 46 months at March 31, 2009 to 57 months at March 31, 2010. The weighted average remaining contractual life for chattel and mortgages was 62 and 42 months, respectively, as of March 31, 2010.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
The average unpaid balance of defaulted loans increased in 2010, due primarily to the increase in percentage of mortgage loan defaults. The portion of Country Place’s defaulted loans attributable to mortgage loans increased to 31.3% in 2010 from 13.4% in 2009. The average unpaid balance of defaulted mortgage loans was $146,000 in 2010 versus $94,000 in 2009. The average unpaid balance of chattel loans was $67,000 in 2010 versus $58,000 in 2009. During 2010, recovery rates for chattel and mortgage loans were 29.7% and 51.6%, respectively, versus 36.1% and 57.6% respectively in 2009.
House price depreciation, elevated unemployment, and general economic weakness continue to adversely affect the rates of delinquency and default in mortgage loan portfolios. California, Florida, and Arizona have been especially affected. With the exception of a 43.2% concentration of loans receivable in Texas, Country Place’s loan portfolio is well diversified across 26 states. Accordingly, Country Place’s exposure to isolated local or regional economic downturns is, in normal conditions, offset by more favorable economic conditions in other states. Texas continues to perform better than other states in the current economic downturn and Country Place’s loans receivable concentration in Texas has offset the effects of economic weakness in other states. The portion of Country Place’s total defaulted loans located in Texas decreased during fiscal 2010 to 37.9% from 52.8% in fiscal 2009. The portion of Country Place’s loans receivable located in Texas that were 61 days or more past due at March 31, 2010 was 0.71%, or 0.66% lower than the delinquency rate for the total loans receivable portfolio of 1.37%.The portion of Country Place’s total defaulted loans located in Florida increased to 10.5% in 2010 from 0.4% in 2009. Florida loans receivable past due 61 days or more represented 0.08% of total loans receivable at March 31, 2010, down from 0.25% at March 31, 2009. The portion of Country Place’s total defaulted loans located in Arizona decreased to 5.2% in 2010 from 8.5% in 2009. The portion of total loans receivable past due 61 days or more located in Arizona at March 31, 2010 increased to 0.20% from 0.14% at March 31, 2009. The portion of defaulted loans located in California in 2010 increased to 9.6% from 2.5% in 2009. However, delinquent accounts in California represent less than 0.1% of the total loans receivable balance at March 31, 2010.
In addition to declining economic growth and increasing levels of unemployment, deteriorating performance of mortgage loans in general has been driven, in large part, by product features (such as adjustable rates, interest-only payments, payment options, etc.) that have a high propensity to induce payment shock or negative equity, and underwriting practices which relied on the expectation of continuous house price appreciation. Country Place’s portfolio is comprised entirely of fixed-rate, full-amortizing loans. Country Place’s underwriting practices and risk management policies have been based on an assumption that the manufactured home collateral would depreciate, rather than appreciate, in value over the life of the loan. Accordingly, its credit standards are based on both the borrowers’ capacity to repay the loan as scheduled, and the borrowers’ history of satisfying repayment obligations. As a result, CountryPlace management believes the portfolio is less susceptible to defaults due to adjustable interest rate resets and default losses, since house price depreciation has always been considered in determining Country Place’s allowance for loan losses.
Allowance for loan losses as of March 31, 2010 was $3.0 million, or approximately 1.6% of the $184.3 million total consumer loans receivable and construction advances balance. The Company believes this allowance is adequate for expected loan losses, considering the geographic and loan-type concentrations of the portfolio, the age and remaining life of the portfolio, expected overall future credit losses, collection history, and recent delinquency experience by geographic area and type of loan collateral.
Transfers of Financial Assets
CountryPlace completed two securitizations of factory-built housing loan receivables both of which were accounted for as financings, which use the portfolio method of accounting in accordance with the guidance in ASC Topic 310 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 Country Place’s balance sheet; and (4) the related interest margin is reflected in the income statement. The securitizations include provisions for removal of accounts by CountryPlace and other factors that preclude sale accounting of the securitizations under the guidance in ASC Topic 860.
The structure of Country Place’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.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
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. The Company guarantees certain aspects of Country Place’s performance as the servicer under the 2005-1 securitization pooling and servicing agreement.
Investment Securities
Management determines the appropriate classification of its investment securities at the time of purchase. The Company’s investments include marketable debt and equity securities that are held as available-for-sale. All investments classified as available-for-sale are recorded at fair value with any unrealized gains and losses reported in accumulated other comprehensive income (loss), net of tax if applicable. Realized gains and losses from the sale of securities are determined using the specific identification method.
Management regularly makes an assessment to determine whether a decline in value of an individual security is other-than-temporary. The Company considers the following factors when making its assessment: (1) the Company’s ability and intent to hold the investment to maturity, or a period of time sufficient to allow for a recovery in market value; (2) whether it is probable that the Company will be able to collect the amounts contractually due; and (3) whether any decision has been made to dispose of the investment prior to the balance sheet date. Investments on which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value with the loss recorded in earnings (losses).
