10-Q 1 g85966e10vq.txt SOUTHERN ENERGY HOMES, INC. UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended October 3, 2003 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to ------- ------- Commission File Number: 0-21204 SOUTHERN ENERGY HOMES, INC. (Exact name of registrant as specified in its charter) Delaware 63-1083246 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 144 Corporate Way, P.O. Box 390, Addison, Alabama 35540 ------------------------------------------------- ----- (Address of principal executive offices) (Zip Code) (256) 747-8589 -------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [ ] No [X] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 12,143,865 shares of Common Stock, $.0001 par value, as of November 11, 2003 ---------------------------------------------------------------------------- SOUTHERN ENERGY HOMES, INC. AND SUBSIDIARIES INDEX

The Management's Discussion and Analysis included in this Form 10-Q contains statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are based upon the current beliefs and expectations of Southern Energy Homes, Inc.'s management and are subject to significant risks and uncertainties. These risks and uncertainties could cause the Company's results to differ materially from those set forth in such forward-looking statements. Such risks and uncertainties are described herein and in the Company's Quarterly Report on Form 10-Q for the quarters ended April 4 and July 4, 2003, and the Annual Report on Form 10-K for the year ended January 3, 2003, filed with the Securities and Exchange Commission and available at the Securities and Exchange Commission's internet site (www.sec.gov), to which reference is hereby made. 2 I. FINANCIAL INFORMATION Item 1. Financial Statements SOUTHERN ENERGY HOMES, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS

The accompanying notes are an integral part of these consolidated condensed financial statements. 3 SOUTHERN ENERGY HOMES, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (Unaudited)

The accompanying notes are an integral part of these consolidated condensed financial statements. 4 SOUTHERN ENERGY HOMES, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)

The accompanying notes are an integral part of these consolidated condensed financial statements. 5 SOUTHERN ENERGY HOMES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES: The consolidated condensed balance sheet as of October 3, 2003, and the consolidated condensed statements of operations for the thirteen and thirty-nine week periods ended October 3, 2003 and September 27, 2002, have been prepared by the Company without audit, but in the opinion of management reflect the adjustments necessary (which include only normal recurring adjustments) for the fair presentation of the information set forth therein. The consolidated condensed balance sheet as of January 3, 2003 has been derived from audited financial statements. Results of operations for the interim 2003 periods are not necessarily indicative of results expected for the full year. While certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission, the Company believes that the disclosures herein are adequate to make the information presented not misleading. These financial statements should be read in conjunction with the audited financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended January 3, 2003, as filed with the Securities and Exchange Commission. STOCK-BASED COMPENSATION Under fixed stock option plans, stock options may be granted to employees and directors at exercise prices that are equal to, less than, or greater than the fair market value of the Company's stock on the date of grant. Compensation expense, equal to the difference in exercise price and fair market value on the date of grant, is recognized over the vesting period for options granted at less than fair market value. In accordance with the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as amended, the Company has elected to apply Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations in accounting for its stock based plans. Accordingly, the Company has recognized no compensation expense for these plans during the interim periods ended October 3, 2003 and September 27, 2002. Had the Company accounted for its stock-based compensation plans based on the fair value of awards granted consistent with the methodology of SFAS 123, the Company's results of operations and related per share amounts for the interim periods ended October 3, 2003 and September 27, 2002 would have been affected as indicated below. The effects of applying SFAS 123 on a pro forma basis for the thirteen and thirty-nine weeks ended October 3, 2003 and September 27, 2002 are not likely to be representative of the effects on reported pro forma net income for future years as options vest over several years and as it is anticipated that additional grants will be made in future years.

PRODUCT WARRANTIES The Company warrants its products against certain manufacturing defects for a period of one year commencing at the time of retail sale. The estimated cost of such warranties is accrued at the time of sale to the independent dealer based on historical warranty costs incurred. Periodic adjustments to the accrual are made when events occur that indicate changes are necessary. The following table summarizes the changes in accrued product warranty obligations during the thirteen and thirty-nine weeks ended October 3, 2003. The accrued product warranty obligation is classified as accrued liabilities in the condensed consolidated balance sheets. 6

2. DISCONTINUED OPERATIONS: The Company closed a retail center in South Carolina in the second quarter of 2003. The closure of this retail center was not material to the financial results of the Company. In 2002, the Company closed eleven retail centers that were formerly part of the retail segment. These retail centers had been negatively affected by weak market conditions and restrictive retail financing conditions, principally as a result of the withdrawal of several lenders from the market. The decision to close the retail centers was based primarily on management's evaluation of recent operating results and future prospects. These centers were sold or closed by the end of December 2002. The Company also sold its consumer financing segment, principally consisting of its Wenco loan portfolio, in December 2002. The Wenco loan portfolio had a book value of approximately $11.8 million. The loan portfolio was sold for $6.1 million in a cash transaction. The decision to sell the loan portfolio was prompted by management's strategic plan to eliminate unprofitable business lines and thereby allow the Company to focus on its core manufacturing business. Accordingly, as required by FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), the operating results and disposal of the eleven retail centers discontinued in 2002 and the Wenco loan portfolio, which were previously reported in the retail and consumer financing segments, have been classified in discontinued operations for all prior periods presented herein. Accordingly, the operating results for the interim periods ended September 27, 2002 reported herein differ from those previously reflected in Forms 10-Q filed in 2002. As required by SFAS 144, any further operating income or losses, as well as adjustments to exit costs accruals (if any), will be reported in discontinued operations as incurred, or when circumstances warrant revisions of the related accounts. Operating results of the discontinued operations were as follows:

