10-Q 1 d10099e10vq.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 26, 2003 Commission file number 0-26188 PALM HARBOR HOMES, INC. ------------------------------------------------------ (Exact name of registrant as specified in its charter) Florida 59-1036634 ------------------------------- ---------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 15303 Dallas Parkway, Suite 800, Addison, Texas 75001-4600 ---------------------------------------------------------- (Address of principal executive offices) (Zip code) 972-991-2422 ---------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) Yes [X] No [ ] and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]. Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [X] No [ ]. Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Shares of common stock $.01 par value, outstanding on October 31, 2003 - 22,859,363. PALM HARBOR HOMES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except per share data)

SEPTEMBER 26, MARCH 28, 2003 2003 ------------- --------- (Unaudited) ASSETS Cash and cash equivalents $ 36,573 $ 45,592 Restricted cash 4,279 4,484 Investments 21,316 23,987 Trade receivables 56,618 66,346 Loans held for investment, net 65,361 32,135 Inventories 107,953 115,753 Prepaid expenses and other assets 25,272 23,499 Property, plant and equipment, net 86,732 92,887 Goodwill 78,506 78,079 --------- --------- TOTAL ASSETS $ 482,610 $ 482,762 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable $ 32,975 $ 32,059 Accrued liabilities 62,119 58,195 Floor plan payable 82,840 114,437 Warehouse revolving debt 39,557 15,135 Other debt obligations 2,473 2,567 --------- --------- Total liabilities 219,964 222,393 Commitments and contingencies Shareholders' equity: Common stock, $.01 par value 239 239 Additional paid-in capital 54,149 54,149 Retained earnings 224,907 223,580 Accumulated other comprehensive income 378 195 --------- --------- 279,673 278,163 Less treasury shares (15,714) (15,657) Unearned compensation (1,313) (2,137) --------- --------- Total shareholders' equity 262,646 260,369 --------- --------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 482,610 $ 482,762 ========= =========

See accompanying notes. 1 PALM HARBOR HOMES, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share data) (Unaudited)

THREE MONTHS ENDED SIX MONTHS ENDED SEPTEMBER 26, SEPTEMBER 27, SEPTEMBER 26, SEPTEMBER 27, 2003 2002 2003 2002 ------------- ------------- ------------- ------------- Net sales $ 148,547 $ 149,612 $ 304,446 $ 288,071 Cost of sales 109,413 105,285 224,935 204,205 Selling, general and administrative expenses 39,075 41,058 79,370 81,532 --------- --------- --------- --------- Income from operations 59 3,269 141 2,334 Interest expense (1,235) (1,758) (2,926) (3,469) Other income 2,052 1,057 4,996 1,621 --------- --------- --------- --------- Income before income taxes 876 2,568 2,211 486 Income tax expense (361) (956) (884) (181) --------- --------- --------- --------- Net income $ 515 $ 1,612 $ 1,327 $ 305 ========= ========= ========= ========= Net income per common share - basic and diluted $ 0.02 $ 0.07 $ 0.06 $ 0.01 ========= ========= ========= ========= Weighted average common shares outstanding - basic and diluted 22,856 22,939 22,858 22,946 ========= ========= ========= =========

See accompanying notes. 2 PALM HARBOR HOMES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (Unaudited)

SIX MONTHS ENDED SEPTEMBER 26, SEPTEMBER 27, 2003 2002 ------------- ------------- OPERATING ACTIVITIES Net income $ 1,327 $ 305 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 7,267 6,867 Provision for credit losses 1,438 -- Deferred income taxes -- (1,012) Loss (gain) on disposition of assets (646) 338 Gain on investments (109) -- Provision for long-term incentive plan 768 1,484 Equity earnings in limited partnership (4,146) (924) Changes in operating assets and liabilities: Restricted cash 205 -- Trade receivables 9,728 (25) Inventories 7,800 7,553 Prepaid expenses and other assets 2,477 (2,253) Accounts payable and accrued expenses 4,739 3,279 ------------- ------------- Cash provided by operations 30,848 15,612 Loans originated -- (40,511) Sale of loans -- 41,262 ------------- ------------- Net cash provided by operating activities 30,848 16,363 INVESTING ACTIVITIES Business acquired, net of cash acquired -- (31,480) Investment in limited partnership -- (3,000) Loans held for investment (39,254) -- Principal payments on loans held for investment 3,642 -- Purchases of property, plant and equipment, net of proceeds from disposition (48) (4,391) Purchases of investments (3,589) (2,172) Sales of investments 6,651 6,197 ------------- ------------- Net cash used in investing activities (32,598) (34,846) FINANCING ACTIVITIES Net payments on floor plan payable (31,597) (7,147) Net proceeds from warehouse revolving debt 24,422 -- Principal payments on other debt obligations (94) (86) ------------- ------------- Net cash used in financing activities (7,269) (7,233) Net decrease in cash and cash equivalents (9,019) (25,716) Cash and cash equivalents at beginning of period 45,592 69,197 ------------- ------------- Cash and cash equivalents at end of period $ 36,573 $ 43,481 ============= ============= Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 2,408 $ 3,260 Income taxes 51 298