Inventories
Raw materials inventories are valued at the lower of cost (first-in, first-out method) or market. Finished goods are valued at the lower of cost or market, using the specific identification method.
Each quarter the Company assesses the recoverability of its inventory by comparing the carrying amount to its estimated net realizable value. Raw materials consist of home building materials and supplies and turn approximately three times per month. Finished goods consist of homes completed under customer order and homes available for purchase at the Company’s retail sales centers. The Company evaluates the recoverability of its finished homes by comparing its inventory cost to its estimated sales price, less costs to sell. The sales price is estimated by product type (HUD code and modular). During fiscal 2010, the Company impaired approximately $1.9 million of retail finished goods inventories. Management is not aware of any other factors that are reasonably likely to result in valuation adjustments in future periods. These valuations are significantly impacted by estimated average selling prices, average sales rates and product type. The quarterly assessments reflect management’s estimates, which management believes are reasonable. However, based on the general economic conditions, future results could differ materially from management’s judgments and estimates.
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 $4.8 million, $5.4 million and $7.1 million in fiscal 2010, 2009 and 2008, respectively. Repairs and maintenance are expensed as incurred.
The Company records impairment losses on long-lived assets used in operations when events and circumstances indicate that long-lived assets might be impaired, the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets, and the net book value of the assets exceeds their estimated fair value. In making these determinations, the Company uses certain assumptions, including, but not limited to: (i) estimated future cash flows expected to be generated by the assets, generally evaluated at the regional level, which are based on additional assumptions such as asset utilization, length of service, and estimated salvage values; and (ii) estimated fair value of the assets, which are generally based on third-party appraisals. Given the difficult business environment in fiscal 2010, indicators of impairment exist with respect to approximately $25.0 million of long-lived assets in the factory-built housing segment. However, based upon events, circumstances and information available at March 26, 2010, the Company’s estimates of undiscounted future cash flows related to these long-lived assets in the normal course of business indicate that such amounts would be recoverable. Nonetheless, it is reasonably possible that estimates of undiscounted cash flows could change in the near term and could result in impairment charges necessary to record the assets at fair value. The Company’s estimates of undiscounted future cash flows could change, for example, based upon changes in events, circumstances and information related to the long-lived assets or the factory-built housing segment generally, changes in overall business conditions, or changes resulting from Company realignments responsive to liquidity needs or consumer demand.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
The Company recorded no impairment charges in fiscal 2010 and fiscal 2009, and $0.6 million for fiscal 2008 related to its assets held and used. The Company recorded approximately $0.3 million and $1.5 million for impairment charges in fiscal 2010 and fiscal 2009, respectively, and none for fiscal 2008 related to its assets held for sale.
Assets held for sale
During fiscal 2008, management committed to sell three manufacturing facilities with a carrying amount of $7.5 million and determined that the plan of sale criteria contained in ASC Topic 360, “Property, Plant and Equipment” had been met. One of the facilities was sold in fiscal 2010. However, as a result of deteriorating market conditions, the other two properties have not been sold and continue to be classified as held for sale. The Company continues to actively market these properties and has reduced the selling prices to respond to the current market conditions. During fiscal 2010, management committed to selling two additional facilities with a carrying amount of $2.3 million.
Impairment losses totaling $0.3 million and $1.5 million in fiscal 2010 and fiscal 2009, respectively, were recorded to adjust the carrying value to estimated fair value less costs to sell, which was determined based on third-party appraisals. The carrying value of the facilities that are held for sale is separately presented in the “Assets Held for Sale” caption in the consolidated balance sheets and is reported under the factory-built housing segment.
Goodwill
Goodwill represents the excess of purchase price over net assets acquired. In accordance with guidance in ASC Topic 350, the Company tests goodwill annually for potential impairment by reporting unit as of the first day of its fourth fiscal quarter or more frequently if an event occurred or circumstances changed that indicated the remaining balance of goodwill may not be recoverable. Due to the difficult market environment and the losses incurred during fiscal 2007 and early 2008, the Company, with the assistance of an independent valuation firm, performed an interim goodwill impairment analysis in fiscal 2008 and concluded that the goodwill relating to its factory-built housing reporting unit was impaired. As a result, during the second quarter of fiscal 2008, the Company recorded a non-cash impairment charge of $78.5 million to fully impair the goodwill related to its factory-built housing segment.
Goodwill totaling $2.2 million at both March 26, 2010 and March 27, 2009 relates to the Company’s minority interest purchase of the remaining 20% of CountryPlace in fiscal 2008 and is included in prepaids and other assets on the Company’s consolidated balance sheets.
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.
Income taxes
Deferred tax assets and liabilities are determined based on temporary differences between the financial statement amounts and the tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. To the extent the Company believes it is more likely than not that some portion or all of its deferred tax assets will not be realized prior to expiration, it is required to establish a valuation allowance against that portion of the deferred tax assets. The determination of valuation allowances involves significant management judgments and is based upon the evaluation of both positive and negative evidence, including the Company’s best estimates of anticipated taxable profits in the various jurisdictions with which the deferred tax assets are associated. Changes in events or expectations could result in significant adjustments to the valuation allowances and material changes to the Company’s provision for income taxes.
