Edgar Filing: CHAMPION ENTERPRISES INC

FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Mark one)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934.

For Quarterly period ended October 1, 2005

o	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

1-9751

CHAMPION ENTERPRISES, INC.

(Exact name of registrant as specified in its charter)

Michigan

38-2743168

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer

Identification No.)

2701 Cambridge Court, Suite 300

Auburn Hills, MI 48326

(Address of principal executive offices)

Registrant’s telephone number, including area code: (248) 340-9090

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

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes X No

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). 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.

75,945,602 shares of the registrant’s $1.00 par value Common Stock were outstanding as of October 27, 2005.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

			CHAMPION ENTERPRISES, INC.
		Consolidated Statements of Operations
	(In thousands, except per share amounts)
				Unaudited				Unaudited
				Three Months Ended				Nine Months Ended
				October 1,		October 2,		October 1,		October 2,
				2005		2004		2005		2004
Net sales				$	335,728	$	276,949	$	897,103	$	754,167

Cost of sales					277,819		226,590		746,357		630,757

Gross margin					57,909		50,359		150,746		123,410

Selling, general and administrative expenses					38,385		32,555		106,696		94,725
Mark-to-market charge (credit) for common stock warrant					—		2,300		(4,300)		3,500
Loss on debt retirement					—		—		901		2,776

Operating income					19,524		15,504		47,449		22,409

Interest income					980		470		2,682		954
Interest expense					(4,340)		(4,556)		(13,549)		(14,204)

Income from continuing operations
before income taxes					16,164		11,418		36,582		9,159

Income tax expense (benefit)					950		800		1,850		(10,300)

Income from continuing operations					15,214		10,618		34,732		19,459

Loss from discontinued operations, net of taxes					(900)		(629)		(4,209)		(361)

Net income					14,314		9,989		30,523		19,098

Basic income (loss) per share:
Income from continuing operations				$	0.20	$	0.14	$	0.45	$	0.25
Loss from discontinued operations					(0.01)		(0.01)		(0.06)		—
Basic income per share				$	0.19	$	0.13	$	0.39	$	0.25

Weighted shares for basic EPS					75,837		71,300		74,520		70,020

Diluted income (loss) per share:
Income from continuing operations				$	0.20	$	0.13	$	0.44	$	0.25
Loss from discontinued operations					(0.01)		(0.01)		(0.05)		(0.01)
Diluted income per share				$	0.19	$	0.12	$	0.39	$	0.24

Weighted shares for diluted EPS					76,886		72,522		75,559		71,610

See accompanying Notes to Consolidated Financial Statements.

CHAMPION ENTERPRISES, INC.

Consolidated Balance Sheets

(In thousands, except par value)

	Unaudited October 1, 2005			January 1, 2005
ASSETS
Current assets
Cash and cash equivalents	$	131,059		$	142,266
Restricted cash		509			529
Accounts receivable, trade		52,246			22,119
Inventories		98,705			71,616
Current assets of discontinued operations		2,814			35,463
Other current assets		14,738			13,535
Total current assets		300,071			285,528

Property, plant and equipment		213,365			207,216
Less-accumulated depreciation		122,811			126,259
		90,554			80,957

Goodwill		154,463			126,591
Amortizable intangible assets		4,050			—
Non-current assets of discontinued operations		2,404			7,747
Other non-current assets		13,212			16,219
	$	564,754		$	517,042

LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS’ EQUITY

Current liabilities
Accounts payable	$	40,630		$	13,819
Accrued warranty obligations		32,365			33,551
Accrued volume rebates		32,992			30,234
Accrued compensation and payroll taxes		25,412			19,659
Accrued self-insurance		28,565			25,988
Current liabilities of discontinued operations		3,661			23,411
Other current liabilities		39,166			29,696
Total current liabilities		202,791			176,358

Long-term liabilities
Long-term debt		191,494			200,758
Long-term liabilities of discontinued operations		18			432
Other long-term liabilities		37,356			41,444
		228,868			242,634
Contingent liabilities (Note 8)

Redeemable convertible preferred stock, no par value, 5,000 shares authorized, 0 shares and 21 shares issued and outstanding, respectively		—			20,750

Shareholders’ equity
Common stock, $1 par value, 120,000 shares authorized, 75,939 and 72,358 shares issued and outstanding, respectively		75,939			72,358
Capital in excess of par value		186,070			164,377
Accumulated deficit		(129,145	)		(159,375	)
Accumulated other comprehensive income (loss)		231			(60	)
Total shareholders’ equity		133,095			77,300
	$	564,754		$	517,042

See accompanying Notes to Consolidated Financial Statements.