See accompanying notes. 3 PALM HARBOR HOMES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation The condensed consolidated financial statements reflect all adjustments, which include only normal recurring adjustments, which are, in the opinion of management, necessary for a fair presentation in conformity with Generally Accepted Accounting Principles. Certain footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted. The condensed consolidated financial statements should be read in conjunction with the audited financial statements for the year ended March 28, 2003. Results of operations for any interim period are not necessarily indicative of results to be expected for a full year. The balance sheet at March 28, 2003 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by Generally Accepted Accounting Principles for complete financial statements. As discussed in the audited financial statements for the year ended March 28, 2003, the Company adopted an accounting policy to present a non-classified balance sheet. As a result, certain prior period amounts have been reclassified to conform to the current period presentation. 2. Acquisitions/Investments On June 7, 2002, the Company acquired Nationwide Custom Homes ("Nationwide"), a manufacturer and marketer of modular homes, for $32.5 million in cash. The acquisition was accounted for using the purchase method of accounting. The final purchase price allocation resulted in approximately $25 million of goodwill related to the acquisition. Due to final transaction costs and normal purchase accounting finalization, goodwill increased $0.4 million during the first quarter of fiscal 2004. In June 2002, the Company invested $3.0 million to become the sole limited partner and 50% owner of an existing mortgage banking firm, BSM Financial L. P. ("BSM") which is being accounted for using the equity method of accounting. The following table represents the condensed income statements for the three and six month periods ending September 26, 2003 and September 27, 2002 (in thousands):

THREE MONTHS ENDED SIX MONTHS ENDED ------------------------------ -------------------------------- SEPTEMBER 26, SEPTEMBER 27, SEPTEMBER 26, SEPTEMBER 27, 2003 2002 2003 2002 ------------- ------------- ------------- ------------- Revenues $16,477 $10,802 $33,493 $13,593 Net income 3,578 1,656 8,295 1,842

3. Inventories Inventories consist of the following (in thousands):

SEPTEMBER 26, MARCH 28, 2003 2003 ------------- --------- Raw materials $ 9,009 $ 7,779 Work in process 4,610 4,493 Finished goods - factory-built 2,702 2,337 Finished goods - retail 91,632 101,144 -------- -------- $107,953 $115,753 ======== ========