In fiscal 2008 the Company recognized in income tax expense a valuation allowance of $27.6 million against all of its net deferred tax assets which resulted in the Company recording a net income tax provision of approximately $8.4 million. In fiscal 2009, the Company recorded an additional $17.0 million valuation allowance against its deferred tax assets generated in fiscal 2009 and an income tax benefit of $8,000. In fiscal 2010, the Company recorded an additional $20.2 million valuation allowance against is deferred tax assets generated in fiscal 2010 and income tax expense of $41,000. The income tax expense related to taxes payable in various states the Company does business. If, after future considerations of positive and negative evidence related to the recoverability of its deferred tax assets, the Company determines a lesser allowance is required, it would record a reduction to income tax expense and the valuation allowance in the period of such determination.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
Other Income
Other income totals $2.9 million, $2.1 million and $3.6 million in fiscal 2010, 2009 and 2008, respectively. In fiscal 2010, other income consists of $1.8 million received from the sale to a third party of a portion of Palm Harbor Insurance Agency’s book of business, including rights to future commissions, profit sharing and renewals, $0.9 million of income earned from mortgage lending and $0.1 million of interest income earned primarily on cash balances. In fiscal 2009, other income consists of $0.7 million of interest income earned primarily on cash balances, $0.7 million of income earned on a real estate investment and $0.7 million of income earned from mortgage lending. In fiscal 2008, other income consists of $3.0 million of interest income earned primarily on cash balances, $0.4 million of income earned from mortgage lending and $0.3 million of income earned on a real estate investment.
Accumulated other comprehensive income (loss)
Accumulated other comprehensive income (loss) is comprised of unrealized gains and losses on available-for-sale investments and changes in fair value of an interest rate hedge.
New Accounting Pronouncements
The Company adopted new accounting guidance related to its accounting for convertible debt instruments as of March 28, 2009. The adoption impacted the historical accounting of certain senior convertible notes. The Company filed a Current Report on Form 8-K on March 18, 2010 to reflect the retrospective adoption of the new accounting guidance on the fiscal 2009, 2008 and 2007 financial statements.
In accordance with U.S. GAAP, the Company has adopted new fair value measurements guidance as it applies to non-financial assets and liabilities. U.S. GAAP defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measurements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The guidance was applied in the fourth quarter of 2010, in conjunction with a reclassification of two facilities as held for sale, at which time the net carrying value of the facilities were measured at their fair value less costs to sell. It was determined through third-party appraisals that the fair value of one facility was less than the carrying value, and the Company adjusted the value of the facility to its fair value less cost to sell.
In June 2009, the FASB issued guidance to change financial reporting by enterprises involved with variable interest entities (VIEs). The standard replaces the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a VIE with an approach focused on identifying which enterprise has the power to direct the activities of a VIE and the obligation to absorb losses of the entity or the right to receive the entity’s residual returns. This accounting standard is effective for fiscal years beginning after November 15, 2009. The Company has evaluated the impact of the adoption of this pronouncement on its consolidated financial statements and has determined the impact of adoption to be immaterial based on its current structures with VIEs.
In June 2009, the FASB issued guidance to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. The standard modifies existing guidance by removing the concept of a qualifying special purpose entity (QSPE) and removing the special provisions for guaranteed mortgage securitizations, requiring those securitizations to be treated the same as any other transfer of financial assets. Therefore, formerly qualifying special-purpose entities (as defined under previous accounting standards) and guaranteed mortgage securitizations should be evaluated for consolidation by reporting entities on and after the effective date in accordance with the applicable consolidation guidance. The standard also limits the unit of account eligible for sale accounting, and clarifies the control and legal isolation criteria to qualify for sale accounting. This accounting standard is effective for fiscal years beginning after November 15, 2009. The Company has evaluated the impact of the adoption of this pronouncement on its consolidated financial statements and has determined the impact of adoption to be immaterial as its securitizations and other financial assets transfers as described in Note 6 are currently consolidated.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
2. Inventories
Inventories consist of the following (in thousands):
Inventories are pledged as collateral with Textron. See Note 5.
3. Investments
The following tables summarize the Company’s available-for-sale investment securities as of March 26, 2010 and March 27, 2009 (in thousands):
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
The following table shows the gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 26, 2010 (in thousands):
The following table shows the gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 27, 2009 (in thousands):
During fiscal 2010, thirty of the Company’s available-for-sale equity securities with a total carrying value of $0.8 million were determined to be other-than-temporarily impaired and a realized loss of $0.2 million was recorded in the Company’s consolidated statements of operations. During fiscal 2009, fifteen of the Company’s available-for-sale equity securities with a total carrying value of $0.9 million were determined to be other-than-temporarily impaired and a realized loss of $0.5 million was recorded in the Company’s consolidated statements of operations.
The Company’s investments in marketable equity securities consist of investments in common stock of bank trust and insurance companies and public utility companies ($1.4 million of the total fair value and $4,000 of the total unrealized losses) and industrial companies ($1.3 million of the total fair value and $45,000 of the total unrealized losses). The Company has seen increases in the market value of its stock portfolio during fiscal 2010, consistent with improvements seen in the overall stock market. Based on the improvements in the stock market and the Company’s ability and intent to hold the investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider any investment to be other-than-temporarily impaired at March 26, 2010.
