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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