Assets and liabilities of the discontinued operations have been reflected in the consolidated balance sheets as current or non-current based on the original classification of these accounts, net of any necessary valuation allowances. Although the Company believes it has appropriately reduced the carrying value of the assets to their estimated recoverable amounts, net of disposal cost where appropriate, actual results could be different and the difference will be reported in discontinued operations in future periods. 7 Net assets of the discontinued operations are as follows:

There are no material contingent liabilities, including environmental liabilities or litigation, related to the closed retail centers or the consumer finance business discontinued in 2002. 3. INVENTORIES: Inventories are valued at first-in, first-out ("FIFO") cost, which is not in excess of market. An analysis of inventories follows:

4. EARNINGS PER SHARE: Basic earnings per share (EPS) excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of shares outstanding during the subject period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock are exercised or converted into common stock or result in the issuance of common stock that will share in the earnings of the Company. The following reconciliation details the numerators and denominators used to calculate basic and diluted earnings per share for the respective periods:

8 5. INVESTMENTS IN JOINT VENTURES The Company owns interests in four joint ventures all of which are accounted for using the equity method. The Company owns a 39% interest in WoodPerfect, Ltd., a manufacturing joint venture, which produces rafters used in the production of homes manufactured by the Company and others. The Company also owns 33% of WoodPerfect of Texas, Inc., which manufactures rafters used in the production of manufactured homes. The Company owns a 33% interest in Hillsboro Manufacturing, Inc., which manufactures laminate wallboard. The Company owns 33% of Lamraft LLP which is a real estate holding company that leases facilities to a third party. The Company formerly owned 33% of Ridge Pointe Mfg., LLC, which manufactures cabinet doors for sale to participants in the joint venture as well as third-party customers. The Ridge Pointe Mfg., LLC interest was sold in May 2002. The Company also formerly owned a 50% interest in Wenco 21, LLC, an entity that originates installment loans for the purchase of homes manufactured by the Company and others. Wenco 21, LLC was liquidated August 31, 2003 and the Company received, in exchange for its pro rata liquidating distribution in the net assets of Wenco 21, LLC, an interest in specified assets and liabilities that were transferred to the other joint venture partner, 21st Mortgage Corporation. The Company's investments in and advances to unconsolidated joint ventures amounted to $3.4 million and $4.3 million at October 3, 2003 and January 3, 2003. The Company's equity in the net earnings of these ventures was $129,000 and $309,000 for the thirty-nine weeks ended October 3, 2003 and September 27, 2002, respectively. The Company received cash distributions from joint venture investments of $175,000 and $185,000 for the thirty-nine weeks ended October 3, 2003 and September 27, 2002, respectively, Retained earnings at October 3, 2003 and September 27, 2002, included undistributed earnings of joint ventures of $0.2 million and $0.5 million, respectively. Since the liquidation of Wenco 21, LLC, the Company's only remaining significant joint venture is WoodPerfect, Ltd., which is accounted for by the equity method of accounting. A summary of financial information relating to the joint ventures is as follows:

The October 3, 2003 summary balance sheet data reflect WoodPerfect, Ltd. only and the January 3, 2003 summary balance sheet data include WoodPerfect, Ltd and Wenco 21, LLC.