CHAMPION ENTERPRISES, INC.

Consolidated Statements of Cash Flows

(In thousands)

	Unaudited Nine Months Ended
	October 1, 2005			October 2, 2004
Cash flows from operating activities
Income from continuing operations	$	34,732		$	19,459

Adjustments to reconcile income from continuing operations to net cash provided by (used for) operating activities:
Depreciation and amortization		7,726			7,765
Loss on debt retirement		901			2,776
Mark-to-market (credit) charge for common stock warrant		(4,300	)		3,500
Gain on disposal of fixed assets		(1,625	)		(154	)
Decrease in allowance for tax adjustments		—			(12,000	)
Increase/decrease
Accounts receivable		(27,617	)		(23,799	)
Refundable income taxes		—			3,123
Inventories		(13,039	)		(22,937	)
Accounts payable		20,840			9,393
Accrued liabilities		12,848			7,962
Other, net		9,224			1,943
Net cash provided by (used for) continuing operating activities		39,690			(2,969	)

Cash flows from discontinued operations
Loss from discontinued operations		(4,209	)		(361	)
Proceeds from sales of retail businesses		30,649			—
Change in net assets of discontinued operations		(11,533	)		(15,240	)
Net cash provided by (used for) discontinued operations		14,907			(15,601	)

Cash flows from investing activities
Additions to property, plant and equipment		(7,976	)		(6,247	)
Acquisition of New Era group		(41,427	)		—
Investments in and advances to unconsolidated subsidiaries		(55	)		(163	)
Proceeds on disposal of fixed assets		5,221			3,645
Net cash used for investing activities		(44,237	)		(2,765	)

Cash flows from financing activities
Decrease in short-term debt, net		(8,195	)		(29	)
Purchase of Senior Notes		(9,885	)		(10,395	)
Decrease in other long-term debt		(277	)		(6,025	)
Purchase of common stock warrant		(4,500	)		—
Decrease in restricted cash		1			7,888
Preferred stock issued, net		—			12,000
Common stock issued, net		1,582			5,154
Dividends paid on preferred stock		(293	)		(419	)
Net cash (used for) provided by financing activities		(21,567	)		8,174

Net decrease in cash and cash equivalents		(11,207	)		(13,161	)
Cash and cash equivalents at beginning of period		142,266			145,868

Cash and cash equivalents at end of period	$	131,059		$	132,707

See accompanying Notes to Consolidated Financial Statements.

CHAMPION ENTERPRISES, INC.

Consolidated Statement of Shareholders’ Equity

Unaudited Nine Months Ended October 1, 2005

(In thousands)

									Accumulated
				Capital in					other						Total
	Common stock			excess of		Accumulated			comprehensive						comprehensive
	Shares	Amount		par value		Deficit			income (loss)			Total			income (loss)

Balance at January 1, 2005	72,358	$	72,358	$	164,377	$	(159,375	)	$	(60	)	$	77,300			—

Net income	—		—		—		30,523			—			30,523		$	30,523
Preferred stock dividends	—		—		—		(293	)		—		—	(293	)		—
Stock options and benefit plans	350		350		2,174		—			—			2,524			—
Issuance for acquisition deferred purchase price payments	171		171		1,829		—			—			2,000			—
Preferred stock conversion	3,060		3,060		17,690		—			—			20,750
Foreign currency translation adjustments	—		—		—		—			291			291			291

Balance at October 1, 2005	75,939	$	75,939	$	186,070	$	(129,145	)	$	231		$	133,095		$	30,814

See accompanying Notes to Consolidated Financial Statements.

CHAMPION ENTERPRISES, INC.

Notes to Consolidated Financial Statements

(Unaudited)

1. The Consolidated Financial Statements are unaudited, but in the opinion of management include all adjustments necessary for a fair statement of the results of the interim period. All such adjustments are of a normal recurring nature. Financial results of the interim period are not necessarily indicative of results that may be expected for any other interim period or for the fiscal year. The balance sheet as of January 1, 2005 was derived from audited financial statements.