4 PALM HARBOR HOMES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited) 4. Floor Plan Payable In March 2003, the Company executed an agreement with a financial institution for a $100.0 million syndicated floor plan facility which consisted of $35.0 million expiring via orderly liquidations by the end of September 2003 and the remaining $65.0 million expiring March 19, 2006. During the quarter ended September 26, 2003, the Company paid off the portion of the facility which expired in September and increased the remaining $65.0 million facility to $75.0 million. In addition, the Company has received commitments from financial institutions to increase the facility by another $10.0 million. The advance rate for this facility is 90% of manufacturer's invoice. The Company has a second facility with another financial institution for $10.0 million, which automatically renews each year unless notification of cancellation is received by the financial institution. These facilities are used to finance a major portion of the new home inventory at the Company's retail superstores and are secured by a portion of its new home inventory and receivables from financial institutions. The interest rates on the facilities are prime (4.00% at September 26, 2003) or prime plus 1.0% to 3.0% for aged units, of which the Company has none under its floor plan arrangements. These two floor plan facilities contain certain provisions regarding minimum financial requirements which the Company must maintain in order to borrow against the facilities. As of September 26, 2003, the Company was in compliance with these provisions; however, no assurances can be made as to whether the Company will be in compliance with these provisions in future periods. In the event the Company is not in compliance with these provisions in future periods, the Company would seek a waiver of any default from the lending institutions and, if no such waiver was obtained, maturities of outstanding debt could be accelerated. The Company had $82.8 million and $114.4 million outstanding on these floor plan credit facilities at September 26, 2003 and March 28, 2003, respectively. 5. Warehouse Revolving Debt The Company, through its subsidiary CountryPlace Mortgage, Ltd. ("CountryPlace"), has a loan warehouse borrowing facility with a financial institution. This facility is collateralized by specific receivables pledged to the facility and bears interest at the rate of LIBOR (1.12% at September 26, 2003) plus 1.25%. The facility terminates on March 19, 2004; however, the Company intends to renew or obtain a similar facility prior to the termination date. The facility provides for an advance of 65% against the outstanding principal balance of eligible receivables, as defined in the warehouse agreement. CountryPlace had outstanding borrowings under this facility of $39.6 million as of September 26, 2003. The facility contains certain requirements relating to the performance and composition of the receivables pledged to the facility and certain financial covenants, which are customary in the industry. The facility also requires Palm Harbor and CountryPlace to maintain a minimum balance of shareholders' equity. As of September 26, 2003, both Palm Harbor and CountryPlace were in compliance with these requirements. In connection with the warehouse borrowing facility, Palm Harbor agreed to fund in cash to CountryPlace, up to 25% of each loan loss incurred. As of September 26, 2003, no such loss funding was required to be made to CountryPlace. Additionally, Palm Harbor has entered into an intercompany financing arrangement with CountryPlace that provides for up to $25 million of funding to be used for the growth of CountryPlace's portfolio and operations. 6. Commitments and Contingencies The Company is contingently liable under the terms of repurchase agreements covering independent retailers' 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 September 26, 2003, the Company estimates that its potential obligations under all repurchase agreements were approximately $11.2 million. It is management's opinion that no material loss will occur from the 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, results of operations, or cash flows of the Company. 5 PALM HARBOR HOMES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited) 7. 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. The accrued product warranty obligation is classified as accrued liabilities in the condensed consolidated balance sheets. The following table summarizes the changes in accrued product warranty obligations during the six months ended September 26, 2003 and September 27, 2002 (in thousands):

SEPTEMBER 26, SEPTEMBER 27, 2003 2002 ------------- ------------- Beginning accrued warranty balance $ 4,133 $ 6,583 Net warranty expense provided 6,390 6,385 Cash warranty payments (6,534) (6,992) ------- ------- Ending accrued warranty balance $ 3,989 $ 5,976 ======= =======

6 PART I. Financial Information Item 1. Financial Statements See pages 1 through 6. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The manufactured housing industry continues to be impacted by the major challenges that affected previous fiscal years - limited retail and wholesale financing availability, continued high levels of repossessions, excessive retail inventory levels and manufacturing capacity. The tightening of credit standards, which began in mid-1999, has resulted in reduced retail sales, declining wholesale shipments and declining margins for most industry participants. Although industry-wide shipments for calendar 2003 through August were down 25% as compared to the prior year, our shipments declined only 6%. Despite these difficult conditions, we have not closed any manufacturing facilities and our number of Company-owned retail superstores has remained constant at 152. In addition, we operated profitably during the first six months of fiscal 2004. We continued to tightly manage receivables and new home inventory per retail superstore, which has declined 13% since the beginning of our fiscal year and over 21% since the second quarter of fiscal 2003. Floor plan payable per retail superstore has declined 27% since the beginning of the fiscal year and over 35% compared to a year ago. During the first six months of fiscal 2004, we stayed focus on executing our strategy of expanding our consumer financing capabilities through our finance subsidiary, CountryPlace Mortgage, Ltd. ("CountryPlace"), and our 50% limited partnership in BSM Financial L.P. ("BSM"). CountryPlace is now servicing over $65 million in chattel loans and during the first half of fiscal 2004, BSM originated 4,248 conventional mortgage loans worth $616 million, $31 million of which were for Palm Harbor customers. For the quarter, 40% of our retail customers were financed by either CountryPlace or BSM. The following table sets forth certain items of the Company's statements of income as a percentage of net sales for the period indicated.