The October 3, 2003 summary income statement information for the thirteen and thirty-nine weeks then ended reflects WoodPerfect, Ltd. only and the September 27, 2002 summary income statement information for the thirteen and thirty-nine weeks then ended includes WoodPerfect, Ltd and Wenco 21, LLC. 9 6. RECENT ACCOUNTING PRONOUNCEMENTS: In June 2001, the FASB issued SFAS 143, Accounting for Asset Retirement Obligations, SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset, except for certain obligations of lessees. SFAS 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002. The adoption of SFAS 143 did not have any impact in the first and second quarters of 2003 on the Company's financial position, results of operations or cash flows. In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51" (FIN 46). FIN 46 addresses whether business enterprises must consolidate the financial statements of entities known as "variable interest entities". A variable interest entity is defined by FIN 46 to be a business entity that has one or both of the following characteristics: (1) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity; and (2) the equity investors lack one or more of the following essential characteristics of a controlling financial interest: (a) direct or indirect ability to make decisions about the entity's activities through voting rights or similar rights, (b) the obligation to absorb the expected losses of the entity if they occur, which makes it possible for the entity to finance its activities, or (c) the right to receive the expected residual returns of the entity if they occur, which is the compensation for risk of absorbing expected losses. FIN 46 does not require consolidation by transferors to qualifying special purpose entities. The effective date for FIN 46 was delayed until periods ending after December 15, 2003 for interests in variable interest entities acquired prior to February 1, 2003. Adoption of FIN 46 is not expected to have an impact on the Company's financial position, results of operations or cash flows. In July 2002, the FASB issued SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS 146 addresses the recognition, measurement and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for pursuant to the guidance set forth in EITF No 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity. SFAS 146 revises the accounting for certain lease termination costs and employee termination benefits, which are generally recognized in connection with restructuring activities. Adoption of this standard as of January 4, 2003 had no impact on the Company's financial position, results of operations or cash flows for the thirty-nine weeks ended October 3, 2003. In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an Interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 32 ("FIN 45"). FIN 45 clarifies the requirements of FASB Statement No. 5, Accounting for Contingencies, relating to a guarantor's accounting for, and disclosure of, specified types of guarantees. FIN 45 requires that upon issuance of a guarantee, the entity (i.e., the guarantor) must recognize a liability for the fair value of the obligation it assumes under that guarantee. The disclosure provisions of FIN 45 were effective for financial statements of interim or annual periods that end after December 15, 2002. FIN 45's provisions for initial recognition and measurement must be applied on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor's fiscal year end. The guarantor's previous accounting for guarantees that were issued before the date of FIN 45's initial application may not be revised or restated to reflect the effect of the recognition and measurement provisions of FIN 45. The Company has guarantees that are subject to the disclosure provisions of FIN 45. See Note 7 "Repurchase Agreements". The adoption of the prospective recognition and measurement aspects of FIN 45 did not have a material effect on the Company's financial position, results of operations or cash flows. 7. REPURCHASE AGREEMENTS: Substantially all of the Company's independent dealers finance their purchases through "floor plan" arrangements under which a financial institution provides the dealer with a loan for the purchase price of the home and maintains a security interest in the home as collateral. In connection with a floor plan arrangement, the financial institution that provides the independent dealer financing customarily requires the Company to enter into a separate repurchase agreement with the financial institution, under which the Company is obligated, upon default by the independent dealer, to repurchase the homes at the Company's original invoice price less cost of all damaged/missing items and less certain curtailments, plus certain administrative and shipping expenses. Repurchases were $159,000 and $383,000 for the thirteen weeks 10 ended October 3, 2003 and September 27, 2002 and $1.1 million and $1.7 million for the thirty-nine week periods then ended, respectively. Losses on homes repurchased under these agreements were $34,000 and $91,000 for the thirteen weeks ended October 3, 2003 and September 27, 2002 and $244,000 and $483,000 for the thirty-nine week periods then ended, respectively. At October 3, 2003, the Company had a reserve of $250,000 for future repurchase losses. At October 3, 2003, the Company's contingent repurchase liability under floor plan financing arrangements through independent dealers was approximately $37 million. While homes that have been repurchased by the Company under floor-plan financing arrangements are usually sold to other dealers, no assurance can be given that the Company will be able to sell to other dealers homes that it may be obligated to repurchase in the future under such floor-plan financing arrangements, or that the Company will not suffer losses with respect to, and as a consequence of, those arrangements. Effective August 31, 2003, Wenco 21, LLC was liquidated with the assets and liabilities of Wenco 21, LLC being transferred into a book entry reserve account to be held by 21st Mortgage Corporation. In exchange for its pro rata distribution of the liquidated assets and liabilities, the Company received an interest (in the form of a revenue sharing agreement) in specified assets and liabilities that were transferred to 21st Mortgage Corporation. Under the terms of the revenue sharing agreement, the Company and 21st Mortgage Corporation will share equally in the profits and losses derived from the loans that comprised the Wenco 21, LLC portfolio. The Company is also obligated under the revenue sharing agreement to repurchase homes that were financed by Wenco 21 LLC, upon repossession, for 50% to 65% of the outstanding loan balance. The Company's contingent repurchase obligation under this commitment is approximately $12.4 million. At October 3, 2003, the Company has included approximately $1.0 million classified in investments in the consolidated balance sheet associated with this interest (in the form of a revenue sharing agreement) in specified assets and liabilities. At October 3, 2003, the carrying amount of loans in the Wenco 21 portfolio included in the reserve account was approximately $21.4 million. These loans collateralize approximately $19.4 million of the reserve account's obligations. The Company currently adjusts the carrying value of this investment for any income or losses incurred by the portfolio through earnings and its maximum exposure to loss as a result of its continuing involvement with the loan portfolio, assuming that 100% of the loans and underlying collateral becomes worthless, is approximately $13.4 million. 8. LEGAL PROCEEDINGS: The Company is a party to various legal proceedings incidental to its business. The Company typically issues a one-year warranty on new manufactured homes. The Company provides for warranty costs at the time of sale in the ordinary course based on historical warranty experience. The majority of the Company's outstanding legal proceedings are claims related to warranty on manufactured homes or employment issues such as workers' compensation claims. Management believes that adequate reserves are maintained for such claims. In the opinion of management, after consultation with legal counsel, the ultimate liability, if any, with respect to these proceedings, will not materially affect the financial position or results of operations of the Company. However, the ultimate resolution of these matters, which could occur within one year, could result in losses in excess of the amounts reserved. For the quarters ended October 3, 2003 and September 27, 2002, accrued litigation reserves, (in addition to normal warranty and workmen's compensation claims reserves) were $0.9 million and $0.8 million, respectively. 9. SEGMENT AND RELATED INFORMATION: The Company has three reportable segments: manufacturing, retail operations and component supply. The manufacturing segment produces manufactured homes for sale to independent and company-owned retail centers. Although each manufacturing facility is an operating segment, they are aggregated into one segment for reporting purposes because they produce similar products using similar production techniques and they sell their products to the same class of customer. In addition, they are subject to the same regulatory environment and their economic characteristics (measured on terms of profitability) are similar. The retail operations segment sells homes, which have been produced by the Company's manufacturing segment and to a lesser extent, by various other manufacturers, to retail customers. The component supply segment sells various supply products to the Company's manufacturing segment and to third party customers. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on total (external and intersegment) revenues, gross profit and segment operating income. The Company accounts for intersegment sales and transfers as if the sales or transfers were to third parties, at current market prices. The Company does not allocate income taxes to its segments. The Company's reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different operating and marketing strategies. 11 Revenue from segments included in "all other" in the accompanying segment disclosures is primarily attributable to a small insurance business. This segment has never met the quantitative thresholds for determining reportable segments. Certain corporate administrative expenses are not allocated to reportable segments. The financial information for the thirteen and thirty-nine week periods ended September 27, 2002 concerning reportable segments has been restated to reflect the reclassification of the eleven retail centers closed in 2002 and the consumer financing business as discontinued operations (see Note 2). The following tables present information about the Company's reporting segments

