Manufactured Homes

1. Manufactured Homes Presented by: Andre Lodhar Roy Fernandes David Storey Sarah Witol

2. Manufactured Homes • Founded in 1975 with 2 retail stores • By 1987 possessed a network of 120 retail outlets, all in Southeasters U.S. • Potential customers were those who could not afford traditional housing, or were looking for a second home • Customers were typically in the 18 to 40 age range who earned $20K per year or less

3. Manufactured Homes con’t • Mobile home ranged in price and in size, but Manufactured Homes mainly sold the lower end units • Behind the industry average of 30% sales to higher models, only achieving 20% of their volume but did not care • Targeted low end market : • They felt that by fulfilling an essential housing need sales were not affected by general ecomomic conditions • Customers to work very hard to keep their primary residence

4. Porter’s 5 Forces • Buyer Power • Many sellers of mobile homes, but has targeted the low end market, thus price sensitivity is very important • Manufactured Homes allows as little as a 5% down payment to take possession • No real Brand Identity in the market • Buyers are concentrated in areas (close to trailer parks)

5. Porter’s 5 Forces • Supplier Power • Discounts based on volume purchases • Products are rather standardized (especially low end mobile homes) • Market concentration in specific states • Manufactured Homes has the ability to manufacture homes on their own incase the market outpaces supply

6. Porter’s 5 Forces • Barriers to Entry • Capital requirements, to have stock of mobile homes on hand • Distribution areas are concentrated, so high competition in these areas already • Manufactured homes rely on their niche market of low end homes, any other seller could go after that market

7. Porter’s 5 Forces • Threat of Substitutes • Depreciation is high on the homes, selling and moving to a different unit is expensive • Purchasers could walk away from their mobile home (force the company to re-claim the home) and purchase a new one • Clients could upgrade with Manufactured Homes as they sell different models

8. Porter’s 5 Forces • Rivalry • Competitive advantage for Manufactured Homes are their niche market of low end mobile homes, availability of financing with small down payments • Concentrated strongly in the Southeastern USA where they have a strong presence with 114 outlets in 7 states • Other sellers are concentration on more profitable higher end units

9. Porter’s 5 Forces • Rivalry con’t • Strategic stakes are high due to re-possession of homes where people have defaulted on payments, market specific • Low exit barriers to retail outlets, but high barriers to those that manufacture the homes as well

10. Industry Direction • Southeastern USA is the fastest growing market of mobile homes, due to the weather climate, availability of land • Shifting towards higher end mobile homes • Net sales from 1986 are 54% higher than a year earlier, sales in 1985 were 125% higher than the preceding year • Southwestern states starting to experience higher concentrations as well

11. Current accounting

12. Current accounting

13. Method #2 • The cash from the bank is treated as a loan • The company transfers installment contracts with recourse to bank • The company records present value of interest rate differential (spread) • Major advantage of this method is no estimating of credit losses required • According to the SEC this is the method that should be used if estimating ability is poor

14. Method #2

15. Sales Analysis *assuming that 80% of SG&A is related to the sale of new homes The sales of new homes is not a significant contributor to Net Income!

16. Income Two Primary sources of income: • Sales of mobile homes • Finance participation

17. Current accounting

18. Red Flags • Estimates of credit losses: page 194 – 195 • Lower interest rates : • Increased refinancing • Shift in demand for Mobile homes to Conventional homes • Increase in number of prepayments • $2M write-off in Q4 1986 for increase in credit losses • Refusal of finance companies to refinance repossessions • Provision for credit losses in 1986 = $3.8M (p.203 Note 7) • Provision for losses in first 9 months = $318,539 (p.211) • Suggest large Q4 adjustment of $3.5M • Decrease in Finance participation income • increased cash sales • increased non-recourse sales • increased manufacturing sales • decrease in interest rate spread

19. Red Flags • P. 192 – Expenses appear to be misstated • P. 193 – Appears that major Q4 adjustments are being made • company not estimating but looking back and adjusting in Q4 • P.196 – Subsidiary set up – MANH Financial Services Inc. • banks refusing to finance • banks losing confidence in Manufactured Homes • P. 206 Note 13 – Recognition of $180M debt which is not on the B/S • P. 208 – New item suggests that credit losses and prepayments are a problem • selling installment contracts are becoming a problem • P. 211 – small provision for losses in first 9 months of 1986 but large full year provision (P. 203)

20. Future Potential of MH Investor Attractiveness Factors • MH currently sells a product for which there is no clear demand • Focused strategy targeted at profitable segment of the market • Rapid Growth enabled via backing of large financial institutions (GE Credit, Prudential Insurance)

21. Future Potential of MH However, • Business of buying and selling homes does not appear to make money. The finance participation income is what drives the profits • MH has a consistent operating cash flow deficit and is heavily leveraged • Grim looking future due to limited room for error due to leverage and past accounting practices

22. Post-Case Highlights • Loss of $4.5 million in the 4th quarter of 1987 resulting in a $0.8 million profit for the year. • Loss driven by 300% increase in reserve for credit losses appears to have been forced by auditors • Management blames on aggressive marketing program and conservative fiscal policy.

23. Post-Case Highlights cont.. • Upon disagreement of the auditors over 1987 interim statement credit loss estimates the company changed auditors. • In effect, the auditor felt that MH was understating the provision for future losses on credit sales and thereby overstating earnings before income taxes.

24. Post Case Highlights cont… • In 1988 the loss grows to $8.5 million for the year. • Financial institutions were now refusing to accept the transfer of instalment notes seriously impacting the finance participation income. • Customer defaults and pre-payments forced further increases in credit loss reserves. • Severe cash shortage resulted from the operating losses and increases in repossessed homes inventory.

25. Post-Case Highlights cont… • SEC announces investigation into MH’s accounting practices primarily focused on the apparent lack of ability to estimate credit losses and thus improperly recognize finance participation income. • Stock price drops significantly after Barron’s publishes an article questioning MH’s accounting practices.

26. What Happened? (1988 figures)

27. Debt Ratios (1988 figures)

28. Debt Ratios (1986 figures) • If we include the 180 million in installment sales contracts sold with recourse mentioned in Note 13 as debt, we get a glimpse into the future:

29. Questions ?