THREE MONTHS ENDED SIX MONTHS ENDED SEPTEMBER 26, SEPTEMBER 27, SEPTEMBER 26, SEPTEMBER 27, 2003 2002 2003 2002 ------------- ------------- ------------- ------------- Net sales 100.0% 100.0% 100.0% 100.0% Cost of sales 73.7 70.4 73.9 70.9 ------ ------ ------ ------ Gross profit 26.3 29.6 26.1 29.1 Selling, general and administrative expenses 26.3 27.4 26.1 28.3 ------ ------ ------ ------ Income from operations 0.0 2.2 0.0 0.8 Interest expense (0.9) (1.2) (1.0) (1.2) Other income 1.4 0.7 1.7 0.6 ------ ------ ------ ------ Income before income taxes 0.5 1.7 0.7 0.2 Income tax expense (0.2) (0.6) (0.3) (0.1) ------ ------ ------ ------ Net income 0.3% 1.1% 0.4% 0.1% ====== ====== ====== ======

7 The following table summarizes certain key sales statistics as of and for the three and six months ended September 26, 2003 and September 27, 2002.

THREE MONTHS ENDED SIX MONTHS ENDED SEPTEMBER 26, SEPTEMBER 27, SEPTEMBER 26, SEPTEMBER 27, 2003 2002 2003 2002 ------------- ------------- ------------- ------------- Homes sold through Company-owned retail superstores 1,570 1,770 3,253 3,460 Homes sold to independent dealers and builders 614 526 1,201 909 Total new factory-built homes sold 2,184 2,296 4,454 4,369 Average new home price - retail $66,000 $62,000 $66,000 $63,000 Number of retail superstores at end of period 152 152 152 152 Number of company-owned builder locations 5 5 5 5