12 Summary of segment assets:

10. SUBSEQUENT EVENT: SHAREHOLDER RIGHTS PLAN. After the close of the third quarter, on October 10, 2003, the Company adopted a shareholder rights plan and designated 40,000 of its 1,000,000 authorized shares of preferred stock as Series A Junior Participating Preferred Stock (the "Preferred Stock"). In connection with this rights plan, the Company declared a dividend of one preferred share purchase right (a "Right") for each outstanding share of common stock, payable to the stockholders of record as of November 3, 2003. Each Right entitles the holder to purchase one one-thousandth (1/1000) of a share of the Preferred Stock, which has economic terms similar to that of one share of the Company's common stock, for $25.00, subject to adjustment. In the event that any person or group acquires 15% or more of the Company's outstanding common stock, each holder of a Right (other than the acquiring person or group) will be entitled to receive, upon payment of the exercise price, shares of common stock (or other equivalent security such as the Preferred Stock) having a market value equal to twice the exercise price , unless the Board redeems the Rights for $.001 per right or exchanges the Rights for one common share or one one-thousandth of a share of Preferred Stock. Existing holdings of 15% or more of the Company's common shares by persons directly or indirectly will not cause the rights to be exercisable, nor entitle the holders of rights to purchase additional shares of the Company, unless such holder acquires additional shares or converts such holdings from indirect to direct beneficial ownership. The purchase price payable and number of shares of preferred stock issuable upon exercise of the rights are subject to customary adjustments to prevent dilution. Rights do not have voting rights and the holder has no rights as a stockholder until rights are exercised. The terms of the rights may be amended by the Board in its discretion, without the consent of the holders of the rights. The rights expire on October 10, 2013 unless earlier redeemed or exchanged. Each one-thousandth share of preferred stock purchased upon exercise of the rights has rights and preferences substantially equivalent to those of one common share and shares are not redeemable. Each share of preferred stock will be entitled to a minimum preferential quarterly dividend payment of $1 per share and an aggregate dividend of 1,000 times the dividend declared per common share. In the event of liquidation, the holders of the Preferred Stock will be entitled to a minimum preferential liquidation payment of $1,000 per share and an aggregate payment of 1,000 times the payment made per common share. Each share of preferred stock will have 1,000 votes, voting together with the common shares. In the event of any merger or exchange transaction, holders of the preferred stock will be entitled to receive 1,000 times the amount received per common share. In connection with the rights plan, the board of directors also announced that it plans to enter into change of control severance agreements with certain of its key executives, and plans to amend outstanding stock option agreements to provide that participants will be fully and immediately vested in the event of a change in control. 13 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS. Forward-looking statements in this Quarterly Report on Form 10-Q, including without limitation, statements relating to the adequacy of the Company's resources are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties, which could cause actual results to differ materially from those in any forward looking statements, including without limitation: availability of financing for prospective purchasers of the Company's homes and availability of floor plan financing for dealers; general economic conditions; the cyclical and seasonal nature of housing markets; competitive pricing pressures at both the wholesale and retail levels; changes in market demand; the impact of cost reduction programs and other management initiatives; the Company's contingent repurchase liabilities with respect to dealer financing and retail buyer financing; the adequacy of accruals for workers' compensation claims and insurance costs; availability and pricing of raw materials; concentration of the Company's business in certain regional markets; adverse weather conditions that reduce retail sales; the possibility of plant shutdowns from weather or other causes; availability of labor for the Company to meet operating requirements; the highly competitive nature of the manufactured housing industry; federal, state and local regulation of the Company's business; the Company's reliance on independent dealers; and other risks indicated from time to time in the Company's filings with the Securities and Exchange Commission. GENERAL During the third quarter of fiscal 2003, difficult industry conditions persisted, as negative economic factors that have influenced financial performance of the entire manufactured housing industry since approximately 1998 continued. The most notable of these conditions currently are more restrictive retail financing conditions for consumers and slow retail sales, together with reduced financing alternatives for dealers. The Company has taken a number of steps since 2000 to decrease costs and improve efficiency and quality. These steps included closing less efficient manufacturing facilities, consolidating divisions, and disposing of unprofitable business lines. In light of this continued difficult market conditions, the Company reduced its salary workforce approximately 12% during the second quarter of 2003 by consolidating and eliminating several administrative functions in an effort to reduce costs in the coming quarters to more closely match sales volume. During the third quarter this year, the Company launched a new housing division, Southern Estates, which produced its first home in August, 2003. The Southern Estates homes are intended to fill a product gap by including the most popular options with less customization. To provide manufacturing space for the new product line, the Company reconfigured certain of its manufacturing operations by combining production of its Lifestyle line into its Southern Energy plant. In addition, the Company will invest $1.5 million to expand the Southern Energy plant into adjacent facilities currently used by its Windmar Supply division. The expanded space will be used for improving efficiencies in finishing operations on the Company's higher end homes. Windmar will move into a new facility that will be added to the distribution warehouse. The Company sells the majority of the homes it produces through its network of independent home dealers in 22 states. DISCONTINUED OPERATIONS The Company closed a retail center in South Carolina in the second quarter of 2003. The closure of this retail center was not material to the financial results of the Company. In 2002, the Company closed eleven retail centers that were formerly part of the retail segment. These retail centers had been negatively affected by weak market conditions and restrictive retail financing conditions, principally as a result of the withdrawal of several lenders from the market. The decision to close the retail centers was based primarily on management's evaluation of recent operating results and future prospects. These centers were sold or closed by the end of December 2002. The Company also sold its consumer financing segment, principally consisting of the Wenco loan portfolio, in December 2002. The Wenco loan portfolio had a book value of approximately $11.8 million. The loan 14 portfolio was