The amortized cost and fair value of the Company’s investment securities at March 26, 2010, by contractual maturity, are shown in the table below (in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
Gross gains realized on the sales of investment securities for fiscal years 2010, 2009 and 2008 were approximately $0.5 million, $0.4 million and $0.9 million, respectively. Gross losses were approximately $0.6 million, $0.7 million and $0.3 million for fiscal years 2010, 2009 and 2008, respectively.
4. Consumer loans receivable and allowance for loans losses
Consumer loans receivable, net of allowance for loan losses, consist of the following (in thousands):
The allowance for loan losses and related additions and deductions to the allowance are as follows (in thousands):
CountryPlace’s policy is to place loans on nonaccrual status when either principal or interest is past due and remains unpaid for 120 days or more. In addition, they place loans on nonaccrual status when there is a clear indication that the borrower has the inability or unwillingness to meet payments as they become due. Payments received on nonaccrual loans are accounted for on a cash basis, first to interest and then to principal. Upon determining that a nonaccrual loan is impaired, interest accrued and the uncollected receivable prior to identification of nonaccrual status is charged to the allowance for loan losses. At March 31, 2010, CountryPlace’s management was not aware of any potential problem loans that would have a material effect on loan delinquency or charge-offs. Loans are subject to continual review and are given management’s attention whenever a problem situation appears to be developing. The following table sets forth the amounts and categories of CountryPlace’s non-performing loans and assets as of March 31, 2010 and March 31, 2009 (dollars in thousands):
(1)
As of March 31, 2010 CountryPlace identified $2.4 million of loans in nonaccrual status for which foreclosure is probable. Accordingly, the Company reduced the loans receivable balance and the allowance for loan losses by $1.2 million to reflect the difference between the unpaid balance and the estimated fair market value of the related loans receivable. At March 31, 2009 loans accounted for on a nonaccrual basis were reflected at the unpaid balance of $2.6 million.
(2)
Consists of land and homes acquired through foreclosure, which are carried at the lower of carrying value or fair value less estimated selling expenses.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
During fiscal 2010, CountryPlace modified loans to retain borrowers with good payment history. These modifications were considered to represent credit concessions due to borrowers’ loss of income and other repayment matters impacting these borrowers. For the years ended March 31, 2010 and March 31, 2009, CountryPlace modified the payments or rates for approximately $1.6 million and $0.1 million, respectively. These loans are not reflected as non-performing loans but as troubled debt restructurings. As of March 31, 2010, the allowance for loan losses totaled $3.0 million.
Loan contracts secured by collateral that is geographically concentrated could experience higher rates of delinquencies, default and foreclosure losses than loan contracts secured by collateral that is more geographically dispersed. CountryPlace has loan contracts secured by factory-built homes located in the following key states as of March 31, 2010 and March 31, 2009:
The states of California, Florida and Arizona, and to a lesser degree Texas, have experienced economic weakness resulting from the decline in real estate values. The risks created by these concentrations have been considered by CountryPlace’s management in the determination of the adequacy of the allowance for loan losses. No other states had concentrations in excess of 10% of the principal balance of the consumer loans receivable as of March 31, 2010 or March 31, 2009. Management believes the allowance for loan losses is adequate to cover estimated losses at March 31, 2010.
5. Floor plan payable
The Company has an agreement with Textron Financial Corporation for a floor plan facility. 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 sales centers and is secured by the assets of the Company, excluding CountryPlace assets. During the third quarter of fiscal 2009, Textron announced that they wanted to perform an orderly liquidation of certain of their commercial finance businesses, including their housing inventory finance business.