THREE MONTHS ENDED SEPTEMBER 26, 2003 COMPARED TO THREE MONTHS ENDED SEPTEMBER 27, 2002 NET SALES. Net sales decreased 0.7% to $148.5 million in the second quarter of fiscal 2004 from $149.6 million in the second quarter of fiscal 2003. The decrease in net sales is primarily due to the contraction of retail financing in the manufactured housing industry partially offset by an increase in modular sales. The volume of manufactured homes sold through Company-owned retail superstores declined 11.9% while overall manufactured housing unit volume, which includes sales to independent retailers, declined 7.8% in the current quarter. This decline in manufactured housing volume is partially offset by an increase in the average selling price of a new home to $66,000 in the second quarter of fiscal 2004 versus $62,000 in the second quarter of fiscal 2003. Modular unit sales increased 24.2% during the current quarter partially offset by a 2.6% decrease in the average selling price to the consumer. The number of superstores was 152 at the end of the second quarter of fiscal 2003 and 2004. GROSS PROFIT. In the quarter ended September 26, 2003, gross profit as a percentage of net sales declined to 26.3%, or $39.1 million, from 29.6%, or $44.3 million, in the quarter ended September 27, 2002. This decrease in gross profit is the result of a high level of repossessions being sold at discounted prices, increasing lumber and gypsum prices and an increase in Nationwide Custom Homes' ("Nationwide") sales volume. Nationwide's gross profit percentage is slightly lower than our manufactured housing gross profit percentage due to Nationwide's much lower 14% internalization rate. The internalization rate, including modular, decreased from 77% in the second quarter of fiscal 2003 to 72% in the second quarter of fiscal 2004. 8 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. As a percentage of net sales, selling, general and administrative expenses decreased to 26.3% in the second quarter of fiscal 2004 from 27.4% in the second quarter of fiscal 2003. Selling, general and administrative expenses decreased slightly from $41.1 million in the quarter ended September 27, 2002 to $39.1 million in the quarter ended September 26, 2003. This reduction reflects Palm Harbor's focus on reducing fixed costs somewhat offset by our continued commitment to building brand awareness via advertising, expenses associated with the expansion of CountryPlace and our investment in training at all levels. INTEREST EXPENSE. Interest expense decreased 29.7% to $1.2 million in the second quarter of fiscal 2004 from $1.8 million in the second quarter of fiscal 2003. This decrease was primarily due to a significant decline in the floor plan liability coupled with a decrease in the prime interest rate from 4.75% in fiscal 2003 to 4.00% in fiscal 2004. OTHER INCOME. Other income includes $1.8 million in fiscal 2004 relating to our equity interest in the earnings of our limited partnership, BSM, compared to $0.8 million in fiscal 2003. SIX MONTHS ENDED SEPTEMBER 26, 2003 COMPARED TO SIX MONTHS ENDED SEPTEMBER 27, 2002 NET SALES. Net sales increased 6% to $304.4 million in the first six months of fiscal 2004 from $288.1 million in the first six months of fiscal 2003. The increase in net sales was primarily due to modular sales which totaled $34.3 million in fiscal 2004 versus $21.3 million in fiscal 2003 somewhat offset by a decrease in overall manufactured housing unit volume. The volume of manufactured homes sold through Company-owned retail superstores declined 6.5% while overall manufactured housing unit volume, which includes sales to independent retailers, decreased 2.9% in fiscal 2004. The average selling price of a new manufactured home increased to $66,000 in the first six months of fiscal 2004 from $63,000 in the first six months of fiscal 2003. The increase in average selling price resulted from a slight shift in product mix towards multi-section manufactured homes to 93% of our manufactured homes sold in the first six months of fiscal 2004 from 90% in the first six months of fiscal 2003. The number of superstores was 152 at both September 27, 2002 and September 26, 2003. GROSS PROFIT. For the six months ended September 26, 2003, gross profit as a percentage of net sales declined to 26.1% from 29.1% in the six months ended September 27, 2002. Gross profit decreased 5.2% to $79.5 million in the first six months of fiscal 2003 from $83.9 million in the first six months of fiscal 2002. This decrease is the result of a decline in unit volume caused by the reduction of retail financing in the manufactured housing industry and Nationwide's gross profit being slightly lower than our manufactured housing gross profit due to Nationwide's much lower 12% internalization rate. The percentage of homes, including modular, sold through Company-owned retail superstores decreased from 79% in the first six months of fiscal 2003 to 73% in the first six months of fiscal 2004. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. As a percentage of net sales, selling, general and administrative expenses decreased to 26.1% in the first six months of fiscal 2004 from 28.3% in the first six months of fiscal 2003. Selling, general and administrative expenses decreased from $81.5 million in the six months ended September 27, 2002 to $79.4 million in the six months ended September 26, 2003 even with fiscal 2004 including six months of Nationwide's expenses totaling $4.9 million versus four months totaling $3.2 in fiscal 2003. This reduction reflects Palm harbor's focus on reducing fixed costs somewhat offset by our continued commitment to building brand awareness via advertising, expenses associated with the expansion of CountryPlace and our investment in training at all levels. 