sold for $6.1 million in a cash transaction. The decision to sell the loan portfolio was prompted by management's strategic plan to eliminate unprofitable business lines and thereby allow the Company to focus on its core manufacturing business. Accordingly, as required by FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144"), the operating results and disposal of the eleven retail centers and the Wenco loan portfolio, which were previously reported in the retail and consumer financing segments, have been classified in discontinued operations for all prior periods presented herein. The Company recognized a loss of $53,000 from discontinued operations in the quarter ended October 3, 2003, as compared to a loss of $3.5 million for the quarter ended September 27, 2002. As required by SFAS 144, any further operating losses, as well as adjustments to exit costs accruals (if any), will be reported in discontinued operations as incurred, or when circumstances warrant revisions of the related accounts. CRITICAL ACCOUNTING POLICIES The Company uses accounting policies that it believes are appropriate to accurately and fairly report its results of operations and financial position, and it applies those accounting policies in a consistent manner. The preparation of the Company's financial statements in conformity with generally accepted accounting principles requires that the Company's management make estimates and assumptions that may affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions are based on historical and other factors believed to be reasonable under the circumstances. The Company evaluates these estimates and assumptions on an ongoing basis. Actual results can and frequently will differ from these estimates. It is possible that materially different amounts would be reported under different conditions or using different methods or assumptions. The Company believes that the following accounting policies are the most critical ones used in the preparation of its financial statements, because these are the ones that involve the most significant judgments and estimates about the effect of matters that are inherently uncertain. PRODUCT WARRANTIES The Company warrants its products against certain manufacturing defects for a period of one year commencing at the time of retail sale. The estimated cost of such warranties is accrued at the time of sale to the independent dealer based on historical warranty costs incurred. Periodic adjustments to the accrual are made when events occur that indicate changes are necessary. LITIGATION The Company is a party to various legal proceedings incidental to its business. The Company typically issues a one-year warranty on new manufactured homes. The majority of these legal proceedings are claims related to warranty on manufactured homes or employment issues such as workers' compensation claims. Management believes that adequate reserves are maintained for such claims. In the opinion of management, after consultation with legal counsel, the ultimate liability, if any, with respect to these proceedings will not materially affect the financial position or results of operations of the Company; however, the ultimate resolution of these matters, which could occur within one year, could result in losses in excess of the amounts reserved. INSURANCE ARRANGEMENTS The Company is partially self-insured for workers compensation and health insurance claims. The Company purchases insurance coverage for all workers compensation claims in excess of $350,000 per occurrence, and for all health care claims in excess of $75,000 per occurrence, with an annual aggregate stop-loss limit of approximately $5.3 million for all claims. Amounts are accrued currently for the estimated costs of claims incurred, including related expenses. Management considers accrued liabilities for unsettled claims to be adequate. However, there is no assurance that the amounts accrued will not vary from the ultimate amounts incurred upon final disposition of all outstanding claims. As a result, periodic adjustments to the reserves will be made as events occur that indicate changes are necessary. REPURCHASE AGREEMENTS Substantially all of the Company's independent dealers finance their purchases through "floor plan" arrangements under which a financial institution provides the dealer with a loan for the purchase price of the home and maintains a security interest in the home as collateral. In connection with a floor plan arrangement, the financial institution that provides the independent dealer financing customarily requires the Company to enter into a separate repurchase agreement with the financial institution, under which the 15 Company is obligated, upon default by the independent dealer, to repurchase the homes at the Company's original invoice price less cost of all damaged/missing items and less certain curtailments, plus certain administrative and shipping expenses. Repurchases were $159,000 and $383,000 for the thirteen weeks ended October 3, 2003 and September 27, 2002 and $1.1 million and $1.7 million for the thirty-nine week periods then ended, respectively. Losses on homes repurchased under these agreements were $34,000 and $91,000 for the thirteen weeks ended October 3, 2003 and September 27, 2002 and $244,000 and $483,000 for the thirty-nine week periods then ended, respectively. At October 3, 2003, the Company had a reserve of $250,000 for future repurchase losses. At October 3, 2003, the Company's contingent repurchase liability under floor plan financing arrangements through independent dealers was approximately $37 million. While homes that have been repurchased by the Company under floor-plan financing arrangements are usually sold to other dealers, no assurance can be given that the Company will be able to sell to other dealers homes that it may be obligated to repurchase in the future under such floor-plan financing arrangements, or that the Company will not suffer losses with respect to, and as a consequence of, those arrangements. Effective August 31, 2003, Wenco 21, LLC was liquidated with the assets and liabilities of Wenco 21, LLC being transferred into a book entry reserve account to be held by 21st Mortgage Corporation. In exchange for its pro rata distribution of the liquidated assets and liabilities, the Company received an interest (in the form of a revenue sharing agreement) in specified assets and liabilities that were transferred to 21st Mortgage Corporation. Under the terms of the revenue sharing agreement, the Company and 21st Mortgage Corporation will share equally in the profits and losses derived from the loans that comprised the Wenco 21, LLC portfolio. The Company is also obligated under the revenue sharing agreement to repurchase homes that were financed by Wenco 21 LLC, upon repossession, for 50% to 65% of the outstanding loan balance. The Company's contingent repurchase obligation under this commitment is approximately $12.4 million. At October 3, 2003, the Company has included approximately $1.0 million classified in investments in the consolidated balance sheet associated with this interest (in the form of a revenue sharing agreement) in specified assets and liabilities. At October 3, 2003, the carrying amount of loans in the Wenco 21 portfolio included in the reserve account was approximately $21.4 million. These loans collateralize approximately $19.4 million of the reserve account's obligations. The Company currently adjusts the carrying value of this investment for any income or losses incurred by the portfolio through earnings and its maximum exposure to loss as a result of its continuing involvement with the loan portfolio, assuming that 100% of the loans