As of December 25, 2009, the Company was required to reduce the outstanding borrowings under the Textron facility to $40 million by December 31, 2009. However, on December 29, 2009, the Company and Textron agreed to an amendment to delay the requirement to reduce outstanding borrowings to $40 million until January 31, 2010. Additionally, certain other covenant and condition modifications to the agreement were made at the time. On January 27, 2010, Textron and the Company agreed to a further amendment that included, among other things, the following modifications:
•
Extends the maturity date from June 30, 2010 to the earlier of June 30, 2012 or one month prior to the date of the first repurchase option for the holder of the Company’s convertible senior notes;
•
Alters the maximum credit line to $45 million for the fourth quarter of fiscal 2010, $43 million for the first quarter of fiscal 2011, $38 million for the second quarter of fiscal 2011, $32 million for the third quarter of fiscal 2011, $28 million for the fourth quarter of fiscal 2011 and $25 million thereafter;
•
Provides for a maximum loan-to-collateral coverage ratio of 65% through the first quarter of fiscal 2011, 62% for the second quarter of fiscal 2011 and 60% for all quarters thereafter;
•
Allows for an increased percentage of eligible inventory to be borrowed subject to the total credit line at the lender’s discretion;
•
Pledges 100% of the Company’s equity in Standard Casualty Company to Textron; and
•
Alters financial covenants as follows:
•
Maximum quarterly net loss before taxes and restructuring charges - $15 million through the second quarter of fiscal 2011, $10 million for the third and fourth quarters of fiscal 2011 and $1 million of net income for all quarters thereafter;
•
Eliminates the borrowing base requirement in its entirety effective December 29, 2009.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
As of March 26, 2010, the Company was required to comply with a minimum inventory turn of not less than 2.75:1, and a maximum quarterly net loss (before taxes and restructuring charges) not to exceed $15 million, as defined by the agreement. The Company was in compliance with these financial covenants as of March 26, 2010 and believes that covenant requirements under the amended Textron facility are achievable for the foreseeable future. However, in light of current market conditions, and because covenant compliance is dependent upon a number of factors, including prevailing economic and financial conditions and other factors beyond the Company’s control, no assurances can be given in this regard. Textron could also declare a loan violation due to a material adverse change, as defined in the agreement. Should a covenant violation occur, the Company would seek a waiver from Textron and consider any other available remedies. However, no assurances can be made that Textron would provide the Company with a waiver or that the Company will otherwise have available remedies and, if a loan violation were to occur and not be waived or remedied in accordance with the terms of the floor plan facility, Textron could declare an event of default and demand that the full amount of the facility be paid in full prior to maturity. Such a demand would result in, among other things, a cross default on the Company’s convertible senior notes described in Note 6.
Additionally, as of March 26, 2010, the Company had a loan-to-collateral coverage ratio of 82% which exceeded the maximum requirement of 65% and resulted in its having an increased percentage of eligible inventory borrowed subject to the total credit line by $8.9 million. While Textron could demand that the entire $8.9 million be repaid immediately, Textron has approved the coverage ratio to be out of formula and in connection with that waiver, reset the total credit line from $43 million to $38 million effective May 18, 2010.
The Company’s liability under this credit facility was $42.2 million as of March 26, 2010.
6. Debt obligations
Debt obligations consist of the following (in thousands):
In fiscal 2005, the Company issued $75.0 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. 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. The note holders may require the Company to repurchase all or a portion of their notes for cash on May 15, 2011, May 15, 2014 and May 15, 2019 at a repurchase price equal to 100% of the principal amount of the notes to be repurchased plus accrued and unpaid interest, if any. 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 certain conditions and contingencies. For fiscal years 2010, 2009 and 2008, the effect of converting the senior notes to 2.1 million, 2.1 million and 2.9 million shares of common stock, respectively, was anti-dilutive, and was, therefore, not considered in determining diluted earnings per share. During fiscal 2009, the Company repurchased $21.2 million principal amount of the Notes, which had a book value of $18.3 million net of debt discount, for $10.6 million in cash, resulting in a gain of $7.7 million. The Company did not repurchase any Notes during fiscal 2010.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
The liability component related to the convertible senior notes is being amortized through May, 2011 and is reflected in the condensed consolidated balance sheets as of March 26, 2010 and March 27, 2009 as follows (in thousands):
Interest expense for fiscal 2010 and 2009 totaled $4.5 million and $5.0 million, respectively, of which $2.5 million and $2.8 million, respectively, represented amortization of the debt discount at an effective interest rate of 9.11%.
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 an expected 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. CountryPlace’s servicing obligation under this securitized financing is guaranteed by the Company.
On March 22, 2007, the Company, through its subsidiary CountryPlace, completed its second securitization (2007-1) for approximately $116.5 million of loans, 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 an expected weighted average maturity of 4.86 years. The proceeds from the securitization were used to repay approximately $97.1 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.
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. 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 is amortized to interest expense over the life of the loans.
On January 29, 2010, the Company, through its subsidiary CountryPlace, entered into an agreement for a $20 million secured term loan from entities managed by Virgo Investment Group LLC. The agreement provides an option for CountryPlace to exercise a subsequent commitment to borrow an additional $5.0 million, which expires on August 1, 2010. Currently, the Company does not expect CountryPlace to exercise the secondary commitment. The facility has a maturity date of January 29, 2014 and bears interest at an annual rate of the Eurodollar Rate plus 12%. The Eurodollar Rate cannot be less than 3.0% nor greater than 4.5%. The proceeds will be used by CountryPlace to repay the intercompany indebtedness to the Company and the Company expects to use the proceeds for working capital and general corporate purposes.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
The agreement also contains financial covenants that CountryPlace must comply with. CountryPlace shall not incur capital expenditures exceeding $300K in any fiscal year; and the maximum amount of the Virgo loan divided by the value of the collateral securing the loan shall not exceed the ratios below for more than three consecutive months during the applicable periods:
For the year ended March 31, 2010, CountryPlace was in compliance with the financial covenants with a loan-to-value ratio of 0.34:1.
As a precedent to Virgo making the loan, the parties also agreed to create a special purpose vehicle (SPV) to hold certain mortgage loans as collateral. Under the agreement, CountryPlace transferred its right, title, and interest to certain manufactured housing installment sales contracts and mortgages, along with certain related property, to a newly created subsidiary, CountryPlace Mortgage Holdings, LLC (“Mortgage SPV”). The transferred sales contracts and mortgages consist of $39.4 million of the overcollateralization on the 2005-1 and 2007-1 securitizations (Class X and R certificates), and $19.8 million of certain other mortgage loans held for investment that were not previously securitized.