For a description of significant accounting policies used by Champion Enterprises, Inc. (“the Company”) in the preparation of its consolidated financial statements, please refer to Note 1 of Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended January 1, 2005.

During 2005, the Company completed the disposal of its traditional retail operations through the sale of its remaining 40 traditional retail sales centers, including the sale of ten sales centers during the quarter ended October 1, 2005. As a result, the Company’s traditional retail operations, excluding its non-traditional California operations, are classified as discontinued operations for the periods reported. Also included in discontinued operations is the Company’s former consumer finance business that was exited in the third quarter of 2003.

The Company accounts for its stock-based employee compensation programs under Accounting Principles Board (“APB”) Opinion No. 25. The additional disclosures and pro forma information required by Statement of Financial Accounting Standards (“SFAS”) No. 123 as amended by SFAS No. 148 follow. If compensation costs for the Company’s stock-based compensation plans had been determined based on the fair value at the grant dates consistent with the requirements of SFAS No. 123, pro forma net income, income per share, and stock-based compensation expense would have been as indicated below:

	Three Months Ended
	October 1, 2005		October 2, 2004
	(In thousands, except per share amounts)
Net income – as reported	$	14,314	$	9,989
Net income – pro forma		15,704		9,577
Basic income per share – as reported		0.19		0.13
Diluted income per share – as reported		0.19		0.12
Basic income per share – pro forma		0.21		0.12
Diluted income per share – pro forma		0.20		0.12
Stock-based employee compensation expense, net of related tax effects – as reported		3,135		256
Stock-based employee compensation expense, net of related tax effects – pro forma	$	1,745	$	668

	Nine Months Ended
	October 1, 2005		October 2, 2004
	(In thousands, except per share amounts)
Net income – as reported	$	30,523	$	19,098
Net income – pro forma		31,585		18,521
Basic income per share – as reported		0.39		0.25
Diluted income per share – as reported		0.39		0.24
Basic income per share – pro forma		0.41		0.24
Diluted income per share – pro forma		0.40		0.23
Stock-based employee compensation expense, net of related tax effects – as reported		5,649		586
Stock-based employee compensation expense, net of related tax effects – pro forma	$	4,586	$	1,163

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting

Standard (“SFAS”) No. 123R, “Share-Based Payment.” Under previous practice, the reporting entity could account for share-based payment under the provisions of APB Opinion No. 25 and disclose share-based compensation as accounted for under the provisions of SFAS No. 123. Under the provisions of SFAS No. 123R, a public entity is required to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award. In April 2005, the Securities and Exchange Commission (“SEC”) postponed the effective date of SFAS No. 123R until fiscal years beginning after June 15, 2005. The Company expects to adopt SFAS No. 123R no later than January 2006. Once the standard is adopted, the Company currently expects full-year 2006 diluted net earnings per share to be reduced by less than $.01 for stock options outstanding at October 1, 2005. The effect of adopting the standard for the Company’s other stock-based compensation plans is not determinable. Application of this pronouncement requires significant judgment regarding the inputs to an option-pricing model, including stock price volatility and employee exercise behavior. Most of these inputs are either highly dependent on the current economic environment at the date of grant or forward-looking over the expected term of the award. As a result, the actual impact of adoption on earnings for 2006 could differ significantly from the Company’s current estimate.

2. On August 8, 2005, pursuant to three separate asset purchase agreements, the Company acquired the assets of New Era Building Systems, Inc. and its affiliates, Castle Housing of Pennsylvania, Ltd. and Carolina Building Solutions, L.L.C. (collectively, "the New Era group"), modular homebuilders, for aggregate cash consideration of $41 million plus the assumption of certain current liabilities, including trade payables, assumed contracts, and working capital lines of credit. These lines of credit, totaling $8.2 million, were subsequently retired. This acquisition expands the Company’s presence in the modular homebuilding industry.

The results of operations of the New Era group from the acquisition date to October 1, 2005 are included in the Company’s results from continuing operations and in its manufacturing segment for the three and nine months ended October 1, 2005.