and underlying collateral becomes worthless, is approximately $13.4 million. IMPAIRMENT OF LONG-LIVED ASSETS The Company records impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of those items. The Company's cash flow estimates are based on historical results adjusted to reflect the Company's best estimate of future market and operating conditions. Any material change affecting the assumptions used to project the estimated undiscounted cash flows or our expectation of future market conditions could result in a different conclusion. Assets for which the carrying value is not fully recoverable are reduced to fair value. RECOVERABILITY OF INVESTMENTS Management assesses the recoverability of the Company's investments in joint ventures when impairment indicators are present. The significant judgment required in management's recoverability assessment is the determination of the fair value of the investment. Since the investments are non-publicly traded investments, management's assessment of fair value is based on the Company's analysis of the investee's estimates of future operating results and the resulting cash flows. Management's ability to accurately predict future cash flows is critical to the determination of fair value. In the event a decline in fair value of an investment occurs, management may be required to make a determination as to whether the decline in market value is other than temporary. Management's assessment as to the nature of a decline in fair value is largely based on the Company's estimates of future operating results, the resulting cash flows and intent to hold the investment. If an investment is considered to be impaired and the decline in value is considered to be other than temporary, an appropriate write-down is recorded. VOLUME INCENTIVES PAYABLE Volume incentives are common practice in the industry in which the Company operates and are accounted for as a reduction to gross sales. The volume incentives payable is estimated and recorded when sales of 16 products are made. The payable is adjusted, if necessary, when information becomes available that indicate revisions are needed. RESULTS OF OPERATIONS Thirty-nine weeks and thirteen weeks ended October 3, 2003 are compared with thirty-nine weeks and thirteen weeks ended September 27, 2002. Net Revenues Total net revenues (consisting of gross sales less volume discounts, returns and allowances) for the thirty-nine weeks ended October 3, 2003 were $93.1 million, as compared with $105.3 million in the prior year period. Net revenues from wholesale sales of manufactured homes were $89.2 million (including intersegment revenues of $1.8 million) for the thirty-nine weeks ended October 3, 2003, as compared with $101.5 million (including intersegment revenues of $5.4 million) for the prior year period, a decline of 12.1%. Total homes shipped for the thirty-nine weeks ended October 3, 2003 was 2,702, down from the 3,272 homes shipped in the prior year period. The average wholesale price per home for the thirty-nine weeks ended October 3, 2003 was $31,325, as compared with $29,432 in the prior year period, an increase of 6.4%. For the thirteen weeks ended October 3, 2003, total net revenues were $34.0 million, as compared with $34.5 million for the comparable period a year ago. For the thirteen weeks ended October 3, 2003, net revenues from the wholesale sale of manufactured homes were $32.7 million (including intersegment revenues of $0.7 million), as compared with $33.7 million (including intersegment revenues of $2.2 million) for the prior year period, a decline of 3.0%. Total homes shipped for the thirteen weeks ended October 3, 2003 was 960, down 11.3% from the number of homes shipped in the prior year period. The unit decline in sales to dealers was largely the result of the continuing soft economy and reduced availability of financing options for the independent dealers and for consumers. The average wholesale price per home for the thirteen weeks ended October 3, 2003 was $32,367, as compared with $29,545 in the prior year period, an increase of 9.6%. The increase in average wholesale price per home sold for both the thirteen and thirty-nine week periods was primarily a function of dealers' choices of various options and custom home features, though it also includes some modest price increases mostly in the form of surcharges reflecting recent increased material costs, primarily lumber. Net revenues from retail sales of manufactured homes were $3.3 million for the thirty-nine weeks ended October 3, 2003, as compared with $6.7 million for the prior year period, a decrease of 50.4%. The decline in retail sales was primarily attributable to competitive pressures and reflects the fact that the Company operated one less retail center during the thirty-nine weeks ended October 3, 2003 compared to the retail centers that were open during all or part of the same period in the prior year. The decline in retail revenues was offset slightly by an increase in the average retail price per home sold. The average retail price per new homes sold during the thirty-nine weeks ended October 3, 2003 was $56,572, as compared with $52,639 in the prior year period, an increase of 7.5%. As with wholesale pricing, the increase in average retail price per home sold for the thirty-nine week period was primarily a function of customers' choices of various options and custom home features, but also includes some modest price increases in certain instances due to increased wholesale prices from the manufacturer. For the thirteen weeks ended October 3, 2003, net revenues from the retail sale of manufactured homes were $0.9 million, as compared with $2.0 million for the prior year period, a decrease of 55.7%. The decline in retail sales was primarily attributable to increased competition and the Company's operation of one fewer retail center during the quarter ended October 3, 2003 compared to the prior year period. The decline in retail revenues also resulted from a decline in the average retail price per home sold during the quarter. The average retail price per new homes sold during the thirteen weeks ended October 3, 2003 was $47,706, as compared with $57,481 in the prior year period, a decline of 17.0%. The decline in average retail price per home sold for the thirteen week period was primarily a function of fluctuation in the sales "mix", with a greater percentage of single section units being sold than multi section units during the third quarter 2003 compared to the third quarter of 2002. Net revenues from the component supply segment were $18.6 million (including intersegment revenues of $16.3 million) for the thirty-nine weeks ended October 3, 2003, as compared with $18.8 million (including 17 intersegment revenues of $16.6 million) for the prior year period, a decline of 1.0%. The decline in supply sales was primarily attributable to the decline in intersegment sales to the manufacturing segment. For the thirteen weeks ended October 3, 2003, net revenues from the component supply segment were $7.2 million (including intersegment revenues of $6.2 million), as compared with $6.7 million (including intersegment revenues of $5.8 million) for the prior year period, an increase of 7.8%. The increase in supply sales for the thirteen weeks ended October 3, 2003 was primarily attributable to the increase in intersegment sales to the manufacturing segment, additional third party customers added during the third quarter of 2003 and an increase in sales to contractors for use in residential applications. Following are summary operating data for the thirteen and thirty-nine weeks ended for October 3, 2003, and September 27, 2002 respectively: OPERATING FACTS