The Mortgage SPV is consolidated on the Company’s financial statements as CountryPlace will continue to service the mortgage loans and collect the related service fee and residual income even after the termination of the loan facility, is obligated to repurchase or substitute contracts that materially adversely affect the Mortgage SPV’s interest, and will be solely liable for losses incurred by the Mortgage SPV.
As partial consideration for the loan with Virgo, the Company issued warrants to purchase up to an aggregate of 1,296,634 shares of the Company’s common stock at a purchase price of $2.1594 per share. These warrants contain an anti-dilution provision that prevents the warrant holder’s fully-diluted percentage interest in the Company from being diluted in the event that any convertible securities of the Company are converted into other securities of the Company. The warrants also contain an anti-dilution provision that prevents the warrant holder from having its percentage ownership in the Company diminished by more than 10% in the event that the Company issues additional securities, subject to certain exceptions. These anti-dilution provisions expire four years after the issuance of the warrants.
On April 27, 2009, the Company issued warrants to each of Capital Southwest Venture Corporation, Sally Posey and the Estate of Lee Posey (collectively, the lenders) to purchase up to an aggregate of 429,939 shares of common stock of the Company at a price of $3.14 per share, which was the closing price of the Company’s common stock on April 24, 2009. The Black-Scholes-Merton method was used to value the warrants, which resulted in the Company recording $0.8 million in non-cash interest expense in the first quarter of fiscal 2010. The warrants were granted in connection with a loan made by the lenders to the Company of an aggregate of $4.5 million pursuant to senior subordinated secured promissory notes between the Company and each of the lenders (collectively, the Promissory Notes). The proceeds were used for working capital purposes. The Promissory Notes were repaid in full on June 29, 2009. The warrants, which expire on April 24, 2019, contain anti-dilution provisions and other customary provisions. The Promissory Notes bore interest at the rate of LIBOR plus 2.0% and were secured by 150,000 shares of Standard’s common stock, which was later released upon repayment of the Promissory Notes.
Scheduled maturities of the Company’s debt obligations consist of the following (in thousands):
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
7. Accrued liabilities
Accrued liabilities consist of the following (in thousands):
8. Income taxes
Deferred tax assets and liabilities are determined based on temporary differences between the financial statement amounts and the tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. To the extent the Company believes it is more likely than not that some portion or all of its deferred tax assets will not be realized prior to expiration, it is required to establish a valuation allowance against that portion of the deferred tax assets. The determination of valuation allowances involves significant management judgments and is based upon the evaluation of both positive and negative evidence, including the Company’s best estimates of anticipated taxable profits in the various jurisdictions with which the deferred tax assets are associated. Changes in events or expectations could result in significant adjustments to the valuation allowances and material changes to the Company’s provision for income taxes.
In fiscal 2008, the Company recognized in income tax expense a valuation allowance of $27.6 million against all of its net deferred tax assets which resulted in the Company recording a net income tax provision of approximately $8.4 million. In fiscal 2009, the Company recorded an additional $17.0 million valuation allowance against its deferred tax assets generated in fiscal 2009 and an income tax benefit of $8,000. In fiscal 2010, the Company recorded an additional $20.2 million valuation allowance against its deferred tax assets generated in fiscal 2010 and income tax expense of $41,000. The income tax expense related to taxes payable in various states the Company does business. If, after future considerations of positive and negative evidence related to the recoverability of its deferred tax assets, the Company determines a lesser allowance is required, it would record a reduction to income tax expense and the valuation allowance in the period of such determination.
Income tax benefit (expense) for fiscal years 2010, 2009 and 2008 is as follows (in thousands):
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
Significant components of deferred tax assets and liabilities are as follows (in thousands):
As of March 26, 2010, the Company has federal net operating loss carryforwards of approximately $133.0 million available to offset future federal income tax and which expire between 2027 and 2030. In addition, the Company has state net operating loss carryforwards of approximately $180.8 million available to offset future state income tax and which expire between 2010 and 2029.
The effective income tax rate on pretax earnings differed from the U.S. federal statutory rate for the following reasons (in thousands):
9. 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.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
10. 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. Effective January 1, 2010, the Company discontinued its 25% match 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 $0.4 million, $0.8 million and $1.0 million in fiscal years 2010, 2009 and 2008, respectively.
11. Stock Incentive Plan
Effective July 22, 2009, the Palm Harbor Homes, Inc. 2009 Stock Incentive Plan (the “Plan”) was adopted. The Plan allows for the issuance of up to 1,844,000 shares of common stock to the Company’s employees and outside directors in the form of non-statutory stock options, incentive stock options and restricted stock awards. During the second quarter of fiscal 2010, the Company granted options for 1,217,040 shares at an exercise price equal to the market price of the Company’s common stock as of the date of grant or $3.02 per share. Such options have a 10 year term and vest over five years of service. Certain option and share awards provide for accelerated vesting if there is a change in control (as defined in the Plan).