Goodwill and other intangible assets recognized in the transactions amounted to $31.9 million, substantially all of which is expected to be fully deductible for tax purposes. All of the goodwill and intangible assets were assigned to the manufacturing segment. As of October 1, 2005, intangible assets resulting from the purchase consisted of $2.8 million for trade names, $1.3 million for customer relationships, and $27.8 million for non-amortizable goodwill. Costs of intangible assets were determined based on valuation information obtained from a third-party valuation expert. Trade names were valued based upon the royalty-saving method and customer relationships were valued based upon the excess earnings method. The straight-line amortization periods to be used are 15 years for trade names and seven years for customer relationships, resulting in annual amortization expense of $0.4 million.

An unaudited condensed balance sheet of the acquired businesses at August 8, 2005 is as follows:

	August 8, 2005
	(in millions)
Current assets	$	18.6
Property, plant, and equipment, net		12.2
Goodwill		27.8
Amortizable intangible assets, net		4.1
Other non-current assets		0.3
Total assets	$	63.0

Current liabilities	$	21.3

Net assets of acquired businesses	$	41.7

The following tables include the unaudited pro forma combined results as if Champion had acquired the New Era group as of the beginning of the periods presented, instead of August 8, 2005.

	Unaudited
	Three Months Ended
	October 1, 2005		October 2, 2004
	(in thousands)
Net sales	$	347,208	$	306,109
Net income		13,865		10,960
Income per share	$	0.18	$	0.14

	Unaudited
	Nine Months Ended
	October 1, 2005		October 2, 2004
	(in thousands)
Net sales	$	966,123	$	834,411
Net income		31,476		21,772
Income per share	$	0.41	$	0.28

The pro forma results include amortization of the intangibles presented above. The pro forma results are not necessarily indicative of what actually would have occurred if the transaction had been completed as of the beginning of each of the fiscal periods presented, nor are they indicative of future consolidated results.

3. The provisions for income tax differ from the amount of income tax determined by applying the applicable U.S. statutory federal income tax rate to pretax income from continuing operations and discontinued operations as a result of the following differences:

	Nine Months Ended
	October 1, 2005			October 2, 2004
	(In thousands)
Continuing operations
Statutory U.S. tax rate	$	12,800		$	2,900
(Decrease) increase in rate resulting from:
Warrant mark-to-market and other permanent differences		(1,200	)		1,500
Deferred tax valuation allowance		(9,900	)		(3,300	)
Decrease in allowance for tax adjustments		—			(12,000	)
Foreign and state taxes		150			600
Total income tax expense (benefit)	$	1,850		$	(10,300	)

	Nine Months Ended
	October 1, 2005			October 2, 2004
Discontinued operations	(In thousands)
Statutory U.S. tax rate	$	(1,500	)	$	(100	)
Increase in rate resulting from:
Deferred tax valuation allowance		1,500			100
Total income tax	$	—		$	—

The Company currently provides a 100% valuation allowance for its deferred tax assets. Deferred tax assets will continue to require a 100% valuation allowance until the Company has demonstrated their realizability through sustained profitability and/or from other factors. As of January 1, 2005, the Company had available federal net operating loss carryforwards of approximately $120 million for tax purposes to offset certain future federal taxable

income. These loss carryforwards expire in 2023 and 2024. As a result of the divestiture of the Company’s remaining traditional retail operations during 2005, an estimated $80 million of additional tax loss carryforwards have been generated.

4.	A summary of inventories by component follows:

	October 1,		January 1,
	2005		2005
	(In thousands)
New manufactured homes	$	30,196	$	18,749
Raw materials		37,382		30,908
Work-in-process		12,986		7,166
Other inventory		18,141		14,793
	$	98,705	$	71,616

Other inventory consists of land, park spaces, and improvements, net of inventory reserves.

5. The Company’s manufacturing operations generally provide retail homebuyers with a twelve-month warranty from the date of purchase. Estimated warranty costs are accrued as costs of sales primarily at the time of the manufacturing sale. Warranty provisions and reserves are based on estimates of the amounts necessary to settle existing and future claims for homes sold by the manufacturing operations as of the balance sheet date. The following table summarizes the changes in accrued product warranty obligations during the nine months ended October 1, 2005 and October 2, 2004. A portion of warranty reserves was classified as other long-term liabilities in the consolidated balance sheet.

