PALM HARBOR HOMES INC /FL/ - 10-Q Quarterly Report

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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 June 27, 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 Identification Number)
incorporation or organization)

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 August 4, 2003 --
22,856,788.

PALM HARBOR HOMES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)

See accompanying notes.

1

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

See accompanying notes.

2

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

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 and accurate
presentation. 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.

As discussed in the audited financial statements for the year ended
March 28, 2003, the Company adopted an accounting policy to no longer
present a 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 as of June
27, 2003 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.

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 month periods ending June 27, 2003 and
June 28, 2002 (in thousands):

3. Inventories

Inventories consist of the following (in thousands):

4

PALM HARBOR HOMES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)

4. Floor Plan Payable

In March 2003, the Company executed a $100.0 million syndicated floor
plan facility with a financial institution. The advance rate for this
facility is 90% of manufacturer's invoice. On March 19, 2006, $65
million of this facility will expire and the remaining $35 million will
expire via orderly liquidations by the end of September 2003. The
Company is continuing to explore its options to replace the $35 million
portion of the facility. During the quarter ended June 27, 2003, the
Company used $14.6 million of its cash to reduce this facility leaving
an outstanding balance on the portion liquidating in September of
approximately $20 million. 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 home inventory at the Company's retail superstores and
are secured by a portion of its home inventory and receivables from
financial institutions. The interest rates on the facilities are prime
(4.00% at June 27, 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 June 27, 2003, the Company was in
compliance with its $100.0 million syndicated floor plan facility and
had obtained a limited forbearance with respect to a violation of its
minimum covenant requirements on its $10.0 million facility. The
Company had $99.9 million and $114.4 million outstanding on these floor
plan credit facilities at June 27, 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 June 27, 2003) plus 1.25%. The facility terminates on
March 19, 2004. The facility provides for an advance of 65% against the
outstanding principal balance of eligible receivables, as further
defined in the warehouse agreement. CountryPlace had outstanding
borrowings under this facility of $27.2 million as of June 27, 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 June 27, 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 June 27, 2003 there had been no losses related to any loans in the
portfolio and no such loss funding was required. 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.

5

PALM HARBOR HOMES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)

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
June 27, 2003, the Company estimates that its potential obligations
under all repurchase agreements were approximately $14.5 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 or results of operations of
the Company.

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 calls and the average cost per call.

The following table summarizes the changes in accrued product warranty
obligations during the first quarter of fiscal 2004. The accrued
product warranty obligation is classified as accrued liabilities in the
condensed consolidated balance sheets.

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, increased 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 levels, declining
wholesale shipments and declining margins for most industry participants.
Although industry-wide shipments for calendar 2003 through May were down 27% as
compared to the prior year, our shipments declined only 7%.

Despite these difficult conditions, we have not closed any manufacturing
facilities and our number of Company-owned retail superstores has slightly
increased to 153. In addition, we operated profitably during the first quarter
of fiscal 2004. We continued to tightly manage receivables and new home
inventory per retail superstore, which has declined 6% since the beginning of
our fiscal year and over 20% since the first quarter of fiscal 2003. Floor plan
payable per retail superstore has declined 13% since the beginning of the fiscal
year and over 25% compared to a year ago.

During the first quarter of fiscal 2004, we have continued 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
$48 million in chattel loans and during the first quarter of fiscal 2004, BSM
originated 4,509 conventional mortgage loans worth $603 million, $53 million of
which were for Palm Harbor customers. For the quarter, 50% 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.

7

The following table summarizes certain key sales statistics as of and for the
three months ended June 27, 2003 and June 28, 2002.

THREE MONTHS ENDED JUNE 27, 2003 COMPARED TO THREE MONTHS ENDED JUNE 28, 2002

NET SALES. Net sales increased 12.6% to $155.9 million in the first
quarter of fiscal 2004 from $138.5 million in the first quarter of fiscal 2003.
The increase in net sales was primarily due to modular sales which totaled $15.0
million in fiscal 2004 versus $4.6 million in fiscal 2003. Overall manufactured
housing unit volume and the average selling prices increased slightly. The
volume of manufactured homes sold through Company-owned retail superstores
declined 1.0% while overall manufactured housing unit volume, which includes
sales to independent retailers, increased 2.1% in the current quarter. The
average selling price of a new manufactured home increased to $65,000 in the
first quarter of fiscal 2004 from $63,000 in the first quarter of fiscal 2003.
The increase in average selling price resulted from a slight shift in product
mix towards multi-section manufactured homes to 94% of our manufactured homes
sold in the first quarter of fiscal 2004 from 91% in the first quarter of fiscal
2003. The number of Company-owned retail superstores increased from 152 at the
end of the first quarter of fiscal 2003 to 153 at the end of the first quarter
of fiscal 2004.