GROSS PROFIT Gross profit consists of net revenues less the cost of sales, which includes labor, materials, and overhead. Gross profit for the thirty-nine weeks ended October 3, 2003 was $15.4 million, or 16.5% of net revenues, as compared with $20.4 million, or 19.4% of net revenues, in the prior year period. This decline in the gross profit percentage was attributable primarily to lower sales volume that resulted in an unfavorable variance on fixed overhead, higher material prices and higher labor costs, due to increased customization. For the thirteen weeks ended October 3, 2003, gross profit was $6.1 million, or 17.8% of net revenues, as compared with $7.0 million, or 20.3% of net revenues, in the prior year period. Higher material prices and the start up of Southern Estates caused the lower gross profit in the thirteen week period compared to the same period in fiscal 2002, and the decline in the gross profit percentage continued to show the effect of lower sales volume and unfavorable variances on fixed overhead, higher material prices, and higher labor costs. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses include primarily sales commissions, advertising expenses, freight costs, salaries for support personnel, administrative compensation, executive and management bonuses, insurance costs, and professional fees. Selling, general and administrative expenses were $15.8 million, or 16.9% of net revenues, during the thirty-nine weeks ended October 3, 2003, as compared with $18.0 million, or 17.1% of net revenues, for the same period of the prior year. 18 For the thirteen weeks ended October 3, 2003, selling, general and administrative expenses were $5.4 million, or 15.9% of net revenues, as compared with $6.2 million, or 18.0% of net revenues, for the same period of the prior year. The decline in selling, general and administrative expenses was attributable primarily to lower sales volume and freight expenses, together with decreases in legal expenses. Administrative salaries also declined due to the cost reduction measures taken during the second quarter of 2003. INTEREST EXPENSE Interest expense, which primarily consists of amortization of debt issuance costs and facility commitment fees, for the thirty-nine weeks ended October 3, 2003, was $377,000, as compared with $485,000 in the prior year period. For the thirteen weeks ended October 3, 2003, interest expense was $116,000, as compared with $125,000 in the prior year period. The decrease in interest expense in the current quarter was a result of lower average borrowings, $0 in the third quarter of 2003 compared to $4.5 million on the credit line for the same period of the prior year. Facility commitment fees and bank availability fees are lower due to the Company renegotiating the fees and lowering its line of credit from $40 million to $10 million at the end of the first quarter of 2003. As part of the negotiations, in July, 2003 the Company extended its $10 million line of credit from March, 2004 to March, 2005. PROVISION FOR INCOME TAXES Income taxes are provided for based on the tax effect of revenue and expense transactions included in the determination of pre-tax book income. Because the Company has operated at a loss in recent fiscal years, management believes that under the provisions of SFAS 109, it is not appropriate to record income tax benefits on current losses in excess of anticipated refunds of taxes previously paid. As a result, the Company has established valuation allowances against the net deferred tax benefits related to net operating loss carry forwards and other net deductible temporary differences between financial and taxable income. The valuation allowance may be reversed in future years if the Company returns to profitability. At January 3, 2003, the Company had no federal net operating loss carry forward. State net operating loss carryforwards amounting to $39.9 million are available to offset future taxable income in a number of states, and they expire at various dates in 2006 through 2022. The tax losses generated in 2002 and 2001 for federal income tax purposes have been carried back under the temporary 5 year net operating loss carry back rules applicable to 2002 and 2001. Accordingly, the Company filed a carryback refund claim in 2003 and received income tax refunds of $5.3 million with respect to the 2002 net operating loss. This income tax refund (net of separate Company state income tax liabilities) was approximately $417,000 higher than expected due to more favorable timing differences (primarily related to depreciation) than originally calculated, resulting in an additional tax benefit of $330,000 in the second quarter ending July 4, 2003 and $87,000 in the third quarter ended October 3, 2003. LIQUIDITY AND CAPITAL RESOURCES During the thirty-nine weeks ended October 3, 2003, cash provided by operations was approximately $4.8 million. Net loss from continuing operations for the thirty-nine weeks was $0.3 million. Included in the net loss were non-cash charges of amortization and depreciation expense of $1.6 million. Cash provided by operating activities reflected tax refunds of $5.3 million, an increased accounts payable of $3.3 million, and an increase in accrued liabilities of $0.8 million partially offset by an increase in accounts receivable of $1.2 million and increased inventories of $3.6 million. In addition to cash provided by operating activities, other significant items affecting cash flows from continuing operations included capital expenditures of $1.0 million which were partially offset by proceeds from sale of property and equipment of $0.2 million. At October 3, 2003, the balance of the revolving credit facility was $0 and the Company's net working capital from continuing operations was $14.5 million, including $11.9 million in cash and cash equivalents, as compared with working capital of $13.2 million at January 3, 2003, including $7.0 million in cash and cash equivalents. The increase in net working capital was primarily attributable to increases in cash and cash equivalents of $5.0 million (primarily from the receipt of the federal income tax refunds described above) and increases in accounts payable of $3.3 million and in accrued liabilities of $0.8 million, partially offset by increases in accounts receivable of $1.2 million and inventories of $3.6 million. 