	2005			2004
	(In thousands)
Reserves at beginning of year	$	40,051		$	47,058
Warranty expense provided		36,160			34,327
Warranty reserves from acquisitions		1,783			—
Cash warranty payments		(39,129	)		(40,078	)
Reserves at end of quarter	$	38,865		$	41,307

6.	Long-term debt consisted of the following:
		October 1, 2005		January 1, 2005
		(In thousands)
7.625% Senior Notes due 2009		$	89,273	$	89,273
11.25% Senior Notes due 2007			88,430		97,510
Obligations under industrial revenue bonds			12,430		12,430
Other debt			1,379		1,545
		$	191,512	$	200,758

During the quarter ended July 2, 2005, the Company purchased and retired $9.1 million of its Senior Notes due 2007 for cash payments of $9.9 million, resulting in a pretax loss of $0.9 million. During the quarter ended July 3, 2004, the Company purchased and retired $10.9 million of its Senior Notes due 2009 for cash payments of $10.4 million, resulting in a pretax gain of $0.5 million. During the first quarter of 2004, the Company purchased and retired $13.5 million of the Senior Notes due 2009 and $13.5 million of the Senior Notes due 2007 in exchange for Company common stock totaling 3.9 million shares, resulting in a pretax loss of $3.2 million. Also during the first quarter of 2004, the Company repaid a $5.7 million obligation under an industrial revenue bond.

Champion Home Builders Co., a wholly-owned subsidiary of the Company, has a three-year, $75 million revolving credit facility currently used for the issuance of letters of credit. Under this facility, as amended January 24, 2005,

letter of credit fees range from 1.75% to 2.25% annually and borrowings bear interest at either the prime interest rate plus up to 0.5% or the Eurodollar rate plus 2.0% to 2.5%. In addition, there is an annual fee of $0.1 million and a 0.375% of the unused portion of the facility. Availability under the facility is determined by a monthly borrowing base calculation based on percentages of eligible accounts receivable, inventory, fixed assets, and, if necessary, cash on deposit. The facility agreement contains certain financial covenants that require the Company, only in the event that its liquidity, as defined, falls below $35 million, to maintain certain levels of consolidated earnings before interest, taxes, depreciation, amortization, non-cash restructuring costs and gains (losses) from extinguishment of Senior Notes and certain ratios of earnings to fixed charges, as defined. Liquidity, as defined, consists of the majority of the Company’s unrestricted cash and cash equivalents plus unused availability under the facility. Fixed charges, as defined, consist primarily of interest expense, capital expenditures, dividends paid in cash, required principal payments of debt and lease payments paid or accrued during the calculation period as well as cash losses under wholesale repurchase obligations. In addition, the facility contains covenants that limit the Company’s ability to incur additional indebtedness and liens, sell assets and, if liquidity falls below $35 million, make certain investments, pay dividends and purchase or redeem its common stock. The line of credit is collateralized by accounts receivable, inventories, fixed assets, cash, and other assets. As of October 1, 2005, availability under the facility was $62.3 million, there were $52.2 million of letters of credit issued and no borrowings outstanding, and the Company’s liquidity, as defined, was $143.6 million, which was in excess of $35 million such that no other financial covenants were in effect.

During the quarter ended October 1, 2005, the Company announced plans to enter into new senior secured credit facilities in an aggregate amount of $200 million. Approximately $100 million of proceeds will represent funded debt to be used to finance a tender offer for the 11.25% Senior Notes due 2007. The remaining amount will be a back-up facility to support the Company’s letters of credit, in addition to providing working capital through a revolving credit facility. It is anticipated that the new credit facility will close in late October 2005.

On September 30, 2005, the Company commenced a cash tender offer and consent solicitation for all of the $88.4 million of its outstanding 11.25% Senior Notes due 2007. As of October 14, 2005, the Company had received tenders from holders of a total of $82 million of the Senior Notes. As a result of the successful consent solicitation, most of the covenants in the indenture will be eliminated upon closing.

7. During the first quarter of 2004, the preferred shareholder exercised its right to purchase $12 million of Series B-2 preferred stock. At January 1, 2005, redeemable convertible preferred stock consisted of $8.75 million of Series C and $12 million of Series B-2 with mandatory redemption dates of April 2, 2009 and July 3, 2008, respectively. Both Series had a 5% annual dividend that was payable quarterly, at the Company’s option, in cash or common stock. Also at January 1, 2005, the preferred shareholder held a warrant that was issued by the Company, which was exercisable based on approximately 2.2 million shares at the strike price at April 2, 2005 of $12.27 per share. The warrant had an expiration date of April 2, 2009 and was exercisable only on a non-cash, net basis, whereby the warrant holder would receive shares of common stock as payment for any net gain upon exercise.

