Mobile Home Installment Sale Contract by gzh11418

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									  Manufactured Homes




Presented by:   Andre Lodhar
                Roy Fernandes
                David Storey
                Sarah Witol
       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
    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
          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)
           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
           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
           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
            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
           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
          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
                              Current accounting

     Cash    + Other Assets       = Liabilities   + RE t-1   +    Salest -   Expensest

                                                                 Net worth
Home buyer makes a down payment and signs an installment contract with Manufactured
Homes (assume purchase price of $100,000)
1.    +5           + 95                                           + 100
      Cash     Installment contract                                 Sales
                   Receivable                                     Revenue
2.                  - 90                                                       - 90
                  Inventory                                                    COGS
3.                                    +5                                        -5
                                  Reserve for losses                          Bad debt
                                   on credit sales                            expenses
                             Current accounting

     Cash   +    Other Assets = Liabilities     + RE t-1    +   Salest   -   Expensest

                                                                Net worth
Company transfers installment contract receivables to financial institution and receives
cash:
1.   + 95                - 95
    Cash          Installment contract
(Face value of note) Receivable
2.    Record present value of participation income

      +5                +5                                        + 10
     Cash          Finance Participation                   Finance Participation
                       Receivable                                Income
3.    Company records an expense of the estimate of customer prepayment and
      defaults
                                      +5                                        -5
                                 Reserve for losses                          Credit loss
                                  on credit sales                             expense
                  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
                             Method #2

       Assets       = Liabilities +            Net Worth
Cash + Other Assets = Liabilities + RE(t-1) + Sales (t) - Expenses (t)

1) Company transfers installment receivables to bank with recourse

95 (cash)                95 (loan)

2) Record present value of interest rate differential
(recognize revenue only when cash is recovered)

5 (cash)                                          5 (finance participation revenue)
                       Sales Analysis

     (in millions)                                      1986          1985   1984

Net Sales                                              106.1          68.7   30.5
Less: COGS                                              86.2          56.2   24.3
      80% of SG&A *                                     18.2          10.9    4.7
      Provision for losses on credit sales               3.8           0.8    0.3
      Contribution to net income from sales
       (of new homes only)                               -2.1          0.8    1.2

     *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!
                 Income

Two Primary sources of income:
• Sales of mobile homes
• Finance participation
                             Current accounting

     Cash   +    Other Assets = Liabilities     + RE t-1    +   Salest   -   Expensest

                                                                Net worth
Company transfers installment contract receivables to financial institution and receives
cash:
1.   + 95                - 95
    Cash          Installment contract
(Face value of note) Receivable
2.    Record present value of participation income

      +5                +5                                        + 10
     Cash          Finance Participation                   Finance Participation
                       Receivable                                Income
3.    Company records an expense of the estimate of customer prepayment and
      defaults
                                      +5                                        -5
                                 Reserve for losses                          Credit loss
                                  on credit sales                             expense
                                 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
                             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)
       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)
        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
         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.
   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.
   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.
  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.
What Happened? (1988 figures)
Balance Sheet                                        As Reported Restated

Current Assets                                       $   79,876   $ 80,010
Net finance participation receivable - non-current   $   20,131   $     -
Installment contracts receivables                    $      -     $ 303,000
Net property plant and equipment                     $    6,748   $   6,748
Deffered income taxes                                $    3,534   $   3,534
Other Assets                                         $    9,088   $   9,088

Total Assets                                         $ 119,377    $ 402,380

Current Liabilities                                  $   59,522 $ 59,522
Notes payable to finance companies                   $      -    $ 303,000
Other long-term debt                                 $   43,000 $ 43,000
Deferred finance participation income                $      -    $ 20,771
Reserve for credit losses                            $   12,975 $    9,063
Stockholder's equity                                 $    3,880 -$ 32,976

Total liabilities and equity                         $ 119,377    $ 402,380
Debt Ratios (1988 figures)


                      As Reported Restated

Debt/Capital Ratio              86%        101%

unhealthily high value of borrowing gets worse

Debt/Equity Ratio            2642%       -1230%

emphasizes the series of losses
   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:

                      As Reported Restated

  Debt/Equity Ratio           477%      1753%
Questions ?

								
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