19 During the thirty-nine weeks ended September 27, 2002, cash provided by operations was approximately $0.7 million Net income from continuing operations for the thirty-nine weeks was $2.0 million. Included in net income were non-cash charges of amortization and depreciation expense of $1.7 million. Cash provided by operating activities also reflected increased accounts receivable of $2.1 million, inventories $0.2 million and prepayments and other of $0.7 million and a decrease of accrued liabilities of $1.9 million, partially offset by an increase in accounts payable of $1.1 million. In addition to cash provided by operating activities, other significant items affecting cash flows from continuing operations included proceeds from the sale of a joint venture of $1.3 million, proceeds from the sale of property and equipment of $1.0 million partially offset by capital expenditures of $0.6 million. At October 3, 2003, outstanding borrowings under the $10 million secured bank line were $0 and availability on the line, which is dependent upon meeting certain financial ratios and covenants, was $9.4 million, $0.6 million of the credit line used to secure three letters of credit. Management believes that operating cash flows, together with borrowing capacity under the line, will provide the Company with adequate liquidity and capital resources through the remaining term of the bank line. The Company presently has plans to make capital expenditures of $1.5 million during the next twelve months to expand the Southern Energy plant to increase operating efficiencies. In conjunction with this expansion the Company will combine the Windmar Supply Company into a new expansion of its existing distribution warehouse. Inflation The Company believes that the relatively moderate rate of inflation over the past few years has not had a significant impact on its sales or profitability. The Company has in the past been able to pass on most of the increases in its costs by increasing selling prices, although there can be no assurance that the Company will be able to do so in the future. Item 3. Quantitative and Qualitative Disclosures of Market Risk. Historically the Company has not entered into derivatives contracts to either hedge existing risk or for speculative purposes. The Company also does not and has not entered into contracts involving derivative financial instruments or derivative commodity instruments. Although the Company's principal credit agreement bears a floating interest rate of 1.0% over prime at October 3, 2003, nothing was outstanding under the credit agreement. Accordingly, the Company presently has no significant exposure to interest rate risks. Item 4. CONTROLS AND PROCEDURES During the 90-day period prior to the filing of this quarterly report, an evaluation was performed under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-4(c) under the Securities Exchange Act of 1934, as amended). Following that evaluation, the Company's management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures were effective at that time. There have been no significant changes in the Company's internal controls, other factors that could significantly affect internal controls, or significant or material weaknesses with regard to the Company's internal controls identified by the Company subsequent to that evaluation. 20 PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company is a party to various legal proceedings incidental to its business. The Company typically issues a one-year warranty on new manufactured homes. The majority of these legal proceedings are claims related to warranty on manufactured homes or employment issues such as workers' compensation claims. Management believes that adequate reserves are maintained for such claims. In the opinion of management, after consultation with legal counsel, the ultimate liability, if any, with respect to these proceedings will not materially affect the financial position or results of operations of the Company; however, the ultimate resolution of these matters, which could occur within one year, could result in losses in excess of the amounts reserved. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits The following exhibits are filed as a part of or furnished with this report. 31.1 Certification 31.2 Certification 32.1 Certification of chief executive officer and chief financial officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K The following reports on Form 8-K were filed during the quarter ended October 3, 2003: On July 25, 2003, Southern Energy Homes, Inc. filed a Form 8-K reporting the issuance of a press release announcing financial results for the quarter ended July 4, 2003. 21 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SOUTHERN ENERGY HOMES, INC. Date: November 14, 2003 By: /s/ Keith O. Holdbrooks ----------------- -------------------------------------------- Keith O. Holdbrooks, Chief Executive Officer Date: November 14, 2003 By: /s/ James L. Stariha ----------------- -------------------------------------------- James L. Stariha, Chief Financial Officer 22

SOUTHERN ENERGY HOMES INC 10-Q