9 INTEREST EXPENSE. Interest expense decreased 15.7% to $2.9 million for the six months ended September 26, 2003 from $3.5 million for the six months ended September 27, 2002. This decrease was primarily due to a significant decline in the floor plan liability coupled with a decrease in the prime interest rate from 4.75% in the first six months of fiscal 2003 to 4.00% in the first six months of fiscal 2004. OTHER INCOME. Other income includes $4.2 million in fiscal 2004 relating to our equity interest in the earnings of our limited partnership, BSM, compared to $0.9 million in fiscal 2003. LIQUIDITY AND CAPITAL RESOURCES. In March 2003, we executed an agreement with a financial institution for a $100.0 million syndicated floor plan facility which consisted of $35.0 million expiring via orderly liquidations by the end of September 2003 and the remaining $65.0 million expiring March 19, 2006. During the quarter ended September 26, 2003, we paid off the portion of the facility which expired in September and increased the remaining $65.0 million facility to $75.0 million. In addition, we received commitments from financial institutions to increase the facility by another $10.0 million. The advance rate for this facility is 90% of manufacturer's invoice. We have a second facility with another financial institution for $10.0 million, which automatically renews each year unless notification of cancellation is received by the financial institution. These facilities are used to finance a major portion of the new home inventory at our retail superstores and are secured by a portion of our new home inventory and receivables from financial institutions. The interest rates on the facilities are prime (4.0% at September 26, 2003) or prime plus 1.0% to 3.0% for aged units, of which we have none under our floor plan arrangements. These two floor plan facilities contain certain provisions regarding minimum financial requirements which we must maintain in order to borrow against the facilities. As of September 26, 2003, we were in compliance with these provisions; however, no assurances can be made as to whether we will be in compliance with these provisions in future periods. In the event we are not in compliance with these provisions in future periods, we would seek a waiver of any default from the lending institutions and, if no such waiver was obtained, maturities of outstanding debt could be accelerated. We had $82.8 million and $114.4 million outstanding on these floor plan credit facilities at September 26, 2003 and March 28, 2003, respectively. With the exit of most of the major industry chattel and non-conforming mortgage lenders, we are expanding CountryPlace from being an originator of loans into a securitizer and servicer of loans as well. CountryPlace has entered into an agreement with a financial institution for a $125 million warehouse facility to fund chattel loans originated by company-owned retail superstores. This facility is collateralized by specific receivables pledged to the facility and bears interest at the rate of LIBOR (1.12% at September 26, 2003) plus 1.25%. The facility terminates on March 19, 2004; however, we plan to renew or obtain a similar facility prior to the termination date. The facility provides for an advance of 65% against the outstanding principal balance of eligible receivables as defined in the warehouse agreement. CountryPlace had outstanding borrowings under this facility of $39.6 million as of September 26, 2003. The facility contains certain requirements relating to the performance and composition of the receivables pledged to the facility and certain financial covenants, which are customary in the industry. The facility also requires Palm Harbor and CountryPlace to maintain a minimum balance of shareholders' equity. As of September 26, 2003, both Palm Harbor and CountryPlace were in compliance with these requirements. In connection with the warehouse borrowing facility, Palm Harbor agreed to fund in cash to CountryPlace, up to 25% of each loan loss incurred. As of September 26, 2003, no such loss funding was required to be made to CountryPlace. Additionally, Palm Harbor has entered into an intercompany financing arrangement with CountryPlace that provides for up to $25 million of funding to be used for the growth of CountryPlace's portfolio and operations. 10 CountryPlace currently intends to originate and hold loans for investment on a long-term basis. CountryPlace intends to securitize its loan portfolio on a routine basis. While the Company believes it will be able to obtain additional liquidity through the securitization of such loans, no assurances can be made that we will successfully complete securitization transactions on acceptable terms and conditions, if at all. Our management believes that cash flow from operations, together with floor plan financing and other available borrowing alternatives in addition to the warehouse facility, will be adequate to support our working capital, currently planned capital expenditure needs and expansion of CountryPlace in the foreseeable future. However, because future cash flows and the availability of financing will depend on a number of factors, including prevailing economic and financial conditions, business, the market for asset backed securitizations and other factors beyond our control, no assurances can be given in this regard. 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: o AVAILABILITY OF RETAIL FINANCING. Since mid-1999, loans to purchase manufactured houses have been subjected to elevated credit standards, resulting in reduced lending volumes and consequently reduced sales in the manufactured housing industry. A further tightening of credit standards by chattel or mortgage lenders may cause us to experience significant sales declines. o AVAILABILITY OF WHOLESALE FINANCING. Several floor plan lenders have chosen to exit the manufactured housing business, thereby reducing the amount of credit available to industry retailers. Further reductions in the availability of floor plan lending may affect our inventory levels of new homes. o MANAGEMENT'S ABILITY TO ATTRACT AND RETAIN EXECUTIVE OFFICERS AND OTHER KEY PERSONNEL. We are dependent on the services and performance of our executive officers, including our Chairman of the Board, Lee Posey and our President and Chief Executive Officer, Larry Keener. The loss of the services of two or more of our executive officers could have a material adverse effect upon our business, financial condition and results of operations. 