GROSS PROFIT. In the quarter ended June 27, 2003, gross profit increased
2.1% to $40.4 million in the first quarter of fiscal 2004 from $39.5 million in
the first quarter of fiscal 2003. Gross profit as a percentage of net sales
declined to 25.9% from 28.6% in the quarter ended June 28, 2002. This depression
in gross profit is the result of planned inventory reductions plus the
availability of super discounted repossessions. In addition, Nationwide Custom
Homes' ("Nationwide") gross profit is slightly lower than our manufactured
housing gross profit due to Nationwide's much lower 25% internalization rate.
The manufactured housing internalization rate decreased from 83% in the first
quarter of fiscal 2003 to 80% in the first quarter of fiscal 2004.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. As a percentage of net
sales, selling, general and administrative expenses decreased to 25.8% in the
first quarter of fiscal 2004 from 29.2% in the first quarter of fiscal 2003.
Selling, general and administrative expenses decreased from $40.5 million in the
quarter ended June 28, 2002 to $40.3 million in the quarter ended June 27, 2003
even with fiscal 2004 including three months of Nationwide's expenses totaling
$3.0 million versus one month totaling $0.6 million in fiscal 2003. This
reduction is 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.

8

OTHER INCOME. Other income includes $2.4 million in fiscal 2004
relating to our equity interest in the earnings of our limited partnership, BSM,
compared to $0.1 million in fiscal 2003.

LIQUIDITY AND CAPITAL RESOURCES. In March 2003, we executed a $100.0
million syndicated floor plan facility with a financial institution. The advance
rate for this facility is 90% of manufacturer's invoice. On March 19, 2006, $65
million of this facility will expire and the remaining $35 million will expire
via orderly liquidations by the end of September 2003. We are continuing to
explore our options to replace the $35 million portion of the facility. Current
market conditions are such that we believe our best option is to use our cash to
pay down this facility. This quarter we used $14.6 million of our cash to reduce
this facility leaving an outstanding balance on the portion liquidating in
September of approximately $20.0 million. 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 home inventory at
our retail superstores and are secured by a portion of our home inventory and
receivables from financial institutions. The interest rates on the facilities
are prime (4.00% at June 27, 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 June 27,
2003, we were in compliance with our $100.0 million syndicated floor plan
facility and had obtained a limited forbearance with respect to a violation of
our minimum covenant requirements on our $10.0 million facility. We had $99.9
million and $114.4 million outstanding on these floor plan credit facilities at
June 27, 2003 and March 28, 2003, respectively.

With the recent 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 June 27, 2003) plus 1.25%. The facility terminates on March 19, 2004.
The facility provides for an advance of 65% against the outstanding principal
balance of eligible receivables as further defined in the warehouse agreement.
CountryPlace had outstanding borrowings under this facility of $27.2 million as
of June 27, 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 June 27, 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 June 27, 2003 there had been no losses
related to any loans in the portfolio and no such loss funding was required.
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.

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.

9

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 quarterly 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 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.

10

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 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.

o CONTROL BY EXISTING SHAREHOLDERS. Approximately 55% of our
outstanding Common Stock is beneficially owned or controlled
by Mr. Posey, Capital Southwest Corporation and our
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 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.

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 terrorist attacks and actions, including armed
conflict by the United States and other governments in
reaction thereto may materially adversely affect us.

11

Item 3. Quantitative and Qualitative Disclosures 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.

There have been no material changes from the information provided in our Form
10-K for the year ended March 28, 2003.

Item 4. Controls and Procedures

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 the Company 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.

12

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 on Matters to a Vote by Security Holders

a) The Annual Meeting of Shareholders of Palm Harbor
Homes, Inc. was held on July 23, 2003.

b) The following nominees were elected Directors until
the next Annual Meeting of Shareholders and until
their respective successors shall have been elected
and qualified.

Lee Posey
Larry H. Keener
William R. Thomas
Walter D. Rosenberg, Jr.
Frederick R. Meyer
John H. Wilson
A. Gary Shilling
Jerry Mallonee

c) The tabulation of votes for each Director nominee was
as follows:

d) To appoint Ernst & Young LLP as independent auditors
for the year ending March 27, 2004.

Item 5. Other Information - Not applicable

13

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: August 6, 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