Triangle Homes Module 1 - Triangle Manufactured Homes...

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Unformatted text preview: Triangle Manufactured Homes Off-Balance-Sheet Transfers of Subprime Loans A capstone case for auditing and accounting studies Robert H. Ashton and Timothy B. Bell Triangle Manufactured Homes Off-Balance-Sheet Transfers of Subprime Loans November 2008 Robert H. Ashton L. Palmer Fox Professor of Accounting Duke University Timothy B. Bell Coggin Distinguished Professor of Accounting University of North Florida KPMG LLP (Retired) © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. 22 TMH Case Study – Module 1 Instructions Module 1 Module 1 Instructions Requirements This assignment requires a memorandum in which you present your understanding of TMH’s business and environment, including its key financial characteristics and accounting practices. In the memorandum, you will also provide your assessment of significant inherent risks, at the account level, in the proposed 2007 financial statements, as well as your assessment of going concern risk and fraud risk in view of the understanding you have developed. A single memo is required, and it should include your insights on four interrelated areas: business analysis, accounting analysis, financial analysis, and audit risk assessments.The memo should include separate sections for the first three analyses, and in a fourth section on risk assessments you should discuss clearly and succinctly the linkages between your risk assessments and your integrated business understanding. Analyses from all three perspectives—business, accounting, and financial—are required to provide a proper basis for risk assessments and audit planning, and your memo should reflect this. The most important element of your memo will be your supporting rationale for why you think the inherent risks you identify are significant, and why your assessments of going concern and fraud risks are at the levels you assess. Identification of the linkages between your risk assessments and your integrated business understanding should help you develop your rationale. If you are working on this assignment in a team of students, your team may parse, and work separately on, different tasks. At some point, however, team members should meet, share findings and brainstorm to develop consensus on your judgments and assessments, before the team’s final memo is prepared. Additional Background and Guidance Business Analysis The business analysis section of your memo should present the results of your evaluation of TMH’s industry and competitive environment. Consider how the company operates within its industry and environment to create value for shareholders. Another way to think of this is: How does TMH make money? Examples of factors you may want to consider during this part of your analysis are: • nature of competition in the industry • business strategy • business model © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Instructions 23 • key profit drivers • business processes and cost drivers • critical success factors and critical risk factors • changes in competitive, economic, social and demographic factors that could affect Accounting Analysis the success of both the industry in which the company operates and the company itself. The accounting analysis section of your memo should present the results of your evaluation of TMH’s accounting and disclosure practices in the context of your business analysis. Consider the extent to which TMH’s financial statements, notes, and related disclosures such as management’s discussion and analysis (MD&A) reflect the company’s underlying economic reality and how effectively they communicate that reality to investors. Examples of factors you may want to consider during this part of your analysis are: • how well reported earnings reflect the company’s economic performance • how well reported values of assets and liabilities reflect its economic resources and obligations • relationship between earnings and cash flows • sustainability of earnings and cash flows over time • complexity of its underlying transactions • management’s key accounting policies and the impact of those policies on reported financial results • extent to which earnings, assets and liabilities involve estimates, judgments, and forecasts made by management and forecasts over time financial statements • changes in accounting policies and management’s estimates, judgments, • how well notes to the financial statements enhance information in the • extent to which information is enhanced through other related disclosures such as MD&A and the letter to shareholders. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 • sustainability of the business model over time 24 TMH Case Study – Module 1 Instructions Module 1 Financial Analysis The financial analysis section of your memo should present the results of your evaluation of TMH’s current financial condition and future prospects in the context of your business analysis and accounting analysis. Included in this section should be a consideration of key financial indicators relevant to the company. Examples of factors you may want to consider during this part of your analysis are: • extent to which profitability and growth are driven by operating, investing, and financing activities • how profitability, growth, and the results of operating, investing, and financing activities are reflected in key balance sheet and income statement accounts composition over time • composition of assets, liabilities, revenues, and expenses, and changes in their • trends in key indicators of profitability, liquidity, and solvency • relation of profitability, liquidity, and solvency indicators to industry norms • impact of management’s accounting policies and management’s estimates, judgments and forecasts on financial indicators. Audit Risk Assessments After completing the business, accounting and financial analyses described above, your attention should turn to an assessment of the risks of material misstatements at the account balance level. Your risk assessments should consider all of the balance sheet and income statement accounts reported in the financial statements. You should consider specific assertions embodied in an account when making risk assessments at the account balance level. Note that the assessed risks of material misstatements for particular financial statement accounts can range from low to high. Your memo should clearly indicate the balance sheet and income statement accounts for which you assess the risks of material misstatements to be other than low. The memo need not discuss accounts you consider low risk. More important, however, is your provision of an in-depth rationale for each accountlevel risk assessment that is other than low. You should carefully explain why you believe the particular financial statement accounts you identify involve other than low risk. In making these assessments of the risks of material misstatements, note that you are assessing inherent risk as you have no specific information on the design and functioning of TMH’s internal control system. Going Concern and Fraud Risks You should also provide preliminary assessments of going concern risk and fraud risk related to the TMH audit, and an in-depth rationale for your going concern risk and fraud risk assessments. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Instructions 25 Provided By Client A key resource that is provided is TMH’s preliminary 2007 financial statements and proposed disclosures. This resource consists of preliminary information management proposes to include in the annual report dated December 31, 2007—including the financial statements, notes to the financial statements, and MD&A—as well as selected additional disclosures required by the SEC. All of the information provided has been prepared by the management of TMH. This information is preliminary in that the TMH audit team has not yet concluded whether it satisfies applicable financial reporting requirements, including SEC requirements, as the audit is still in process. The information provided, however, is a substantial portion of what TMH management proposes be filed with the SEC and released to shareholders and the public. You also have available the results of some financial analyses that TMH management has conducted, for its own internal purposes, on the preliminary 2007 numbers and those of preceding years. These consist of financial ratio analyses and common-size and growth analyses. International Standards on Auditing You should review three International Standards on Auditing (ISAs) to help you plan your risk assessment approach: ISA 315 dealing with audit risk assessment generally; ISA 240 dealing with the auditor’s need to consider fraud during the audit; and ISA 570 dealing with the going concern risk assessment. These materials can be accessed via the web at: http://www.ifac.org/ IAASB/About.php by following these instructions: 1) Highlight the “Pronouncements” drop down menu 2) Select “Standards” 3) Under Standards select International Standards on Auditing (ISAs) 4) Under “Publication: (choose most recent year, e.g., 2008) Handbook of International Auditing, Assurance, and Ethics Pronouncements (PDF Version).” 5) Click on “Download for Free” 6) In the lower portion of the box labeled Auditing, Assurance & Related Services under the Linked PDF section select “(Year) Handbook of International Auditing, Assurance, and Ethics Pronouncements— Part I (Linked) 7) Click on Download in the PDF box 8) At the bottom of the first page, select Auditing, Review, Other Assurance, and Related Services 9) In the Table of Contents scroll down to the specific ISA (same as Handbook section number) that you want to download and click on the ISA title 10) Select “Save As” from the File menu and save the ISA to your desktop or destination folder 11) To download another ISA (section number), click the Back arrow in the toolbar menu and repeat steps 9 and 10. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 Resources 26 TMH Case Study – Module 1 Instructions Module 1 Other Resources You may access additional resources as well. Additional resources you might find useful include professional accounting and auditing pronouncements, textbooks and other instructional materials, and resources available on the Internet. The Internet is an excellent source for industry information. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Annual Report © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 28 TMH Case Study – Module 1 Proposed Annual Report Module 1 TRIANGLE MANUFACTURED HOMES Preliminary Information for Form 10K and Annual Report December 31, 2007 Quality Value A Square Deal for Today’s Manufactured Home Buyer TM Comfort Style © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 29 Preliminary Information for Form 10K and Annual Report December 31, 2007 Letter to Stockholders .................................................................................................... 2 Business Description ....................................................................................................... 5 Selected Financial Information.................................................................................... 19 Information on Common Stock Prices and Dividends ............................................ 20 Consolidated Financial Statements ........................................................................... 22 Balance Sheets Statements of Income Statements of Stockholders’ Equity Statements of Cash Flows Notes to Consolidated Financial Statements ........................................................... 27 Management’s Discussion and Analysis of Financial.............................................. 46 Condition and Results of Operations © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 TRIANGLE MANUFACTURED HOMES 30 TMH Case Study – Module 1 Proposed Annual Report Module 1 Letter to Stockholders The year 2007 was a period of significant accomplishment for your company that served to strengthen our leadership position in the manufactured homes industry. The results achieved were the culmination of a corporate development plan set in motion years ago. For the fourth consecutive year revenues reached record levels, $267 million compared with $176 million in 2006. From $24 million in revenues in 2004 and a position of near obscurity in the industry, our progress has led us to a position of industry leadership. We are now one of the largest retailers of manufactured homes in the nation. As part of our long-term efforts to increase market share, we added 39 retail sales outlets in 2007, bringing the total to 114 at year-end. This 52 percent increase in retail sales outlets was accompanied by a 61 percent increase in new and used homes sold, bringing the total to 6,239 homes sold. We now have retail outlets in nine states that combined represent approximately 45 percent of the total U.S. market for manufactured homes. We continue to be primarily a sales and marketing company with manufacturing and retail financing on a limited basis to support the company’s growth plan. We completed a major financing in April 2007 and a second financing in February 2008 that together totaled $95 million. A portion of the proceeds was used to pay down variable rate debt— associated with inventory financing— with fixed rate debt and save money in the process. The remainder of the proceeds will be used for general corporate purposes. We are pleased with our growth over the last four years. Some describe our growth as explosive. We, however, consider these accomplishments a direct result of a well-structured and carefully executed corporate development plan. Our plans for growth are founded on the basic premise that expansion must not exceed our ability to manage our affairs. While we are extremely pleased with our revenue performance, we are also mindful that we must operate profitably—basic earnings per share for 2007 was only 69 cents. The sharp decline in 2007 earnings is directly related to a fourth quarter net loss of $3.6 million. Charges against earnings in the fourth quarter for losses related to sales of receivables totaling approximately $6.5 million, coupled with the cost of strengthening your companys position in the marketplace, created a temporary setback in earnings while establishing a basis for a strong 2008. A strategic plan can only be confirmed as correct when tested by adversity; and last year was something of an acid test for our industry. During 2007, many retailers, in hopes of gaining greater market share, or in some cases hoping for survival, engaged in excessive price cutting. In addition, some financial institutions, in response to concern over the economy in some geographic areas, tightened their lending policies. Others exited the market altogether. We not only dealt with the problems that confronted us but turned some into opportunities. Over the years management has made it a practice to monitor the various retailers of manufactured homes in our operating area. First, we wanted to understand our competition; and second, we were looking for acquisition candidates. From a large list of companies, we singled out those that best met our standards of performance. We wanted only those firms with superior management and sales teams. During 2007, we were able to acquire two of these firms on favorable terms, and we left management in place. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 31 Our independent dealer network continues to grow; as of March 1, 2008, we have 26 independent dealers. The independent dealer program offers important advantages and opportunities. Because of the advantages we bring to these small dealers, we continue to receive more requests to join our team. Our Company owned and operated sales centers continue their strong growth as well. In 2004, we had 13 company owned and independent outlets combined; in 2005, the number was 32 and as of January 1, 2008, we have 125 Company owned and independent outlets. During the last half of 2007, we sacrificed short-term results to increase market share. We attained that share and as expected it cost us dearly. Selling, general and administrative expense increased from an average of $10 million in the first and second quarters to $13 million in the third, and to $18 million in the fourth quarter. As we look to 2008, it is with the knowledge that we are working from a solid foundation. Our financial position is strong. Our debt service requirements are manageable without impairing future earnings performance. Our retail network continues to mature, and sales by location will increase. Our goal in 2008 is to maintain our market share and show a substantial increase in profit margin. Your Board of Directors has shown confidence in our ability to perform by authorizing me to give you a conservative estimate of our 2008 revenues. Our first quarter revenues are expected to be $75 million with earnings per share at 36 cents. If current economic conditions continue, we expect 2008 revenues to be $350-360 million. A Square Deal for Today’s Manufactured Home BuyerTM is not just a slogan. At Triangle Manufactured Homes, it’s a philosophy that guides everything we do. The results since our initial public offering in 2004 are a testament to that philosophy. With the continued confidence and support of our employees, financial institutions, suppliers and customers, and especially our investors, 2008 should be another great year. Vernon L. Bryant Chairman of the Board, President and Chief Executive Officer © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 As a result, we succeeded in not only deepening our market penetration in our traditional states of North Carolina, South Carolina, Tennessee, Georgia, and Florida, but were able to enter new markets with 11 retail outlets in Kentucky and Virginia and four additional outlets in Tennessee and Alabama. 32 TMH Case Study – Module 1 Proposed Annual Report Module 1 Business Description General Established in 1996, Triangle Manufactured Homes (the Company), a North Carolina corporation, is primarily engaged in retail sales of manufactured homes (commonly referred to as “mobile homes”). At the beginning of 2007, the Company was selling through 75 retail sales centers, of which 64 were Company owned. The Company had agreements with 11 independent retailers pursuant to which the Company supplies inventory and financing. The retail sales centers owned by the Company were located in North Carolina, South Carolina, Tennessee, Florida, Georgia, Alabama, and West Virginia, and were operated under various trade names representing the retail sales outlets owned by the Company’s subsidiaries: AMH Home Centers, headquartered in Apex, North Carolina; Northern Florida Home Retailers, headquartered in Tallahassee, Florida; and West Virginia Mountain Valley Homes, headquartered in Morgantown, West Virginia. During 2007, as part of the Company’s overall strategy to reorganize itself along geographic and operational lines and to begin to centralize administrative operations in the parent company, four new subsidiaries were acquired or formed. The Company acquired Howard Connell Homes of Tennessee, headquartered in Columbia, Tennessee, with four retail sales centers located in Tennessee and Alabama, and completed the acquisition of Jim Bell Majestic Homes, headquartered in Middlesboro, Kentucky, with 11 retail sales centers located in Kentucky and Virginia. On December 18, 2007, the Company formed TMH Independent Retailers Corp., which will supervise and administer the Company’s independent retailer program, leaving supervision of Company owned sales facilities to the Company’s retail sales subsidiaries. By the end of 2007, the Company was selling through 114 retail centers, of which 92 were Company owned. On October 15, 2007, the Company established TMH Financial Services Corp. This wholly owned subsidiary will emphasize retail financing and the transfer, to unrelated financial institutions, of retail installment sales contracts received by the Company and its independent retailers in connection with the sale of new and used manufactured homes. The Company did not establish this finance subsidiary to compete with the financial institutions that have historically provided mortgage banking requirements. Instead, this new entity will be employed primarily to facilitate financing agreements with the Company’s banks. TMH Financial Services Corp. has mortgage lending capabilities that will only be employed when conventional banking arrangements are unable to act on a timely basis. Management has no intention of expanding its finance operations. As it exists now, it provides the Company with the flexibility required to deal quickly with mortgage finance transactions. The Company’s executive offices are located at 6300 Fernwood Parkway, Raleigh, North Carolina, where it leases 16,000 square feet of an office building containing approximately 24,000 square feet. The principal offices of TMH Financial Services Corp. and TMH Independent Retailers Corp. are also located within the Company’s facilities at 6300 Fernwood Parkway. Two of the Company’s subsidiaries, AMH Home Centers and Rockdale Manufactured Home Builders, own 11,000 square feet in Apex, North Carolina, and 6,000 square feet in Roxboro, North Carolina, respectively, for their principal offices. Howard Connell Homes of Tennessee’s principal offices are located in a 1,680 square foot manufactured home office unit on leased property in Columbia, Tennessee. Northern Florida Home Retailers, West Virginia Mountain Valley Homes, and Jim Bell Majestic Homes lease approximately 5,000 square feet in Tallahassee, Florida, 2,800 square feet in Morgantown, West Virginia and 2,200 square feet in Middlesboro, Kentucky, respectively, for their principal offices. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 33 The Company’s sales operations are conducted from 92 Company owned sales centers located in North Carolina, South Carolina, Tennessee, Georgia, Alabama, Florida, Kentucky, Virginia and West Virginia. All sales centers are located on leased premises. Leases have varying provisions, with lease terms ranging from month-to-month to periods expiring in 2017 (including options to renew). Rents paid by the Company during the year ended December 31, 2007, for the leased sales centers totaled approximately $2.2 million. Aggregate current annual rentals for all properties leased by the Company approximate $3 million. The Company’s retail sales centers generally consist of lots varying from one to five acres on which the manufactured home inventory and a small sales office are located. The sales offices range in size from 672 square feet to 1,344 square feet and are typically manufactured home office units. The 92 sales centers are located as follows: North Carolina (39), South Carolina (15), Tennessee (10), Georgia (4), Florida (6), Alabama (5), Kentucky (6), Virginia (5), West Virginia (2). In addition to the office facilities described above, the Company owns two parcels of real estate, one in Asheville, North Carolina, and one in Kernersville, North Carolina. There is a sales center on the Asheville property, and the Kernersville property is vacant. Rockdale Manufactured Home Builders, the Company’s manufacturing facility, owns a 128,000 square foot building in Roxboro, North Carolina. On April 25, 2007, the Company entered into a Note Agreement with Delaware Insurance and Guaranty (Delaware), whereby Delaware purchased $40,000,000 of the Company’s 9% Convertible Subordinated Notes (the Notes) due May 15, 2022. The Notes are convertible into the Company’s common stock at $17.50 per share. On February 13, 2008, the Company entered into a second Note Agreement with Delaware Insurance and Guaranty, whereby Delaware purchased the Company’s 8.64 % Senior Notes (Series A Notes) due February 15, 2011, in the aggregate principal amount of $33 million, and the Company’s 9.42 % Senior Notes (Series B Notes) due February 15, 2013, in the aggregate principal amount of $22 million. Both placements were managed by Hayes Willingham and Co. Both the Series A Notes and the Series B Notes are unsecured. The proceeds of the purchase of the notes from both transactions were used to reduce the Company’s floor plan indebtedness, capitalize TMH Financial, and for general corporate purposes. Products The Company offers a variety of styles of manufactured homes, including both single-section and multi-section units. Single-section homes are 14 feet wide. Multi-section homes are built as two 12- or 14-foot-wide units that are joined together at the installation site. The manufactured homes sold by the Company typically have two to four bedrooms, two or three baths, a living room, kitchen and dining areas, and often a family room with a wide variety in the size, number and layout of rooms among the various models. The homes vary in length from 48 to 76 feet. The single-section homes range in size from 672 to 1,064 square feet and retail at prices ranging from $30,000 to $55,000, with a majority of homes selling at prices below $38,000. The multisection homes range in size from 1,152 to 2,128 square feet and retail at prices ranging from $43,000 to $90,000. While approximately 40 percent of all unit sales in the industry in 2007 were multi-section homes, sales of multi-section homes represented approximately 22 percent of the Company’s unit volume in 2007, consistent with the Company’s marketing strategy. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 34 TMH Case Study – Module 1 Proposed Annual Report Customer differentiation between models of manufactured homes is based principally on price and the size, layout and features of the models. Generally, the stated price of a home includes as standard equipment central heating, range, refrigerator, a gas or electric water heater, draperies, and wall-to-wall carpeting as well as delivery and set-up on the purchaser’s site. Additional items that would be available as options in a conventional home may also be purchased as options in manufactured homes. Additional options include central air conditioning, energy efficiency packages, a wood-burning fireplace, washing machine, dryer, dishwasher, garbage disposal unit, microwave oven, bay windows, and various types of furniture. Several decors may be selected. Homes are usually purchased completely furnished. Module 1 Industry Developments The manufactured home industry is fragmented. The majority of manufactured home retailers throughout the nation are small. The industry has undergone a period of consolidation during the past five years. More and more of the smaller firms, lacking volume buying power and adequate capitalization, are disappearing or becoming part of a larger company like Triangle Manufactured Homes. The industry has always been competitive but has become more competitive in recent years. Continuing increases in the price of conventional housing have forced low income families to seek other alternatives. Many are turning to manufactured homes, which have more to offer than an apartment, with the added advantage of equal or lower monthly payments. In 2007, sales of manufactured homes accounted for approximately 10 percent of all sales of singlefamily housing in the United States. In the past, the manufactured home industry suffered from consumer misconceptions created in large part by use of the term “mobile home.” While manufactured homes can be transported from place to place, only about five percent are ever relocated once in place.In addition, more than two-thirds of all manufactured homes sold are placed on private property. And furthermore, the features offered in today’s homes are equal to those found in conventional housing but at less cost. Industry estimates indicate there are 23 million people living in 10 million manufactured homes, with a median household income of $30,000. Because of the quality and price advantage, the number of manufactured home buyers is expected to increase for the foreseeable future. As competition for market share increases, companies like Triangle Manufactured Homes will benefit if for no other reason than the financial advantages volume buying affords. This is the primary reason so many independent dealers are actively seeking a working relationship with our company. The same can be said of those companies willing to be acquired. The manufactured home industry faced a very difficult year in 2007. Industry sales nationwide were down approximately 18 percent from 2006. The nine-state regional market where the Company concentrates its sales efforts experienced a 14 percent drop in sales. Despite these poor economic conditions, the Company experienced approximately a 50 percent increase in sales over 2006. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 35 The Company’s marketing strategy has proven effective in that its repossession experience in 2007 was among the lowest in the industry. Repossessions have caused an increasing problem in the industry in 2007 due to the limited number of lenders willing to finance sales of repossessed homes. The Company has had some success in addressing this problem because of its arrangements with financial institutions that allow the Company to finance the resale of repossessions with the original lenders. Competition Retail sales of manufactured homes is highly competitive. There are numerous retail dealers in the areas where the Company has its sales centers. The Company competes with both small companies and with large vertically integrated manufacturers and retailers. Competition is based primarily on the price and features of homes offered, availability and terms of customer financing, and reputation for service and durability of the home over time. Other factors are sales center location and the ability of the sales force. Other forms of housing, such as conventionally built homes, condominiums, and rental housing, compete with manufactured homes as sources of moderately priced housing. Management believes that consumer demand for manufactured homes increases as the price of traditional housing increases. The Company’s success also depends on management’s ability to recognize and react to changes in market conditions and consumer preferences. The availability of sites for manufactured homes and the restrictive zoning practices of some municipalities in the Company’s markets have an impact on consumer demand. Sales and Marketing The Company’s sales consist of manufactured homes purchased from several manufacturers and homes manufactured by the Company’s subsidiary, Rockdale Manufactured Home Builders, headquartered in Roxboro, North Carolina. The Rockdale facility was not acquired as a means of competing with the major manufacturers, but to safeguard the Company during periods when demand for homes outpaced supply. It also provides the opportunity to manufacture specially designed homes in smaller numbers, thereby eliminating the major commitment that would be required by partnering with unaffiliated suppliers. When Rockdale was acquired in September 2006, it was producing one home per day. That operation is now producing ten homes per day. Large numbers of customers have been asking for more entertainment features in their homes. Relying on this new manufacturing capability, the Company has responded with a home called the Family Entertainment model, and sales have been most rewarding. The principal materials used in the production of the Company’s factory-built homes include wood, wood products, sheetrock, insulating materials, steel, vinyl, and carpet. The Company purchases from outside suppliers various other components that are built into the homes, including windows, doors, lighting and plumbing fixtures, ceiling panels, pre-finished siding, axles, and tires. The Company is not dependent upon any particular suppliers for its materials or components. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 The Company’s growth is attributable to its concentration on the lower end of the manufactured home market. By emphasizing single-section rather than multi-section homes, which have traditionally been more sensitive to economic conditions, the Company has been able to maintain a strong sales record. Individuals in single-section manufactured homes may tend to upgrade, but they often upgrade to another manufactured home. 36 TMH Case Study – Module 1 Proposed Annual Report Module 1 There is no immediate need or intention to enlarge the Rockdale facility. As it stands, manufacturing can make important contributions, but this operation can also be put on hold without damage to either revenues or earnings. In 2007, the Company sold homes manufactured by several major manufacturers. The Company was the leading retailer of homes manufactured by both Knightdale Quality Homes and Greenwood Southern Home Builders. The Company plans to continue to purchase most of its manufactured homes from independent manufacturers. In 2007, approximately 10 percent of total retail sales were homes manufactured by Rockdale, which permitted approximately 50 percent of the total production of the Rockdale facility to be utilized for sales to independent dealers. The Company estimates that in 2008, approximately 12 percent of total unit sales will be homes manufactured by Rockdale, and that approximately 50 percent of Rockdale’s production will again be utilized for sales to independent dealers. During 2007, Rockdale doubled its potential production capacity by adding a second production line. The Company does not intend to become a vertically integrated manufacturer and retailer of manufactured homes, unlike many companies in the industry. The primary purpose of the manufacturing facility is to complement the company’s retail sales effort by providing homes when supplies from third-party manufacturers are not readily available and to supply the Company with specialty private label homes in response to special market needs. The Company’s purchases of its inventory of manufactured homes are financed through a combination of floor plan (inventory) financing arrangements made with independent commercial financial companies and long-term fixed rate financing. Floor plan notes payable to financial companies are collateralized by inventory. The establishment of TMH Financial Services Corp. will complement the Company’s sales and marketing program by allowing its subsidiaries and independent retailers to expedite completion of the credit approval process. TMH Financial will collect installment sales contracts executed at the subsidiary or independent retailer level and sell them to third-party financial institutions. TMH Financial is expected to provide timely approval for such sales. Unlike vertically integrated companies in the industry, which have established financial subsidiaries to underwrite a substantial portion of their retail finance portfolio, the Company does not presently intend to purchase and retain retail installment sales contracts to any significant extent. As of February 29, 2008, 644 applications had been received by TMH Financial, of which 241 had been funded. While the Company intends for TMH Financial’s portfolio to reflect the general character of the Company’s retail sales, most of the contracts funded to date by TMH Financial relate to financing of the resale of repossessed manufactured homes. The Company’s business varies according to season with sales historically being higher in the spring and summer and lower in the fall and winter. Customers and Customer Financing The potential market for manufactured homes includes individuals seeking a single-family residence but lacking the means to purchase conventional housing. Manufactured homes are also sold to retirees and those wanting a second home for vacation purposes. People over 50 years of age account for more than half of manufactured home purchases. The Company has chosen to concentrate on a single segment of the market: lower and middle income individuals and families in the 21-40 year old age group. Retirees are the second largest category of buyers, and a smaller percentage of sales are for second or vacation homes. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 37 The availability and terms of customer financing are important factors affecting retail sales of manufactured homes. Since a majority of the Company’s homes sold are financed, the business is affected by the level of interest rates and the terms and availability of credit. The Company expects TMH Financial to enhance the availability of acceptable customer financing. Sales of homes are generally carried out on an installment sales contract basis. Sources of financing for these purchases consist of various financial institutions that purchase customer installment sales contracts from the Company. Income from Sales of Installment Contracts Income from sales of installment contracts is important to the Company. Almost all of the Company’s installment sales contracts with its customers are sold to unrelated financial institutions. The majority are sold with recourse. In exchange for its endorsement of the contract and guarantee of payment, the Company receives income from sales of installment contracts equal to the difference between the aggregate finance charges payable by the customer and the aggregate finance charges under the arrangement with the financial institution. As the difference or “spread” between the charges becomes greater, the amount of income from sales of installment contracts recognized by the Company increases. The rate the Company can charge on its installment sales contracts is limited by competitive conditions. Income from sales of installment contracts is recognized upon the sale of the installment contract with discount for the estimated time to collection. Subject to financial institution reserve requirements, the Company receives a portion of such income at the time of the sale. The remainder is withheld by the financial institution as security against credit losses and is paid to the Company over the life of the contract, normally 120 to 180 months. The reserve required varies up to seven percent of the aggregate amount financed, including principal and interest. If the financial institution’s aggregate amount required to be withheld for all contracts purchased from the Company exceeds the aggregate amount of income from sales of installment contracts that is payable, the Company’s subsequent income from sales of installment contracts is applied toward satisfying the amount required to be withheld until the requirement is met. These reserves are taken into income at the time of sale, and are discounted to present value based on the estimated term over which they are to be collected. Income recognition for contracts placed with TMH Financial Services Corp. is handled in one of three ways. If the contract is retained by TMH Financial, income is recognized over the life of the contract as it is actually received. If the contract is sold to an unrelated financial institution with recourse, income is recognized in the manner described in the preceding paragraph. Finally, if the contract is sold to an unrelated financial institution without recourse, the entire amount of income from sales of installment contracts is recognized at the time the contract is sold to such institution. For the year ended December 31, 2007, income from sales of installment contracts recognized was $26.8 million compared to $21.6 million for the year ended December 31, 2006. Collections of receivables from sales of installment contracts in 2007 were approximately $16.8 million compared to approximately $15 million for 2006. Regulation Manufactured homes are subject to a number of federal, state, and local laws, codes and regulations. The National Manufactured Housing Construction and Safety Standards Act of 1974, as amended, provides broad federal standards, many of which are administered by the U.S. Department of Housing and Urban Development (HUD). © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 38 TMH Case Study – Module 1 Proposed Annual Report Among the standards administered by HUD are those concerning manufactured housing design and construction, strength and durability, transportability, fire resistance, and energy efficiency. HUD also sets performance standards for heating, plumbing, air conditioning, and electrical systems. The Company’s manufacturing facilities and the plans and specifications of the Company’s manufactured homes have been approved by a HUD-certified inspection agency, and an independent HUD-certified third-party inspector regularly reviews the Company’s homes for compliance with HUD regulations. The transportation of manufactured homes on highways is subject to regulation by various federal, state, and local authorities, including restrictions with respect to routes, travel periods, speed limits, safety equipment, and size. Federal, state, and local laws also govern the description and substance of the Company’s manufactured home warranties, including the Magnuson-Moss Warranty Act and Federal Trade Commission rulings that regulate warranties on consumer products. Certain components of manufactured homes are subject to regulation by the U.S. Consumer Product Safety Commission, which is empowered to ban the use of component materials believed to be hazardous to health. A variety of federal laws, including the Consumer Credit Protection Act, regulate disclosures to consumers with regard to financing of the purchase of manufactured homes. The Company’s manufacturing operations are subject to federal, state, and local laws and regulations relating to the generation, storage, handling, emission, transportation, and discharge of materials into the environment. The management of Triangle Manufactured Homes believes the Company’s products and practices currently meet or surpass all federal, state, and local legal and regulatory requirements, and that the costs incurred to comply with such requirements in the future will not have a significant effect on financial condition, operating results or cash flows. Module 1 Proposed Operations The Company is considering the further expansion of its activities in North Carolina, South Carolina, Tennessee, Georgia, Alabama, Florida, Kentucky, Virginia, and West Virginia, the states in which the Company now operates. Such expansion could take place through acquisitions, new sales centers, agreements with independent retailers, or a combination of these methods. The Company is also considering developing manufactured home subdivisions if an opportunity arises and is considered to be economically feasible. Employees The Company consistently seeks and employs high quality individuals at every level in the organization. Employees are provided with suitable working conditions and remuneration, including important incentives for retail managers and salespeople. The base salaries of such people are among the highest in the industry, and a bonus incentive plan tied directly to margin performance is added. The Company’s executives are incentivized by a bonus plan tied to annual financial performance, including a stock option award program. As of December 31, 2007, the Company had 931 full-time employees, of which 554 were engaged in sales activities, 196 in manufacturing activities, and 181 in executive and administrative capacities. The Company considers its relations with its emploees to be good. No employees are represented by unions. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 39 Certain statements contained herein could be construed to be forward looking statements within the meaning of the Securities Exchange Act of 1934. In addition, persons acting on behalf of the Company may from time to time publish or communicate other items that could also be construed to be forward looking statements. Statements of this sort are, or will be, based on estimates, assumptions, and projections, and are subject to risks and uncertainties that could cause actual results to differ substantially from those included in the forward looking statements. The following risk factors, among others, could significantly affect the Company’s operating results or financial condition. Cyclical and Seasonal Nature of the Industry The manufactured housing industry is highly cyclical and seasonal and has experienced wide fluctuations in aggregate sales in the past. The industry is subject to many of the same national and regional economic and demographic factors that affect the broader housing industry. Such factors, which can result in volatility in operating results, include, but are not limited to, the following: • changes in general economic conditions • levels of consumer confidence • interest rates • housing supply and demand • employment trends • inventory levels • availability of retail (consumer) financing • availability of wholesale (dealer) financing • availability of raw materials • regulatory and zoning matters • access to capital markets. Industry statistics show that aggregate shipments of manufactured homes increased 120 percent between 1993 and 2000. During 1999 and 2000, the annual growth rate gradually slowed, began to decline in 2001, and has declined significantly since. In 2007, aggregate industry shipments were approximately 40 percent of their 2000 level. The manufactured housing industry is also affected by seasonality, with sales during the period from March to October traditionally higher than in other months. The cyclical and seasonal nature of the industry make it difficult for management to forecast sales and profits and may cause the Company to experience operating losses during market downturns. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 Forward Looking Statements/Risk Factors 40 TMH Case Study – Module 1 Proposed Annual Report Module 1 Competition The manufactured housing industry is highly competitive at both the manufacturing and retail levels. Competition is based, among other things, on price, product features, reputation for quality and service, depth of inventory, merchandising, warranty repair service, terms of retailer promotional programs, and terms of retail customer financing. Because barriers to entry are low, it is relatively easy for new retailers to enter the market as competitors. Many of the Company’s competitors are larger and may possess greater financial, manufacturing, distribution, and marketing resources. In addition, the Company’s homes compete with other forms of low- to moderate-cost housing, including new and existing site-built homes, prefabricated and modular homes, apartments, townhouses, and condominiums. If the Company is unable to compete effectively in this environment, retail sales could be reduced and operating results and cash flows could suffer. Geographic Concentration The Company’s operations are currently restricted to a nine-state region of the southeastern United States: North Carolina, South Carolina, Tennessee, Georgia, Alabama, Florida, Kentucky, Virginia, and West Virginia. Almost 60 percent of the Company’s retail sales outlets are located in North Carolina and South Carolina. Consequently, the Company’s sales, operating results, and cash flows could be adversely affected by a decline in the demand for manufactured housing in these states, a decline in the general economic outlook of these states, and other related economic and demographic factors. Dependence on Independent Retailers If the Company is unable to maintain relationships with independent retailers who sell its homes, sales could decline and operating results and cash flows could suffer. During 2007, approximately 20 percent of the Company’s retailers were independent, and that percentage has been growing at a faster rate than Company-owned outlets. As is common in the industry, independent retailers may choose to sell competitors’ homes as well as the Company’s homes. The Company may not be able to establish relationships with new independent retailers or maintain good relationships with independent retailers that sell its homes. The independent retailers with whom the Company has relationships can cancel these relationships on short notice. In addition, these retailers may not remain financially solvent as they are subject to industry, economic, demographic, and cyclical and seasonal factors similar to those faced by the Company. Consequently, while the Company believes its relationships with independent retailers are generally good, it cannot be assured that those relationships will be maintained, that these retailers will continue to sell the Company’s homes, that these retailers will be successful, or that quality independent retailers will continue to be attracted and retained. Availability and Prices of Raw Materials The operating costs of the Company can be significantly affected by the availability and pricing of raw materials. Three of the most important raw materials components purchased by the Company (wood, sheetrock, and insulating materials) have experienced significant price fluctuations in the past year. Sudden increases in the demand for these materials, as has occurred recently due to natural disasters and other market forces, can greatly increase the costs of materials or limit their availability. Increases in such costs cannot always be reflected immediately in retail prices, especially considering the competitive nature of the industry, and, consequently, may adversely affect operating results and cash flows. Further, a reduction in the availability of raw materials may affect the ability of the Company’s manufacturing subsidiary, Rockdale Manufactured Home Builders, to maintain production requirements. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 41 The Company is subject to warranty claims on the manufactured homes that it sells. Although reserves are maintained for such claims, which to date have been adequate, there can be no assurance that warranty expense levels will not increase or that such reserves will continue to be adequate. A large number of warranty claims exceeding current warranty expense levels could have a significant adverse effect on operating results and cash flows. Availability of Retail (Consumer) Financing Third-party lenders generally provide retail (consumer) financing for manufactured home purchases. The availability, terms and costs of consumer financing depend on the number of such lenders, their lending practices, the strength of the credit markets generally, and government policies and regulations. During the past six years, consumer lenders have tightened credit underwriting standards and loan terms and increased interest rates for loans to purchase manufactured homes, and several consumer lenders have exited the market or limited their participation. If consumer financing were to become further curtailed, the Company’s sales could decline and its operating results and cash flows could suffer. Recourse Arrangements and Other Contingent Obligations Almost all of the Company’s receivables related to the sale of manufactured homes to customers are sold to unrelated financial institutions. The majority of such sales are with recourse, obligating the Company to repay the financial institution in the event of customer defaults or prepayments. Customer defaults typically involve the repossession of used manufactured homes. An increase in the level of recourse obligations that the Company must satisfy could have a significant impact on inventories of used homes and could adversely affect operating results and cash flows. In addition, the Company has, and will continue to have, other contingent obligations in the ordinary course of business, some of which could become actual obligations that must be satisfied. Availability of Wholesale (Dealer) Financing Retailers of manufactured homes generally finance their inventory purchases with floor plan financing provided by lending institutions. During the past six years, the industry has been affected by reduced availability of dealer floor plan financing and tighter floor plan terms. If floor plan financing were to become further curtailed, the new home inventory levels of the Company’s retailers and the number of retail sales outlets could be affected, and the Company’s sales could decline and its operating results and cash flows could suffer. Leverage and Restrictive Covenants The Company’s debt in the form of floor plan notes payable and long-term debt could limit its ability to obtain additional financing, require that a substantial amount of cash flows from operations be dedicated to debt service, and prevent the fulfillment of debt obligations. In addition, the terms of the Company’s debt contain various financial performance and other covenants and provisions with which the Company must remain in compliance. Failure to remain in compliance with these covenants and provisions could result in certain of the Company’s debt obligations being accelerated and certain of its debt facilities being terminated and the amounts outstanding thereunder becoming immediately due and payable. Regulations, Zoning, and Environmental Laws The Company and the manufactured housing industry generally are subject to numerous regulations concerning, among other things, the manufacture, marketing, and transportation of manufactured homes; the number and location of sites available for placement of manufactured homes, and the operation of manufactured housing communities; and the generation, storage, © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 Warranty Claims 42 TMH Case Study – Module 1 Proposed Annual Report handling, emission, transportation, and discharge of materials into the environment. Failure to comply with such laws and regulations could expose the company to a wide variety of sanctions. In addition, as is typical in the industry, federal, state, and local bodies have regulatory matters concerning manufactured housing under continuous review, and the Company cannot predict what effect, if any, additional laws and regulations promulgated by such bodies will have on the Company or the manufactured housing industry. Module 1 Dependence on Executive Officers The Company’s success is highly dependent on the personal efforts and abilities of its current executive officers. Specifically, the Company relies on its Chairman of the Board, President and Chief Executive Officer, Vernon L. Bryant, its Chief Financial Officer and Treasurer, Ralph H. Warren, and its Chief Operating Officer, Marlon M. Petty. The loss or prolonged absence of the services of one or more of these individuals could have a significant adverse effect on the business and its financial condition, operating results, and cash flows. The Company’s continued growth also depends on its ability to attract and retain experienced management personnel. Volatility of Stock Price The market price of the Company’s common stock may be subject to significant fluctuations in response to a number of factors. These include, but are not limited to, the Company’s results and other factors affecting the Company specifically; factors affecting the manufactured housing industry generally; the perceived prospects of the Company and the industry; differences between the Company’s actual financial and operating results and those expected by investors and analysts; changes in analysts’ recommendations and projections; actions or announcements of competitors; changes affecting the availability of financing in the wholesale and retail lending markets; future issuances of the Company’s common stock for stock options or acquisitions; changes in the regulatory environment; and changes in general economic or market conditions. In addition, stock markets generally experience significant price and volume volatility from time to time that may adversely affect the market price of the Company’s common stock for reasons unrelated to the Company’s performance. All of these factors may adversely affect the market price of the Company’s common stock in the future. Market Risk Certain of the Company’s financial instruments are subject to market risk, including interest rate and equity share price risks. Due to the makeup of the investment portfolio, this market risk is considered minimal. The Company manages its exposure to such risks through its regular operating and financing activities. The Company does not invest in, or trade, market-risk-sensitive financial instruments, nor does it purchase for investing or hedging financial instruments that expose the Company to significant market risk, whether interest rate, foreign currency, commodity price, or equity price risk. The Company’s financial instruments are not currently subject to foreign currency or commodity risk. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 43 The following table presents selected financial information that has been extracted from the Company’s financial statements for the five years ended December 31, 2007. The information should be read in conjunction with the Company’s Consolidated Financial Statements (and accompanying Notes) and Management’s Discussion and Analysis of Financial Condition and Results of Operations. Year Ended December 31, 2007 Selected Financial Data (in millions, except per share data) Operating Results: Revenues Cost of sales Selling, general, and administrative Net income Earnings per share: Earnings per share - basic Earnings per share - diluted Weighted average common shares outstanding - basic Weighted average common shares oustanding - diluted Financial Position at Year-End: Cash and cash equivalents Working capital Total Assets Long-term Debt Stockholders' Equity $ 36.6 37 .6 189.9 41.3 36.4 $ 14.2 5.1 114.2 2.4 27 .1 $ 0.9 3.8 41.8 0.9 18.2 $ 4.8 3.9 15.3 — 11.0 $ 3.5 (0.4) 11.3 1.1 1.8 $ $ 0.69 0.65 8.2 8.6 $ $ 1.14 1.05 7 .8 8.4 $ $ 0.93 0.89 7 .8 8.1 $ $ 0.21 0.21 7 .1 7 .1 $ $ 0.02 0.02 6.4 6.4 $ 267 .0 191.4 50.7 5.6 $ 176.6 124.8 31.4 8.8 $ 80.5 54.0 13.1 7 .2 $ 24.4 17 .2 4.2 1.5 $ 16.6 11.7 2.8 0.1 2006 2005 2004 2003 © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 Selected Financial Information 44 TMH Case Study – Module 1 Proposed Annual Report Module 1 Information on Common Stock Prices and Dividends The Company’s common stock has been publicly traded since August 9, 2004, the date on which the initial public offering was completed. The following table presents high and low stock prices for the periods indicated: High Year ended December 31, 2007 Fourth Quarter Third Quarter Second Quarter First Quarter $ 12.00 15.00 16.50 15.75 $ 8.75 9.75 12.25 10.00 Low Year ended December 31, 2006 Fourth Quarter Third Quarter Second Quarter First Quarter $ 14.00 15.50 13.25 8.75 $ 8.75 10.50 8.25 4.50 At February 29, 2008, the Company had approximately 2,000 shareholders of record, and approximately 9,500 holders overall based on an estimate of the number of individual participants represented by security position listings. The Company has never paid a cash dividend and does not intend to pay a cash dividend in the foreseeable future. The present policy of the Board of Directors is to retain earnings in order to provide funds to develop and expand the Company’s business. The payment of cash dividends in the future will be at the discretion of the Board of Directors and will depend on factors such as earnings levels, financial condition, capital requirements, and restrictive covenants. The Company’s current ability to pay cash dividends is restricted by certain agreements entered into in connection with the Company’s outstanding long-term indebtedness. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 45 CONSOLIDATED FINANCIAL STATEMENTS © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 46 TMH Case Study – Module 1 Proposed Annual Report Module 1 TRIANGLE MANUFACTURED HOMES Consolidated Balance Sheets December 31, 2007 and 2006 (in millions) 2007 ASSETS Current Assets: Cash and cash equivalents Cash Temporary investments Contract proceeds receivable from financial institutions Total cash and cash equivalents Investments Retained interest in sold receivables, current portion (Note 2) Other receivables (Note 4) Inventories (Notes 5 and 9) Prepaid expenses Deferred income taxes (Note 11) Total current assets Retained interest in sold receivables, noncurrent portion (Note 2) Property, plant and equipment at cost (Note 6) Accumulated depreciation and amortization Net property, plant and equipment Goodwill (Note 3) Other assets Total Assets LIABILITIES AND STOCKHOLDER'S EQUITY Current Liabilities: Notes payable Long-term debt - current installments (Note 10) Floor plan notes payable (Note 9) Accounts payable Income taxes (Note 11) Accrued expenses and other liabilities (Note 8) Total current liabilities Long-term debt - noncurrent installments (Note 10) Recourse liability for sold receivables (Note 7) Deferred income taxes (Note 11) Total liabilities Commitments and contingent liabilities (Note 14) Stockholder's equity (Notes 12 and 13) Common stock - $.50 par value per share; authorized 20 million shares; issued and outstanding 8.2 million shares in 2007 and 7 million shares in 2006 .8 Additional paid-in capital Retained earnings Accumulated other comprehensive income Total stockholder's equity Total Liabilities and Stockholder's Equity $ 10.0 1.1 25.5 36.6 5.5 4.2 8.3 84.7 1.2 1.6 142.1 27 .1 16.7 (5.4) 11.3 4.7 4.7 189.9 $ 2.5 0.2 11.5 14.2 1.9 4.4 4.6 56.9 0.9 1.8 84.7 16.2 12.1 (3.5) 8.6 2.4 2.3 114.2 2006 $ $ $ 2.4 1.8 78.2 10.8 5.1 6.1 104.4 41.3 6.7 1.1 153.5 $ — 2.4 61.0 7 .1 6.4 2.7 79.6 2.4 4.1 1.0 87 .1 $ 4.1 8.6 23.5 0.2 36.4 189.9 $ 3.9 5.2 17 .9 0.1 27 .1 114.2 © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 47 2007 Revenues: Net sales Income from sales of installment contracts Interest income Other income Total revenues Costs and expenses: Cost of sales Selling, general and administrative Loss on recourse liability (Note 7) Interest Total costs and expenses Income before income taxes Income taxes (Note 11) Net income Other comprehensive income, net of tax: Unrealized investment gains Comprehensive income $ 0.1 5.7 $ 191.4 50.7 8.4 7 .5 258.0 9.0 3.4 5.6 $ 235.5 26.8 0.7 4.0 267 .0 $ 2006 152.5 21.6 0.3 2.2 176.6 124.8 31.4 1.8 4.1 162.1 14.5 5.7 8.8 0.1 8.9 $ $ 2005 67 .7 11.6 0.3 0.9 80.5 54.0 13.1 0.6 1.3 69.0 11.5 4.3 7 .2 — 7 .2 Weighted average number of shares outstanding Basic Diluted Earnings per share: Net earnings per share - basic Net earnings per share - diluted $ $ 0.69 0.65 $ $ 1.14 1.05 $ $ 0.93 0.89 8.2 8.6 7 .8 8.4 7 .8 8.1 © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 TRIANGLE MANUFACTURED HOMES Consolidated Statements of Income Years Ended December 31, 2007, 2006, and 2005 (in millions, except per share data) Module 1 48 TRIANGLE MANUFACTURED HOMES Consolidated Statements of Stockholders' Equity Years Ended December 31, 2007, 2006, and 2005 (in millions) Common Stock Shares Common Stock $ 3.9 $ 5.2 $ 1.9 $ — $ — $ Retained Earnings Treasury Stock 7 .8 Additional Paid-In Capital Accumulated Other Comprehensive Income Total 11.0 — — — — 7 .2 7 .8 3.9 5.2 9.1 — — — 7 .2 18.2 — — — 0.1 8.8 7 .8 0.4 0.8 0.7 0.1 5.6 8.2 $ 4.1 $ 8.6 $ 23.5 $ 0.2 $ — $ 0.2 1.9 3.9 5.2 17 .9 0.1 — 0.1 8.8 27 .1 — 2.1 — 0.8 0.7 0.1 5.6 36.4 Balance at 12/31/04 Purchase of treasury stock Exercise of employee stock options Cash dividends paid Unrealized investment gains (losses) Net income Balance at 12/31/05 Purchase of treasury stock Exercise of employee stock options Cash dividends paid Unrealized investment gains (losses) © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Net income Balance at 12/31/06 Purchase of treasury stock Exercise of employee stock options Cash dividends paid Tax benefits related to exercise of stock options Stock option compensation Unrealized investment gains (losses) Net income TMH Case Study – Module 1 Proposed Annual Report Balance at 12/31/07 TMH Case Study – Module 1 Proposed Annual Report 49 TRIANGLE MANUFACTURED HOMES Consolidated Statements of Cash Flows Years Ended December 31, 2007, 2006, and 2005 (in millions) 2007 Cash flows from operating activities: Net income $ 5.6 $ Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 1.9 Deferred income taxes 0.4 Loss on recourse liability 8.4 Payments of credit losses incurred Decrease (increase) in: Retained interest in sold receivables Other receivables Inventories Prepaid expenses Other assets (Decrease) increase in: Accounts payable Income taxes payable Accrued expenses and other liabilities Net cash used for operating activities Cash flows from investing activities: Purchase of property, plant and equipment Purchase of investments Investment in subsidiaries Net cash used for investing activities Cash flows from financing activities: Proceeds from short-term notes payable and long-term debt Increase in floor plan notes payable Principal payment on short-term notes payable and long-term debt Tax benefits related to exercise of stock options Proceeds from exercise of employee stock options Net cash provided by financing activities Increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period Cash paid for: Interest Income taxes $ $ $ (6.8) (10.0) (3.7) (27 .8) (0.3) (1.9) 3.7 (1.3) 3.3 (28.5) (4.2) (3.6) (0.9) (8.7) 2006 8.8 $ 2005 7 .2 1.2 1.0 1.8 (2.2) (5.4) (3.8) (38.7) (0.8) 1.7 4.2 (0.3) 1.3 (31.2) (4.5) — (2.9) (7 .4) 0.5 0.4 0.6 (0.3) (5.5) (0.5) (12.5) (0.1) 0.5 0.5 0.5 1.1 (7 .6) (1.0) (1.8) (3.0) (5.8) 43.1 17 .2 (3.6) 0.8 2.1 59.6 22.4 14.2 36.6 $ 7$ .4 2.8 $ 1.4 51.0 (0.5) — — 51.9 13.3 0.9 14.2 $ 3.8 5.5 $ 0.9 8.8 (0.1) — — 9.6 (3.8) 4.7 0.9 1.1 3.3 © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 50 TMH Case Study – Module 1 Proposed Annual Report Module 1 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2007, 2006 and 2005 © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 51 Principles of Consolidation and Nature of Business The consolidated financial statements include the accounts of Triangle Manufactured Homes and all subsidiaries, each wholly owned, and hereafter referred to collectively as the “Company.” All significant intercompany items are eliminated. The Company is engaged principally in the retail sale of new and used manufactured homes throughout a nine-state region of the southeastern United States. In addition, the Company offers retail installment sale financing and insurance products. The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates. Revenue Recognition The Company recognizes revenue when the Company and the customer enter into a legallybinding sales contract and payment is received or, in the case of credit sales, when a down payment (generally 5 percent to 10 percent of the sales price) is received, title is transferred, and the home is accepted by the customer and delivered and permanently located at the customer’s site. For credit sales, retail installment sales contracts are normally payable over periods ranging from 120 to 180 months. Credit sales represent the majority of the Company’s sales. Under existing financing arrangements, the majority of retail installment sales contracts are sold, with recourse, to unrelated financial institutions at an agreed upon rate that is below the contractual interest rate of the installment sales contract. At the time of sale, the Company receives immediate payment for the stated principal amount of the retail installment sales contract and a portion of the income from the sale resulting from the interest rate differential. The remainder is held back by the financial institution as security against credit losses and is paid to the Company in proportion to customer payments received by the financial institution. The Company accounts for these transactions as sales in accordance with FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and recognizes income from sales of installment contracts related to the difference between the contractual interest rates of the installment contracts and the agreed-upon rates to the financial institutions; the portion held back by the financial institutions is discounted for estimated time of collection and carried at its present value. Recourse Liability for Sold Receivables Losses that arise or may arise from the recourse provisions of the Company’s financing arrangements with unrelated financial institutions are provided for currently based on historical loss experience and current industry and economic conditions and consist of actual and estimated future rebates of income from sales of installment contracts due to defaults, repossessions and prepayments, estimated future losses on retail installment sales contracts repurchased from financial institutions, and estimated future losses on retail installment sales contracts transferred to new purchasers in lieu of repossession. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 Note 1 Summary of Significant Accounting Policies 52 TMH Case Study – Module 1 Proposed Annual Report Module 1 Fair Value of Financial Instruments Cash and cash equivalents, other receivables, accounts payable, accrued expenses and other liabilities, and floor plan notes payable are stated at expected settlement amounts, which approximate fair value. Cash and Cash Equivalents The Company considers cash equivalents to include temporary investments and contract proceeds receivable from financial institutions. Temporary investments are highly liquid investments with original maturities of three months or less and are carried at cost, which approximates market value because of their short maturities. Contract proceeds receivable from financial institutions are carried at the contractual amount to be collected within three months or less. Investments Investments are classified as available-for-sale securities and consist of marketable debt and equity securities of public companies carried at fair value. Unrealized gains and losses on the available-for-sale securities, net of tax, are recorded in accumulated other comprehensive income and reported in stockholders’ equity. Inventories Inventories are stated at the lower of cost or market, with cost determined using the specific identification method for new and used manufactured homes and the first-in, first-out method for materials and supplies. Property, Plant, and Equipment Property, plant, and equipment are stated at cost. Depreciation is calculated by the straight-line method over the estimated useful lives of the respective assets. Maintenance and repairs are expensed as incurred. Amortization of leasehold improvements is provided by the straight-line method over the shorter of the lease terms or the estimated useful lives of the improvements. The Company evaluates the carrying value of long-lived assets in accordance with FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Such an evaluation is made when events and circumstances warrant. Carrying value is considered impaired when the anticipated undiscounted cash flow from the assets is less than carrying value. In that event, a loss is recognized based on the amount by which carrying value exceeds fair market value. Fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair market values are based primarily on independent appraisals and preliminary or definitive contractual arrangements less disposal costs. The Company recorded no impairment charges for long-lived assets in 2007, 2006, or 2005. Warranties The Company provides the retail home buyer a one-year warranty from the date of purchase covering manufacturing defects in home construction. Estimated warranty costs are accrued at the date of sale based on historical warranty experience and current industry trends. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 53 Advertising costs, consisting primarily of radio, television, and newspaper advertising, are expensed as incurred and included in selling, general, and administrative expenses. Advertising expenses amounted to $3.5 million, $2.3 million and $691,000 in 2007, 2006, and 2005, respectively. Insurance Commissions The Company acts as agent for insurance companies and receives commissions from homeowner’s insurance written for customers at the time of sale of the home and from renewal premiums. Insurance Commissions are included under Other Income in the Consolidated Statements of Income. Manufacturers Volume Rebates The Company receives volume rebates from manufacturers based on achieving certain levels of home purchases during specified time periods. Estimated volume rebates are accrued based on planned levels of home purchases and prior experience with particular manufacturers. Income Taxes Deferred income taxes are determined by the asset and liability method and are recognized for income and expense items that are reported in different periods for financial reporting and income tax purposes. Goodwill Goodwill represents the excess of cost over fair value of the net assets of businesses acquired. FASB Statement No. 142, Goodwill and Other Intangible Assets, requires that goodwill be reviewed at least annually for impairment and that an impairment charge be recorded when the estimated fair value of goodwill is below its carrying value. The Company tests for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. No goodwill impairment charges have been recorded by the Company. Earnings per Share Both basic and diluted earnings per share are reported for all periods presented. Basic earnings per share is calculated using the weighted average number of common shares outstanding. Diluted earnings per share is calculated using the weighted average number of common shares outstanding, adjusted for dilutive common shares. Diluted earnings per share includes the dilutive effects of stock options and warrants after the assumed repurchase of common shares with the related proceeds at the average price during the period. Diluted earnings per share in 2007 does not include the effect of the assumed conversion of the convertible subordinated notes issued in 2007 and elimination of the applicable interest expense less related income tax benefit because its inclusion would have been anti-dilutive. In 2006 and 2005, no convertible subordinated notes were outstanding. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 Advertising 54 TMH Case Study – Module 1 Proposed Annual Report Module 1 A reconciliation of the numerators and denominators used in the Company’s basic and diluted earnings per share calculations follows (in millions, except per share data): Year Ended December 31, 2007 Income (Numerator) Basic EPS Income available to common stockholders Effects of Dilutive Securities Warrants Options 9% Convertible Subordinated Notes Diluted EPS Income available to common stockholders adjusted for dilutive securities $ 5.6 8.6 $ 0.65 0.3 0.1 — $ 5.6 8.2 $ 0.69 Shares (Denominator) Per-Share Amount Year Ended December 31, 2005 Income (Numerator) Basic EPS Income available to common stockholders Effects of Dilutive Securities Warrants Options 9% Convertible Subordinated Notes Diluted EPS Income available to common stockholders adjusted for dilutive securities $7 .2 8.1 $ 0.89 0.3 — — $7 .2 7 .8 $ 0.93 Shares (Denominator) Per-Share Amount Year Ended December 31, 2006 Income (Numerator) Basic EPS Income available to common stockholders Effects of Dilutive Securities Warrants Options 9% Convertible Subordinated Notes Diluted EPS Income available to common stockholders adjusted for dilutive securities $ 8.8 8.4 $ 1.05 0.3 0.3 — $ 8.8 7 .8 $ 1.14 Shares (Denominator) Per-Share Amount © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 55 The Company has adopted the provisions of FASB Statement No. 123(R), Share-Based Payment, using the modified prospective method. Statement No. 123(R) requires companies to recognize the cost of employee services received in exchange for awards of equity instruments based upon the grant date fair value of those awards. Under the modified prospective method of adopting Statement No. 123(R), the Company recognized compensation cost for all sharebased payments granted after January 1, 2007, plus any awards granted to employees prior to January 1, 2007 that remained unvested at that time. During 2007 the Company recognized $668,500 in compensation cost and additional paid-in capital related to stock options. The adoption of Statement No. 123(R) did not have a significant impact on income from continuing operations, income before income taxes, net income, cash flow from operations, or earnings per share during the period. Upon the adoption of Statement No. 123(R), the Company utilized the alternative transition method of FASB Staff Position 123(R)-C and determined that no pool of excess tax benefits existed at the date of adoption. Prior to January 1, 2007, the Company recognized the cost of employee services received in exchange for equity instruments in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Opinion No. 25 required the use of the intrinsic value method, which measures compensation cost as the excess, if any, of the quoted market price of the stock over the amount the employee must pay for the stock. Had stock-based compensation expense been recorded by the fair value method, based on the grant-date market value of the award, as encouraged by FASB Statement No. 123, Accounting for Stock-Based Compensation, the Company’s net income and earnings per share for 2006 and 2005 would have approximated the pro forma amounts below (in millions, except per share data): 2006 Net income, as reported Deduct: Stock-based compensation expense included in net earnings, net of related tax effects Pro forma net earnings Basic EPS As reported Proforma Diluted EPS As reported Pro forma $ $ 1.05 0.99 $ $ 0.89 0.88 $ $ 1.14 1.08 $ $ 0.93 0.91 $ $ 8.8 $ 2005 7 .2 (0.5) $8.3 $ (0.1) 7 .1 Reclassifications Certain items in the prior years’ consolidated financial statements have been reclassified to conform to the current year presentation. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 Stock-Based Compensation 56 TMH Case Study – Module 1 Proposed Annual Report Module 1 Recent Accounting Pronouncements In September 2006, the Financial Accounting Standards Board issued FASB Statement No. 157, Fair Value Measurements. Statement No. 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. Statement No. 157 does not require any new fair value measurements. Statement No. 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company is currently assessing the effects of the adoption of Statement No. 157 on the Company’s financial position, results of operations, and cash flows. In February 2007, the Financial Accounting Standards Board issued FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. Statement No. 159 permits companies to choose to measure many assets and liabilities at fair value. Once the fair value option is elected, the decision is irrevocable. Statement No. 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently assessing the effects of the adoption of Statement No. 159 on the Company’s financial position, results of operations, and cash flows. Note 2 Retained Interest in Sold Receivables The Company has arrangements to sell retail installment sales contracts to unrelated financial institutions. The majority of such sales are with recourse. The Company retains an interest in the sold retail installment sales contracts related to the portion of the income from sales of such contracts that is held by the financial institution as security against credit losses. Retained interest in sold receivables represents the Company’s right to receive from the financial institutions further collections on the sold receivables consistent with the recourse provisions included in the Company’s contracts with the financial institutions. Retained interest in sold receivables is recorded at its present value upon the initial sale of the retail installment sales contracts and is adjusted periodically to reflect actual and expected future default and prepayment experience. Note 3 Acquisitions On January 6, 2005, Triangle Manufactured Homes acquired 100 percent of the outstanding common stock of AMH Home Centers, a retailer of manufactured housing located in North Carolina. The purchase agreement required cash payments of $900,000 and potential earnout payments of $1.3 million, all earned at December 31, 2005. The purchase price allocation resulted in no goodwill recorded at December 31, 2005. The operations of AMH are included in the consolidated financial statements of Triangle Manufactured Homes beginning in 2005. Effective March 22, 2006, Triangle Manufactured Homes acquired 100 percent of the outstanding common stock of Northern Florida Home Retailers (NFHR), a retailer of manufactured housing located principally in Tallahassee, Florida. The purchase agreement required cash payments of $1.9 million and potential earn-out payments of $4.4 million over the period 2007 to 2011. The potential earn-out is based on a percentage of NFHR’s pre-tax earnings as defined. At December 31, 2007, $1.4 million ($879,000 in 2007 and $548,000 in 2006) of the potential earn-out had been earned and recorded as an adjustment of the purchase price. The purchase price allocation resulted in goodwill of $2.4 million recorded at December 31, 2006. The operations of NFHR © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 57 Years ended December 31, Total revenues Net Income Earnings per share: Basic Diluted 2006 $ 194.8 6.9 $ $ .89 .81 2005 $ 132.5 6.2 $ $ .81 .77 In September 2007, Triangle Manufactured Homes acquired 100 percent of the outstanding common stock of two companies engaged in the retail sale of manufactured homes. The purchase agreements required aggregate cash payments of $335,000 and potential earn-out payments of $1.9 million over the period 2008 to 2013. The potential earn-outs are based on a percentage of the respective companies’ pre-tax earnings as defined. The purchase price allocation resulted in goodwill of $2.3 million recorded at December 31, 2007. The companies’ operations, which are not material, are included in the consolidated financial statements of Triangle Manufactured Homes since September 2007. Note 4 Other Receivables Other receivables consist of the following (in millions): December 31, Manufacturers volume rebates Other Diluted 2007 $4.4 3.9 $8.3 2006 $3.5 1.1 $4.6 Note 5 Inventories Inventories consist of the following (in millions): December 31, New manufactured homes Used manufactured homes Materials and supplies 2007 $66.4 15.5 2.8 $84.7 2006 $50.5 4.6 1.8 $56.9 © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 are included in the consolidated financial statements of Triangle Manufactured Homes since March 22, 2006. The following unaudited pro forma data present the results of operations of the Company and NFHR as if the acquisition had occurred at January 1, 2005 (in millions, except per share data): 58 TMH Case Study – Module 1 Proposed Annual Report Module 1 Note 6 Property, Plant and Equipment The cost and estimated useful lives of the major classifications of property, plant, and equipment are as follows (dollar amounts in millions): Estimated useful life --15-20 years 5-7 years 3-5 years 3-10 years 3-5 years 3-7 years December 31, Land Buildings Manufactured homes—office units Leasehold improvements Furniture and equipment Vehicles Signs 2007 $1.6 3.7 2.3 1.4 4.3 3.3 0.1 $16.7 2006 $1.4 1.9 2.2 1.2 2.5 2.5 0.4 $12.1 Note 7 Recourse Liability for Sold Receivables Unrelated financial institutions to which the Company sells retail installment sales contracts have recourse to the Company upon default or prepayment by the customer and other conditions specified in the Company’s contracts with the financial institutions. The Company provides for losses that arise or may arise from recourse provisions related to sales of retail installment sales contracts at the time of sale and during the term of the retail installment sales contract. Recourse liability for sold receivables is recorded at fair value upon the initial sale of the retail installment sales contracts and fair value is adjusted periodically to reflect actual and expected losses from defaults, prepayments, and other conditions. Such losses result from the actual and estimated costs of defaults, resales of repossessed homes, and rebates of income from sales of installment contracts due to prepayment of retail installment sales contracts. The provision gives consideration to the Company’s historical loss experience and general industry and economic conditions. An analysis of the recourse liability for sold receivables follows (in millions): Year Ended December 31, Balance at beginning of year Amount at date of acquisition applicable to acquired companies, less actual charges of $0.2 in 2007 and $1.4 in 2006 Provision for losses Actual charges Balance at end of year 2007 $ 4.1 2006 $ 0.9 2005 $ 0.4 0.9 8.4 (6.7) $ 6.7 2.3 1.8 (0.9) $ 4.1 0.2 0.6 (0.3) $ 0.9 © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 59 A summary of accrued expenses and other liabilities follows (in millions): December 31, Salaries, wages, and benefits Accrued warranty expenses Other accrued expenses 2007 $3.6 1.5 1.0 $6.1 2006 $1.5 0.8 0.4 $2.7 Note 9 Floor Plan Notes Payable A substantial portion of the Company’s new manufactured home inventories is financed through floor plan facilities with unrelated financial institutions. The floor plan arrangements generally require periodic partial repayments with the unpaid balance due upon sale of the related inventory. The floor plan liability at December 31, 2007 is collateralized by inventory. A summary of floor plan notes payable follows (dollar amounts in millions): December 31, North American Diversified Credit Atlantic Seaboard Credit Southeast Financial Services Tri-States Acceptance Corporation Others Rate Prime + 2.50 (9.75%) Prime + 2.25 (9.50%) Prime + 2.25 (9.50%) Prime + 2.00 (9.25%) Various $ $ Floor Plan Lines 60.0 16.0 8.9 5.6 6.3 96.8 $ $ 2007 50.2 13.0 8.8 2.8 3.4 78.2 $ $ 2006 38.2 11.6 3.9 1.8 5.5 61.0 The weighted average interest rate paid on the outstanding floor plan liability was 9.3%, 8.6 %, and 8.0 % for 2007, 2006, and 2005, respectively. The maximum amount outstanding at any month-end during each year was $78.2 million for 2007; $70 million for 2006; and $10 million for 2005, with a weighted average balance outstanding for each year of approximately $70 million, $44 million, and $14.5 million, respectively. The floor plan facilities generally contain provisions requiring the Company to maintain minimum liquidity and inventory turns in order to borrow against the facility. If the Company should become noncompliant with such provisions in future periods, a waiver of the applicable provision(s) would be sought and, if no such waiver was obtained, maturities of outstanding debt could be accelerated. At December 31, 2007, the Company was in compliance with all floor plan facility provisions. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 Note 8 Accrued Expenses and Other Liabilities 60 TMH Case Study – Module 1 Proposed Annual Report Module 1 Note 10 Long-Term Debt A summary of long-term debt follows (in millions): December 31, 9% convertible subordinated notes payable, due in annual installments of $4 million beginning May 15, 2013 through May 15, 2022 Notes payable, due in monthly installments of $148,000 through October 1, 2008, interest at prime rate (7 .25%) and collateralized by property, plant and equipment with a depreciated cost of $2.6 million Note payable in January 2009, interest at prime rate (7 .25%) and collateralized by the common stock of Northern Florida Home Retailers (Note 3) Note payable in annual installments of $444,000 through April 15, 2008, repaid in 2007 Various notes payable, due in monthly installments, including interest at rates ranging from 5 % to 10 % $ Less current installments Long-term debt—noncurrent installments $ 2007 2006 $ 40.0 $ — 1.5 3.2 0.9 — 0.7 43.1 1.8 41.3 $ $ — 0.9 0.7 4.8 2.4 2.4 The aggregate annual maturities of long-term debt for the five years following December 31, 2007 are: 2008, $1.8 million; 2009, $1.1 million; 2010, $119,000; 2011, $74,000; 2012, $33,000. Pursuant to an agreement dated April 25, 2007 (the “2007 Agreement”), the Company sold Delaware Security and Guaranty Convertible Subordinated Notes due May 15, 2022, in the amount of $40 million. The proceeds from these notes have been used principally to reduce floor plan notes payable. The notes are convertible, at the option of the holder, into shares of the Company’s common stock at the conversion price of $17.50 per share. The conversion price is subject to adjustment in the event of stock dividends, stock splits, payment of extraordinary distributions, granting of options, or sale of additional shares of common stock. The notes are subject to prepayment at the option of the Company between October 29, 2007 and May 15, 2017 at 100 percent of par if for a specified period preceding the written notice of prepayment the closing market price per share of the Company’s common stock is equal to or greater than a percentage of the conversion price. Such percentage decreases from 200 percent through May 15, 2010 to 110 percent at May 15, 2017. After May 15, 2017, the notes are subject to prepayment at the option of the Company at 108 percent of par decreasing to 100 percent at May 15, 2022. The 2007 Agreement contains various restrictive covenants that concern, among other things, maintenance of a minimum level of working capital as defined, maintenance of a minimum level of net income available for fixed charges as defined, consolidated current assets as defined, equal or greater than senior debt, payment of cash dividends, and the creation of additional indebtedness. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 61 Subsequent to December 31, 2007, and pursuant to an agreement dated February 13, 2008 (the “2008 Agreement”), the Company sold Delaware Insurance and Guaranty Series A and Series B Senior Notes in the aggregate of $55 million. The Series A Notes in the amount of $33 million bear interest at the rate of 8.64% and are due February 15, 2011. The Series B Notes in the amount of $22 million bear interest at the rate of 9.42% and are due February 15, 2013. Both the Series A Notes and the Series B Notes are unsecured. The proceeds from these notes have been used partially to reduce floor plan notes payable and the remainder added to general corporate funds. The 2008 Agreement also contains restrictive financial covenants. The 2008 Agreement financial covenants were changed to reflect more accurately the Company’s current financial structure. Concurrent with the execution of the 2008 Agreement, the financial covenants contained in the 2007 Agreement were amended to conform to the covenants in the 2008 Agreement. At December 31, 2007, the Company was in compliance with the various restrictive covenants in the 2007 Agreement with the exception of the net income available for fixed charges covenant. The Company was in compliance with all of the restrictive covenants in the 2007 Agreement, as amended. Retained earnings available for the payment of cash dividends amounted to $4 million at December 31, 2007. Note 11 Income Taxes Components of income tax expense (benefit) are as follows (in millions): Year Ended December 31, Current: State Federal Deferred: State Federal Provision for income taxes $ 0.1 0.3 0.4 3.4 $ 0.1 0.3 0.4 5.7 $ 0.1 0.3 0.4 4.3 0.4 2.6 3.0 0.8 4.5 5.3 0.4 3.5 3.9 2007 2006 2005 Reconciliation of statutory tax rate to actual provision for income taxes (in millions): Year Ended December 31, Provision—federal statutory rate Increase (decrease) resulting from: State taxes, net of fedeal tax benefit Permanent differences Other Provision for income taxes $ 0.3 0.1 (0.1) 3.4 $ 0.6 0.2 (0.1) 5.7 $ 0.3 0.1 (0.1) 4.3 $ 2007 3.1 $ 2006 $5.0 $ 2005 4.0 © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 62 TMH Case Study – Module 1 Proposed Annual Report Module 1 Significant components of deferred tax assets and liabilities are as follows (in millions): Deffered Tax Assets: Accrued liabilities Volume rebates Other Gross deferred tax assets Diferred Tax Liabilities: Depreciation Other Gross deferred tax liabilities Net deferred tax assets $ (0.8) (0.3) (1.1) 0.5 $ (1.0) — (1.0) 0.8 $ 2007 0.2 0.1 1.3 1.6 $ 2006 0.1 0.3 1.4 1.8 The Company believes it is more likely than not that the net deferred tax assets of $0.5 million at December 31, 2007 will be realized on future tax returns, primarily from the generation of future taxable income. Note 12 Common Stock In connection with a public offering of common stock in 2004, the Company sold to the primary underwriter warrants to purchase 300,000 shares of common stock at a price equal to 120 percent of the public offering price. The warrants are exercisable for a four-year period beginning in 2005 at $3.84 per share. At December 31, 2007, 3.4 million shares of the Company’s authorized common stock were reserved for issuance as follows: 300,000 shares for the outstanding warrants, 800,000 shares for the Incentive Stock Option Plan, and 2.3 million shares for the convertible subordinated notes. The Company has no authorized or outstanding preferred stock. Note 13 Stock-Based Compensation On June 14, 2004, the Board of Directors approved an Incentive Stock Option Plan and reserved 1.4 million shares of the Company’s authorized common stock for award to certain officers, directors, and key employees. Under the Plan, options are granted at the discretion of the compensation committee of the Board of Directors and may be either incentive stock options or nonqualified stock options. Incentive options are exercisable only at a price equal to or greater than fair market value at date of grant. Nonqualified options may be exercisable at a price below fair market value at date of grant at the discretion of the compensation committee. Options are exercisable beginning 18 months after the date on which they are granted. The Plan expires June 13, 2014. No options were granted at exercise prices below fair market value in 2007, 2006, or 2005. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 63 Number of Shares Outstanding at 12/31/04 Granted Canceled Outstanding at 12/31/05 Granted Canceled Outstanding at 12/31/06 Granted Exercised Canceled Outstanding at 12/31/07 232,545 264,735 (45,510) 451,770 660,672 (11,655) 1,100,787 71,706 (400,000) (40,515) 731,978 $ $ $ $ $ $ $ $ $ $ $ Stock Option Price Range 2.40 - 3.20 2.40 - 3.75 3.20 2.40 - 3.75 4.50 - 13.00 2.40 - 3.75 2.40 - 11.25 11.00 - 16.00 2.40 - 4.06 2.70 - 10.38 2.40 - 17 .50 $ $ Weighted Average Exercise Price 2.80 2.90 3.20 2.82 8.00 2.60 5.93 13.50 3.83 3.50 7 .95 The following table summarizes information about stock options outstanding at December 31, 2007: Options Outstanding Range of Exercise Prices $2.40 - $3.75 $4.06 - $11.25 $11.00 - $17 .50 Shares Outstanding 216,250 444,022 71,706 731,978 Weighted Average Life 1 2 3 2 Weighted Average Exercise Price 3.75 9.91 14.50 8.54 Options Exercisable Number Exercisable 144,300 372,072 — 516,372 Weighted Average Exercise Price 3.75 9.91 14.50 8.19 The weighted-average fair value per share of the options was estimated using the Black-Scholes option-pricing model at the grant date based on the expected dividend yield, risk-free interest rate, volatility of the stock, and lives of the options. The weighted-average assumptions used in the Black-Scholes model were as follows: 200 7 Dividend yield Risk-free interest rate Expected volatility Expected life Weighted-average fair value per share of options granted during the year 0.0% 4.3% 45% 3 years $4.97 2006 0.0% 3.3% 45% 3 years $2.60 2005 0.0% 3.3% 45% 3 years $1.03 © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 Information regarding the Company’s stock options is summarized below: 64 TMH Case Study – Module 1 Proposed Annual Report Module 1 The total intrinsic value for options exercised during 2007 was approximately $3 million. The fair value of options that vested during 2007 was approximately $1.6 million. As of January 1, 2008, the Company had approximately $1.7 million in compensation expense related to stock option plans that will be recognized over the weighted average period of 1.5 years. Note 14 Commitments and Contingent Liabilities The Company leases office space, the majority of its retail sales centers, and certain equipment under noncancellable operating leases that expire over the next five years. Total expenses under such leases amounted to $3 million in 2007, $2 million in 2006, and $963,000 in 2005. Approximately five percent, 12 percent, and 16 percent, respectively, of such amounts were paid to certain of the Company’s directors and the officers of certain subsidiaries. Future minimum payments under noncancellable operating leases as of December 31, 2007 follow (in millions): Year Ending December 31, 2008 2009 2010 2011 2012 Minimum Payments $ 2.9 1.8 1.1 0.7 0.4 $ 6.9 The Company is contingently liable under recourse provisions related to sales of retail installment sales contracts to unrelated financial institutions. The maximum amount of this contingent liability was approximately $400 million, $233 million, and $155 million at December 31, 2007, 2006, and 2005, respectively. Certain claims and suits arising in the ordinary course of business have been filed or are pending against the Company. In the opinion of management, the amount of ultimate liability with respect to these matters will not have a significant adverse effect on the Company’s financial position, results of operations, or cash flows. Note 15 Employee Benefit Plan The Company has a defined contribution retirement plan qualifying under Section 401(k) of the U.S. Internal Revenue Code that covers employees who have met certain service requirements. Participating employees may contribute from one percent to 15 percent of eligible compensation. The Company matches 50 percent of the first six percent of employees’ contributions. Company contributions vest ratably over the employee’s first five years of employment and are fully vested after five years. Amounts expensed under the plan were approximately $465,000, $365,000, and $210,000 in 2007, 2006, and 2005, respectively. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 65 A summary of the unaudited interim results of operations for each quarter in the years ended December 31, 2007 and 2006 follows (in millions, except per share data): Year ended December 31, 2007 Total revenues Cost of sales Net income Earnings per share Basic Diluted Year ended December 31, 2006 Total revenues Cost of sales Net income Earnings per share Basic Diluted 0.20 0.19 0.41 0.38 0.35 0.32 0.18 0.17 $ 24.3 16.9 1.6 $ 49.1 34.5 3.2 $ 53.5 38.8 2.6 $ 49.7 34.6 1.4 0.21 0.20 0.53 0.50 0.40 0.38 (0.44) (0.42) $ First 51.8 37 .6 1.6 Second 65.4 46.3 4.3 Third 73.6 52.7 3.3 Fourth 76.2 54.8 (3.6) $ $ $ The sum of quarterly earnings per share does not necessarily equal earnings per share for the year. During the fourth quarter of 2007, the Company provided approximately $6.5 million for losses related to sales of receivables with recourse, primarily due to industry conditions that are causing unusually high costs relating to the repossession of homes. In addition, the Company incurred costs in the fourth quarter of approximately $700,000 relating primarily to the write-off of previously recognized income from sales of installment contracts. The aggregate provision for these items amounted to approximately $7.2 million in the fourth quarter. The Company cannot determine the extent to which these fourth quarter provisions may be applicable to the first, second, and third quarters of 2007. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 Note 16 Quarterly Financial Information (Unaudited) 66 TMH Case Study – Module 1 Proposed Annual Report Management’s Discussion and Analysis of Financial Condition and Results of Operations Results of Operations 2007 Versus 2006 The Company’s net sales in 2007 were $235.5 million compared with $152.5 million in 2006, an increase of $83 million or 54 percent. The Company’s program of managed sales growth resulted in greater market penetration due to: 2007 An increase of 44 percent in the number of company owned and operated sales centers A 100 percent expansion of the TMH Independent Retailer network A total increase of 52 percent in sales centers for the year 92 22 114 2006 64 11 75 Increase 28 11 39 Module 1 The total number of new and used homes sold in 2007 was 6,239, a 61 percent increase over the 3,866 homes sold in 2006. New home sales for both years were 82 percent of total home sales. A manufactured home sales center usually experiences a five-year growth and development period. A Triangle Manufactured Homes sales center should develop a sales production level of at least 100 new homes per year at maturity, although this average annual sales volume can vary widely by geographic location. The Company in 2007 averaged 47 new sales per sales center versus 45 in 2006. The average reflects the rapid expansion of new sales centers. Approximately 47 percent of the average potential capacity per sales center had been achieved, leaving significant growth potential within the Company’s current sales center network without the need for significantly increasing the number of sales centers. New home sales were 78 percent single-wides in 2007, as compared with 82 percent in 2006. This reflects a shift to more double-wides resulting from the acquisition of two subsidiaries. However, the primary emphasis of our marketing plan continues to be toward the less expensive, single-wide home that fits the economic capability of a significant percentage of potential customers within the market area of the nine southeastern states in which we operate. The average selling price of new homes by Company sales centers for 2007 was $39,000 versus $38,600 in 2006. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 67 Rockdale Manufactured Home Builders, a wholly owned subsidiary, expanded its production capability in 2007 from one production line to two. Revenues in 2007 were $35 million, of which $16.6 million were direct sales to nonaffiliated dealers with $18.4 million being sold to Company sales centers for resale. The Company purchased the manufacturing facility in September 2006. The Rockdale manufacturing subsidiary sold 481 homes directly to dealers not associated with the Company in 2007 as compared with 130 homes in 2006. Repossessions and Early Pay-offs Manufactured housing, as an industry, has been significantly impacted by the slow economic growth of the economy coupled with an extended period of low interest rates. These factors are reflected in the year-to-year decrease in 2007 of 14 percent in manufactured homes sold throughout the Company’s market area. Lower interest rates have resulted in two noticeable shifts within the housing industry: (1) certain home owners may select conventional homes over manufactured homes; and (2) an intensive marketing effort by financial institutions for mortgage refinancing has resulted in many home owners refinancing their mortgages at lower interest rates, which for the Company usually means a mortgage prepayment. The Company’s experience relative to prepayments of home mortgages, until 2006, had been minor. However, late in 2007, prepayments became a recognized concern. Prepayment of mortgages caused management to reevaluate certain assumptions resulting in a significant increase in the recourse liability for sold receivables related to mortgage prepayments in order to address the prospects of mortgage interest rates continuing to remain at present levels. Repossessions of homes result primarily from customers’ inability to meet their mortgage payment commitment. Approximately 80 percent of all the Company’s credit sales are with recourse, which means the Company will buy back from the financial institution holding a customer’s mortgage those homes repossessed by the mortgage holder that were originally sold by the Company. The Company’s experience related to repossessions has shown little change during the past ten years. However, during the fourth quarter of 2007, the Company charged off approximately $4.5 million related to customer defaults and repossessions. A charge to earnings for both prepayments and repossessions was made and the recourse liability for sold receivables was increased to $6.7 million at December 31, 2007. One of the causes of the $4.5 million charge was the refusal of some unrelated financial institutions to refinance the repossessions that occurred in their portfolio, and a second cause was that the Company had to finance them through TMH Financial Services Corp., thereby not recognizing income from sales of installment contracts on the resale. During the first three quarters of 2007, the provision for credit losses was approximately one percent of net sales. Due to the recent fourth quarter charges, management will increase the provision for 2008 to 1.5 percent of net sales as a precautionary measure against future repossession and early pay-off. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 68 TMH Case Study – Module 1 Proposed Annual Report Module 1 Income from Sales of Installment Contracts Income from sales of installment contracts was $26.8 million in 2007 versus $21.6 million in 2006, a 24.4 percent increase. As a percentage of net sales, it was 11.4 percent in 2007 compared with 14.1 percent in 2006. Several factors caused the percentage decrease in income from sales of installment contracts: (1) increased cash sales; (2) increased nonrecourse sales where no such income is received; (3) contributions of manufacturing to the sales volume where no such income is received; and (4) a decrease in the interest rate “spread” earned by the Company when the installment contracts are sold to financial institutions. The decreased spread was the most important factor in 2007 as two major financial institutions changed their “retail rate” and reduced the spread received by the Company by 33 percent. Income from sales of installment contracts is important for the Company. It is monitored closely and alternative sources of financing are considered for customer mortgage funding on an ongoing basis. Selling, General and Administrative Expense The Company’s selling, general and administrative expense (SG&A) has historically ranged around 17 percent of revenue. This range varies according to the Company’s growth pattern and marketing emphasis. In 2007, the significant factors affecting the Company’s SG&A expense, which was 19 percent of revenue, were that the Company: (1) initiated a second production line at its manufacturing plant; (2) acquired two additional subsidiaries— Howard Connell Homes of Tennessee and Jim Bell Majestic Homes, in Kentucky, in mid-September 2007; (3) initiated two additional operating subsidiaries—West Virginia Mountain Valley Homes (formerly part of the Company) and TMH Independent Retailers Corp. (formerly spread among several subsidiaries for operational purposes); (4) opened 13 new company sales centers and added 11 independent dealers to the retail network; and (5) formed TMH Financial Services Corp. as of October 2007. This expansion and realignment of subsidiaries, which occurred mostly during the fourth quarter, were part of an overall marketing strategy to more effectively penetrate the Company’s market. The significant increase in sales over 2006 of 54 percent resulted from staffing an additional 13 company-owned sales centers and expanding the marketing activity at all 114 sales centers, with special emphasis on bonus programs to sell aged inventory and homes received in trade for new sales. This aggressive marketing program was designed to achieve momentum for a strong 2008, but increased SG&A expense significantly at the same time. Other cost factors affecting SG&A expense were: (1) an increase in liability insurance rates on policy renewals during 2007 at an annual rate 40 percent higher than in 2006, or approximately an additional $775,000; and (2) the cost incurred during the year related to the completion of a 15-month standardization of accounting procedures and information processing enhancement program that centralized the Company’s management information with improved on-line capability to each subsidiary. This is a significant step forward in better information management and timely preparation of financial information. Interest Expense Interest expense increased $3.4 million to $7.5 million in 2007 from $4.1 million in 2006, or 85 percent. The increase resulted from a $27.8 million increase in total inventory and approximately a $10.8 million increase in total receivables directly related to the expansion of 39 sales centers in 2007. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Proposed Annual Report 69 The Company’s effective income tax rate was 37.7% in 2007 compared to 39.3% in 2006. This decrease resulted primarily from a decrease in state taxes. Organization All of the Company’s subsidiaries are profit centers. Each subsidiary has its own chief executive officer with total profit and loss responsibility. The Company’s long range plan for growth is by strategic acquisitions, expanding market share, and developing management talent through a newly organized salesperson training program, all to meet the need of providing low-cost housing to the U.S. consumer. Manufacturing Rockdale Manufactured Home Builders, the Company’s manufacturing subsidiary, commenced operations in September 2006. It has grown from virtually a start-up operation to a sales volume in excess of $34 million in 2007. Approximately 52 percent of the 1,119 homes manufactured were sold to and through Company related sales centers. The balance of the homes was sold to nonrelated independent retailers. The Rockdale plant operates two production lines with a plant capacity of approximately 3,500 floors (multi-section homes require more than one floor) per year. Financial Services TMH Financial Services Corp. was organized on October 15, 2007 to facilitate the marketing of new, repossessed, and pre-owned homes. Two major retail financial sources curtailed the purchase of retail installment sales contracts, which resulted in slow response to contract applications and therefore lost sales. The Company responded with the formation of TMH Financial Services Corp. to operate on a limited basis. The growth of this subsidiary will depend largely on whether or not the unrelated financial institutions continue to service the Company’s growth. 2006 Versus 2005 The Company’s net sales for 2006 were $152.5 million compared to $67.7 million for 2005, an increase of 125 percent. The majority of this increase was due to the addition of eight retail sales centers during the first quarter and the acquisition of Northern Florida Home Retailers on March 22, 2006, with 20 retail sales centers. The Company also opened seven retail sales centers in the second quarter, six in the third quarter, and two in the fourth quarter. Volume increases in sales centers that were in operation at the end of 2005 also occurred while the average sales price per unit remained fairly constant from 2005 to 2006. The Company’s purchase of a manufacturing facility on September 4, 2006, contributed approximately seven percent of the 2006 sales increase. Income from sales of installment contracts for 2006 was $21.6 million compared to $11.6 million for 2005, an increase of 86 percent. This was less than the percentage increase in sales due primarily to three factors: (1) discounting to present value the unreceived portion of income from sales of installment contracts; (2) NFHR earned significantly less such income than the other retail groups, primarily because of nonrecourse sales; and (3) the inclusion of manufacturing sales, which do not earn such income. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 Income Taxes 70 TMH Case Study – Module 1 Proposed Annual Report Cost of sales as a percentage of net sales increased approximately two percent in 2006. This increase was due to the substantial increase in sales to independent retailers that traditionally have lower margins, and a slight decrease in margins at Company-owned sales centers. Selling, general, and administrative expenses increased in 2006 as a result of increased sales volume and reflect the increase in number of sales centers and additional personnel to support our continued growth. Loss on recourse liability increased slightly as a percentage of net sales from 2005 to 2006. Interest rates were generally higher in 2006; total interest cost increased significantly due principally to increased inventories to support the added sales centers. Module 1 Liquidity and Capital Resources The Company, in April 2007, sold $40 million of 9% convertible subordinated notes due May 15, 2022. The proceeds were used primarily to reduce floor plan notes payable and to significantly improve the Company’s liquidity. During 2007, the Company purchased Jim Bell Majestic Homes with 11 sales centers and Howard Connell Homes of Tennessee with four sales centers, opened 13 Company-owned sales centers, formed a finance company subsidiary with an initial capitalization of $1.1 million, expanded the principal offices of its wholly owned subsidiary, AMH Home Centers, and opened a second production line at its manufacturing facility, using funds generated from the sale of the subordinated notes and from operations. At December 31, 2007, the Company had available $2.2 million in a bank line of credit and $18.6 million in unused floor plan lines of credit. On February 13, 2008, the Company sold $55 million of unsecured senior notes due in 2011 and 2013 bearing interest at a blended rate of 8.95%. The proceeds have been partially used to reduce floor plan notes payable. Although total cash and cash equivalents increased significantly in 2007, operations used cash and cash equivalents of $28.5 million compared to $31.2 million in 2006 and $7.6 million in 2005. The use of cash and cash equivalents by operations in 2007 was principally due to an increase in inventories and to the interest rate spread applicable to income from sales of installment contracts. © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Financial Ratio Analyses Common Size Growth Analyses © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 72 TMH Case Study – Module 1 Financial Ratio Analyses Module 1 TRIANGLE MANUFACTURED HOMES Ratio Analysis December 31, 2007, 2006, and 2005 2007 Profitability Rate of return on Assets Profit Margin (before interest expense) Total Asstets Turnover Ratio Accounts Receivable Turnover Ratio Inventory Turnover Ratio Fixed Asset Turnover Ratio Rate of Return on Common Shareholders' Equity Profit Margin (after interest expense) Financial Leverage Ratio Earnings per Share of Common Stock (basic) Liquidity Current Ratio Quick Ratio CFO to Current Liabilities Ratio Accounts Payable Turnover Days in Accounts Receivable Days in Inventory Days in Accounts Payable Solvency Long-term Debt Ratio Debt-Euquity Ratio CFO to Total Liabilities Ratio Interest Coverage Ratio Market Price / Earnings Ratio Market-to-Book Ratio 12.86 2.02 8.77 2.87 9.21 3.65 0.53 0.81 (0.19) 2.20 0.08 0.76 (0.36) 4.58 0.05 0.57 (0.32) 10.03 1.36 0.55 (0.27) 24.35 35.45 135.04 14.99 1.06 0.35 (0.39) 32.57 34.44 109.74 11.21 1.23 0.36 (0.36) 25.08 39.53 78.66 14.56 6.75% 3.84% 1.76 10.30 2.70 26.71 17 .69% 2.10% 4.80 0.69 14.48% 6.39% 2.26 10.60 3.33 32.95 39.08% 5.00% 3.45 1.14 27 .94% 9.93% 2.81 9.23 4.64 62.65 49.35% 8.94% 1.96 0.93 2006 2005 © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Financial Ratio Analyses 73 ASSETS Current Assets: Cash and cash equivalents Cash Temporary investments Contract proceeds receivable from financial institutions Total cash and cash equivalents Investments Retained interest in sold receivables, current portion (Note 2) Other receivables (Note 4) Inventories (Notes 5 and 9) Prepaid expenses Deferred income taxes (Note 11) Total current assets Retained interest in sold receivables, noncurrent portion (Note 2) Property, plant and equipment at cost (Note 6) Accumulated depreciation and amortization Net property, plant and equipment Goodwill (Note 3) Other assets Total assets LIABILITIES AND STOCKHOLDER'S EQUITY Current Liabilities: Notes payable Long-term debt - current installments (Note 10) Floor plan notes payable (Note 9) Accounts payable Income taxes (Note 11) Accrued expenses and other liabilities (Note 8) Total current liabilities Long-term debt - noncurrent installments (Note 10) Recourse liability for sold receivables (Note 7) Deferred income taxes (Note 11) Total liabilities Commitments and contingent liabilities (Note 14) Stockholder's equity (Notes 12 and 13 ) Common stock - $.50 par value per share; authorized 20 million shares; issued and outstanding 8.2 million shares in 2007 and 7 million shares in 2006 .8 Additional paid-in capital Retained earnings Accumulated other comprehensive income Total stockholder's equity Total Liabilities and Stockholder's Equity 2007 5.2% 0.6% 13.4% 19.2% 2.9% 2.2% 4.4% 44.6% 0.6% 0.8% 74.8% 14.3% 8.8% -2.8% 6.0% 2.5% 2.5% 100.0% 2006 2.2% 0.2% 10.1% 12.5% 1.6% 3.8% 4.0% 49.8% 0.8% 1.6% 74.2% 14.2% 10.6% -3.0% 7 .6% 2.1% 2.0% 100.0% 1.3% 0.9% 41.2% 5.7% 2.7% 3.2% 55.0% 21.8% 3.5% 0.6% 80.9% 2.2% 4.5% 12.4% 0.1% 19.1% 100.0% 0.0% 2.1% 53.4% 6.2% 5.6% 2.4% 69.7% 2.1% 3.6% 0.9% 76.3% 3.4% 4.6% 15.7% 0.0% 23.7% 100.0% © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 TRIANGLE MANUFACTURED HOMES Common Size Balance Sheets December 31, 2007 and 2006 74 TMH Case Study – Module 1 Financial Ratio Analyses Module 1 TRIANGLE MANUFACTURED HOMES Common Size Income Statements Year Ended December 31, 2007, 2006, and 2005 2007 Revenues: Net sales Income from sales of installment contracts Insurance commissions Interest income Other income Total revenue Costs and expenses: Cost of sales Selling, general and administrative Loss on recourse liability (Note 7) Interest Total costs and expenses Income before income taxes Income taxes (Note 11) Net income Other comprehensive income, net of tax: Unrealized investment gains Comprehensive income 0.0% 2.1% 0.0% 5.0% 0.0% 8.9% 71.7% 19.0% 3.1% 2.8% 96.6% 3.4% 1.3% 2.1% 70.7% 17 .8% 1.0% 2.3% 91.8% 8.2% 3.2% 5.0% 67 .2% 16.3% 0.7% 1.6% 85.8% 14.2% 5.3% 8.9% 88.2% 10.0% 0.0% 0.3% 1.5% 100.0% 86.4% 12.2% 0.0% 0.2% 1.2% 100.0% 84.2% 14.4% 0.0% 0.3% 1.0% 100.0% 2006 2005 © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. TMH Case Study – Module 1 Financial Ratio Analyses 75 ASSETS Current Assets: Cash and cash equivalents Cash Temporary investments Contract proceeds receivable from financial institutions Total cash and cash equivalents Investments Retained interest in sold receivables, current portion (Note 2) Other receivables (Note 4) Inventories (Notes 5 and 9) Prepaid expenses Deferred income taxes (Note 11) Total current assets Retained interest in sold receivables, noncurrent portion (Note 2) Property, plant and equipment at cost (Note 6) Accumulated depreciation and amortization Net property, plant and equipment Goodwill (Note 3) Other assets Total assets LIABILITIES AND STOCKHOLDER'S EQUITY Current Liabilities: Notes payable Long-term debt - current installments (Note 10) Floor plan notes payable (Note 9) Accounts payable Income taxes (Note 11) Accrued expenses and other liabilities (Note 8) Total current liabilities Long-term debt - noncurrent installments (Note 10) Recourse liability for sold receivables (Note 7) Deferred income taxes (Note 11) Total liabilities Commitments and contingent liabilities (Note 14) Stockholder's equity (Notes 12 and 13) Common stock - $.50 par value per share; authorized 20 million shares; issued and outstanding 8.2 million shares in 2007 and 7 million shares in 2006 .8 Additional paid-in capital Retained earnings Accumulated other comprehensive income Total stockholder's equity Total Liabilities and Stockholder's Equity 2007 2006 303% 351% 122% 157% 195% -4% 82% 49% 32% -14% 68% 67% 37% 55% 30% 98% 108% 66% 1928% n/a 1249% 1358% 3% 155% 501% 213% 1011% -14% 230% 47% 248% 137% 327% n/a -25% 173% -26% 28% 53% -20% 123% 31% 1619% 61% 8% 76% 450% 510% 144% 4% 92% 281% 171% 359% 8% 269% 7% 65% 31% 137% 34% 66% 0% 0% 97% n/a 49% 173% © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. Module 1 TRIANGLE MANUFACTURED HOMES Growth in Consolidated Balance Sheets December 31, 2007 and 2006 76 TMH Case Study – Module 1 Financial Ratio Analyses Module 1 TRIANGLE MANUFACTURED HOMES Growth in Consolidated Statements of Income Year Ended December 31, 2007, 2006, and 2005 2007 Revenues: Net sales Income from sales of installment contracts Interest income Other income Total revenue Costs and expenses: Cost of sales Selling, general and administrative Loss on recourse liability (Note 7) Interest Total costs and expenses Income before income taxes Income taxes (Note 11) Net income Other comprehensive income, net of tax: Unrealized investment gains Comprehensive income 37% -36% n/a 24% n/a 382% 53% 62% 376% 85% 59% -38% -40% -36% 131% 140% 214% 220% 135% 27% 34% 23% 213% 213% 212% 65% 208% 468% 714% 382% 54% 24% 107% 80% 51% 125% 86% 32% 162% 120% 216% 339% 232% 221% 229% 2006 2005 © 2008 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. ...
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This note was uploaded on 10/28/2009 for the course ACCOUTING 4566 taught by Professor Robert during the Fall '09 term at Aarhus Universitet.

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