The fair value of each option award is estimated on the date of grant using a Black-Scholes-Merton option valuation model that assumed an expected volatility of 65%, an expected term of 6.5 years, zero dividend payments, and a risk-free rate of 3%.
Expected volatilities are based on historical, implied, and expected volatilities from the Company and other comparable entities. The expected term of options granted is derived from the simplified method given the Company has not historically granted stock options. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
The grant-date fair value of options granted during the second quarter was $1.81 per share. As of March 26, 2010, there was approximately $2.0 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over 5 years. The outstanding stock options were not included in the calculation of dilutive EPS because to do so would be anti-dilutive.
12. Commitments and contingencies
Future minimum lease payments for all noncancelable operating leases having a remaining term in excess of one year at March 26, 2010, are as follows (in thousands):
Rent expense (net of sublease income) was $8.0 million, $8.1 million and $9.8 million for fiscal years 2010, 2009 and 2008, 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 26, 2010, the Company estimates that its potential obligations under all repurchase agreements were approximately $3.0 million. However, it is management’s opinion that no material loss will occur from the repurchase agreements. During fiscal years 2010, 2009 and 2008, the Company did not incur any significant losses under these repurchase agreements.
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.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
13. Sale-leaseback transactions
During the fourth quarter of fiscal 2010, the Company completed a sale leaseback transaction where it sold two retail sales center properties for $0.9 million in cash. The transaction resulted in a $0.3 million gain which will be amortized over the term of the lease. Concurrent with the sale, the Company leased the properties back for a period of ten years at an aggregate rental of $0.1 million plus escalation under certain circumstances. The lease is renewable at the Company’s option for an additional five years.
During the fourth quarter of fiscal 2009, the Company completed two sale leaseback transactions (one transaction was with two members of senior management of the Company who are related parties) where it sold in total 13 retail sales center properties for $6.5 million in cash. One transaction (the related party transaction) resulted in a $0.7 million gain which will be amortized over the term of the lease and the other transaction resulted in a $0.5 million loss which was recorded in selling, general and administrative expenses in the Company’s consolidated statement of operations. Concurrent with the sale, the Company leased the properties back for a period of ten years at an aggregate annual rental of $0.6 million plus escalation under certain circumstances. The lease is renewable at the Company’s option for an additional five years.
The Company does not have continuing involvement in the properties other than through a normal leaseback. The future minimum lease payments under the terms of the related lease agreements are disclosed in Note 12.
14. Losses from natural disaster
During the third quarter of fiscal 2007, the Company’s Burleson, Texas manufacturing facility was destroyed by fire. The Company had business interruption and general liability insurance that covered the losses. During fiscal 2007, the Company received $2.0 million in recoveries and recorded $2.5 million in losses. During fiscal 2008, the Company received recoveries totaling $4.3 million and recorded $0.5 million in losses. Final settlement of the claim occurred in fiscal 2008 resulting in a gain of $3.3 million which is included as a reduction of cost of sales in the consolidated statements of operations.
15. Restructuring charges
In order to more effectively align its manufacturing capacity and distribution channels with current and expected regional demand, the Company closed its Albemarle, North Carolina manufacturing facility and 23 under-performing retail sales centers during the fourth quarter of fiscal 2010. In connection with these actions, the Company recorded restructuring charges totaling $9.2 million. Of this $9.2 million, approximately $4.8 million was recorded in cost of sales and primarily related to the quick selling of retail inventories at reduced margins at the locations that were closing and $4.4 million was recorded in selling, general and administrative expenses and primarily related to sales centers and plants closing costs as well as expenses for legal and financial consultants. No significant additional charges are expected to be incurred in connection with this restructuring.
During the fourth quarter of fiscal 2008, the Company closed its Sabina, Ohio, Casa Grande, Arizona and one of its Plant City, Florida manufacturing facilities as well as 18 under-performing retail sales centers. The Company recorded restructuring charges totaling $8.3 million primarily related to facility closure costs. Of this $8.3 million, approximately $2.9 million is included in cost of sales and $5.4 million is included in selling, general and administrative expenses on the Company’s statement of operations.
Also, as part of these restructurings, the Company listed two of its manufacturing facilities for sale in fiscal 2010 and three of its manufacturing facilities for sale in fiscal 2008. The Company sold one of these facilities in the first quarter of fiscal 2010 and continues to try to sell the other four. The carrying value of these facilities is included in assets held for sale on the consolidated balance sheets.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
16. Fair value of financial instruments
The book value and estimated fair value of the Company’s financial instruments are as follows (dollars in thousands):
(1)
The fair value approximates book value due to the instruments’ short term maturity.
(2)
The fair value is based on market prices.
(3)
Includes consumer loans receivable held for investment and held for sale. The fair value of the loans held for investment is based on the discounted value of the remaining principal and interest cash flows. The fair value of the loans held for sale approximates book value since the sales price of these loans is known as of March 31, 2010.
(4)
For fiscal 2009, the fair value is estimated using quoted market prices for similar securities, and for fiscal 2010, fair value is estimated using recent asset backed and commercial real estate securities.