11 o ABILITY TO SECURITIZE OR FUND LOANS. CountryPlace originates chattel and non-conforming land home mortgage loans that are funded with proceeds from its warehouse borrowing facility borrowings from us. CountryPlace intends to enter into asset-backed securitization transactions to obtain longer term funding for these loan purchases. The proceeds from these securitizations will be used to repay borrowings from the warehouse facility and us, as well as to purchase new loans. The asset-backed securitization market for manufactured housing lenders has continued to deteriorate in the past year in terms of access to the markets as well as pricing and credit enhancement levels. If CountryPlace is unable to securitize its loans on terms that are economical, it will be required to seek other sources of long term funding. o ABILITY TO SERVICE NEW LOANS. Although CountryPlace has originated loans since 1995, it has limited loan servicing and collections experience. CountryPlace has 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 a loan portfolio. However, if CountryPlace is not successful in its servicing and collection efforts, the profitability and cash flow from the loan portfolio on its balance sheet could be adversely affected. o ABILITY OF CUSTOMERS TO REPAY LOANS. CountryPlace makes loans to borrowers that it believes are creditworthy based on its credit guidelines. These customers may experience adverse employment, financial, or life circumstances that affect their ability to repay their loans. If customers do not repay their loans, the profitability and cash flow from the loan portfolio on its balance sheet could be adversely affected. o CONTROL BY EXISTING SHAREHOLDERS. Approximately 55% of our outstanding Common Stock is beneficially owned or controlled by Mr. Posey, Capital Southwest Corporation and its wholly-owned subsidiary, Capital Southwest Venture Corporation, and William R. Thomas, President of Capital Southwest Corporation. As a result, these shareholders, acting together, will be able to determine the outcome of elections of our directors and thereby control the management of our business. o INTEREST RATE RISK. Palm Harbor is exposed to market risks related to fluctuations in interest rates on our variable rate debt and our fixed rate loans receivable balances. A material increase in interest rates could adversely affect Palm Harbor's operating results by increasing interest expense on our variable rate obligations and decreasing the fair value of our loan portfolio. o IMPACT OF INFLATION. The past several years have shown a relatively moderate rate of inflation which we have has been able to offset through increased selling prices. A material increase in inflation in the future could adversely affect our operating results. o COMPETITIVE PRODUCT ADVERTISING, PROMOTIONAL AND PRICING ACTIVITY. There are numerous manufactured housing companies in the industry and many have their own retail distribution systems and consumer finance operations. In addition to competition within the manufactured housing industry, our products also compete with other forms of lower to moderate-cost housing, including site-built homes, apartments, townhouses and condominiums. If we are unable to address this competition, growth of our business could be limited. 12 o CYCLICALITY OF THE MANUFACTURED HOUSING INDUSTRY. The cyclical and seasonal nature of the industry causes our revenues and operating results to fluctuate and makes it hard for management to forecast sales and profits in uncertain times. As a result of seasonal and cyclical downturns, we may experience fluctuations in our operating results that make difficult period-to-period comparisons. o VOLATILITY IN OUR STOCK PRICE. Our stock is traded on the Nasdaq National Stock Market and is therefore subject to market fluctuations. o TERRORIST ATTACKS/WAR. Market disruptions and other effects resulting from the terrorist attacks on September 11, 2001 or any future attacks and actions, including armed conflict by the United States and other governments in reaction thereto may materially adversely affect us. Item 3. Quantitative and Qualitative Disclosure About Market Risk We are exposed to market risks related to fluctuations in interest rates on our variable rate debt, which consists primarily of our liabilities under retail floor plan financing arrangements and warehouse revolving debt, and our fixed rate loans receivable balances. We are not involved in any other market risk sensitive contracts or investments such as interest rate swaps, futures contracts, or other types of derivative financial instruments. CountryPlace is exposed to market risk related to the accessibility and terms of financing in the asset-backed securities market. CountryPlace intends to securitize its loan portfolio as a means to obtain long term fixed interest rate funding. The asset-backed securities market for manufactured housing has been volatile during the past year. The inability to securitize its loans would require CountryPlace to seek other sources of funding or to reduce or eliminate its loan originations if other sources of funding are not available. For variable interest rate obligations, there have been no material changes from the information provided in our form 10-K for the year ended March 28, 2003. For fixed rate loans receivable, changes in interest rates generally do not change future earnings and cash flows, but do affect the fair market value of the loan portfolio. Assuming CountryPlace's level of loans held for investment as of September 26, 2003 is held constant, a 10% increase in average interest rates would decrease the fair value of our portfolio by approximately $4.5 million. Item 4. Controls and Procedure Based on our most recent evaluation, which was completed within 90 days of the filing of this Form 10-Q, our Chief Executive Officer and Chief Financial Officer believe our disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) are effective to ensure that information required to be disclosed by us in this report is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. There were no significant changes in our internal controls or other factors that could significantly affect these controls subsequent to the date of their evaluation and there were no corrective actions with regard to significant deficiencies and material weaknesses. 13 PART II. OTHER INFORMATION Item 1. Legal Proceedings - Not applicable Item 2. Changes in Securities - Not applicable Item 3. Defaults upon Senior Securities - Not applicable Item 4. Submission of Matters to a Vote by Security Holders - Not applicable Item 5. Other Information - Not applicable Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits Exhibit 31.1 - Certificate of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Exhibit 31.2 - Certificate of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Exhibit 32.1 - Certificate of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Exhibit 32.2 - Certificate of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K - Not applicable SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereto duly authorized. Date: November 3, 2003 Palm Harbor Homes, Inc. ----------------------- (Registrant) By: /s/ Kelly Tacke ------------------------------- Kelly Tacke Chief Financial and Accounting Officer By: /s/ Lee Posey ------------------------------- Lee Posey Chairman of the Board 14