(5)
The fair value is estimated based on the remaining cash flows discounted at the implied yield when the transaction was closed.
In accordance with guidance in ASC Topic 820, fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC Topic 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level-Quoted prices in active markets for identical assets or liabilities.
Level 2-Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3-Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. (The Company had no level 3 securities at the end of 2010 or during the year then ended).
The Company utilizes the market approach to measure fair value for its financial assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
Assets measured at fair value on a recurring basis are summarized below (in thousands):
(1)
Unrealized gains or losses on investments are recorded in accumulated other comprehensive loss at each measurement date.
(2)
Consists of land and homes acquired through foreclosure.
Assets measured at fair value on a non-recurring basis are summarized below (in thousands):
(1)
Long-lived assets held for sale with a carrying amount of $0.9 million were written down to their fair value of $0.7 million, resulting in a loss of $0.3 million, which was included in operating results for the period.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
17. 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 2010, 2009 and 2008 (in thousands):
(1)
Includes $78.5 million of goodwill impairment charges.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
18. Acquisition
On February 15, 2008, the Company entered into an agreement with CountryPlace’s minority interest holders (related parties to the Company) in which the Company purchased the remaining 20% of CountryPlace. In accordance with the agreement, the Company paid the minority interest holders $1.8 million on February 15 and issued a promissory note to pay $1.8 million plus interest (LIBOR plus 1.25%) on June 30, 2008 in exchange for 500,000 shares of CountryPlace Common Stock, $1 par value. Additionally, as an inducement to each minority interest holder to remain in his management capacity with CountryPlace, the Company issued to each minority interest holder who was in the employ of CountryPlace on February 10, 2010, 52,424 shares of the Company’s Common Stock. The minority interest acquisition was accounted for using purchase accounting and resulted in goodwill of $2.2 million. The common stock transaction will be recorded as compensation expense over the service period and is included in selling, general and administrative expenses on the Company’s consolidated statements of operations.
19. 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 26, 2010, March 27, 2009 and March 28, 2008 (in thousands).
20. Related party transactions
During the fourth quarter of fiscal 2009, the Company completed a sale leaseback transaction with a partnership which included two members of senior management of the Company. See note 13 for further details of the transaction.
On April 27, 2009, the Company issued warrants to each of Capital Southwest Corporation, Sally Posey and the Estate of Lee Posey, all of which are related parties to the Company. The warrants were granted in connection with a loan made by these related parties to the Company. See Note 6 for further details of the transaction.
The Company did not have any other significant related party transactions in fiscal 2010, 2009 or 2008.
Palm Harbor Homes, Inc. and Subsidiaries
Notes to Consolidated Financial Statements-(Continued)
21. Quarterly financial data (unaudited)
The following table sets forth certain unaudited quarterly financial information for the fiscal years 2010 and 2009.
(1)
Includes restructuring charges totaling $9.2 million in the fourth quarter of fiscal 2010 and $8.3 million in the fourth quarter of fiscal 2009. Of the $9.2 million in fiscal 2010, approximately $4.8 million was recorded as a reduction in gross profit and $4.4 million was recorded in selling, general and administrative expenses. Of the $8.3 million in fiscal 2009, $2.9 million was recorded as a reduction in gross profit and $5.4 million was recorded in selling, general and administrative expenses.
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 26, 2010. 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 26, 2010. During the quarter ending on March 26, 2010, 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 26, 2010 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 26, 2010, the Company’s internal control over financial reporting was effective based on those criteria.
The effectiveness of internal control over financial reporting as of March 26, 2010, has been audited by Ernst & Young LLP, the independent registered accounting firm who also audited the Company’s consolidated statements. Ernst & Young LLP’s attestation report on the effectiveness of the Company’s internal control over financial reporting appears on page 63.
/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
Item 9B.
Item 9B. Other Information
None.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of Palm Harbor Homes, Inc. and Subsidiaries
We have audited Palm Harbor Homes Inc. and subsidiaries’ internal control over financial reporting as of March 26, 2010, 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. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on 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, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, 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, Palm Harbor Homes, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of March 26, 2010, 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 26, 2010 and March 27, 2009, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended March 26, 2010 of Palm Harbor Homes, Inc. and subsidiaries and our report dated June 15, 2010 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Dallas, Texas
June 15, 2010
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”, “Governance of the Company”, and “Executive Officers” in the Company’s proxy statement for the 2010 annual meeting of shareholders 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 2010 annual meeting of shareholders 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 2010 annual meeting of shareholders 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 2010 annual meeting of shareholders is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information set forth in the Section entitled “Related Party Transaction” in the Company’s proxy statement for the 2010 annual meeting of shareholders is incorporated herein by reference.
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 2010 annual meeting of shareholders 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 26, 2010 are included on pages 34 through 61 of this report.
(2) Financial Statement Schedules
Schedule II Valuation and Qualifying Accounts and Reserves is included on page 67 of this report.
(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 17, 2010.
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 26, 2010 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.
Palm Harbor Homes, Inc.
Schedule II-Valuation and Qualifying Accounts