On April 18, 2005, the Company repurchased and subsequently cancelled the common stock warrant in exchange for a cash payment of $4.5 million and the preferred shareholder elected to immediately convert all of the outstanding Series B-2 and Series C preferred stock into 3.1 million shares of common stock under the terms of the respective preferred stock agreements.

During the nine months ended October 1, 2005, the Company recorded a mark-to-market credit of $4.3 million for the change in estimated fair value of the warrant. During the quarter and nine months ended October 2, 2004, the Company recorded mark-to-market charges of $2.3 million and $3.5 million, respectively.

8. The majority of the Company’s manufacturing sales to independent retailers are made pursuant to repurchase agreements with lending institutions that provide wholesale floor plan financing to the retailers. Pursuant to these agreements, generally for a period of up to 24 months from invoice date of the sale of the homes and upon default by the retailers and repossession by the financial institution, the Company is obligated to purchase the related floor plan loans or repurchase the homes from the lender. The contingent repurchase obligation at October 1, 2005 was estimated to be approximately $265 million, without reduction for the resale value of the homes. Losses under repurchase obligations are determined by the difference between the repurchase price and the estimated net proceeds from the resale of the homes. Losses incurred on homes repurchased totaled $0.3 million and $0.2 million for the nine months ended October 1, 2005 and October 2, 2004, respectively.

At October 1, 2005 the Company was contingently obligated for approximately $52.5 million under letters of credit, primarily comprised of $35.3 million to support insurance reserves, $12.6 million to support long-term debt, and $3.1 million to secure surety bonds. Champion was also contingently obligated for $10.6 million under surety bonds, generally to support license and service bonding requirements. Approximately $48.0 million of the letters of credit support insurance reserves and long-term debt that are reflected as liabilities in the consolidated balance sheet.

At October 1, 2005 certain of the Company’s subsidiaries were guarantors of $4.6 million of debt of unconsolidated subsidiaries, none of which was reflected in the consolidated balance sheet. These guarantees are several or joint and several and are related to indebtedness of certain manufactured housing community developments which are collateralized by the properties being developed.

The Company has provided various representations, warranties, and other standard indemnifications in the ordinary course of its business, in agreements to acquire and sell business assets, and in financing arrangements. The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business.

Management believes the ultimate liability with respect to these contingent obligations will not have a material effect on the Company’s financial position, results of operations or cash flows.

9. During the three months ended October 1, 2005, the Company’s potentially dilutive securities consisted of outstanding stock options and awards. During the nine months ended October 1, 2005 and the three and nine months ended October 2, 2004, the Company’s potentially dilutive securities consisted of outstanding stock options and awards, convertible preferred stock, a common stock warrant, and, in the 2004 periods, deferred purchase price obligations. Convertible preferred stock and common stock warrants were not considered in determining the denominator for diluted earnings per share (“EPS”) in any period presented because the effect would have been antidilutive. A reconciliation of the numerators and denominators used in the Company’s basic and diluted EPS calculations follows:

	Three Months Ended						Nine Months Ended
	October 1, 2005			October 2, 2004			October 1, 2005			October 2, 2004
Numerator	(In thousands)
Net income	$	14,314		$	9,989		$	30,523		$	19,098
Plus loss from discontinued operations		900			629			4,209			361
Less preferred stock dividend		—			(259	)		(293	)		(678	)
Less amount allocated to participating securities holders		—			(718	)		(952	)		(1,244	)
Income from continuing operations available to common shareholders for basic and diluted EPS		15,214			9,641			33,487			17,537

Loss from discontinued operations available to common shareholders for basic and diluted EPS		(900	)		(629	)		(4,209	)		(361	)

Income available to common shareholders for basic and diluted EPS	$	14,314		$	9,012		$	29,278		$	17,176

Denominator
Shares for basic EPS--weighted average shares outstanding		75,837			71,300			74,520			70,020
Plus effect of dilutive securities
Deferred purchase price obligations		—			423			—			647
Stock options and awards		1,049			799			1,039			943

Shares for diluted EPS

76,886

72,522

75,559

71,610

10.The Company evaluates the performance of its manufacturing and retail segments based on income before interest, income taxes, and general corporate expenses. Reconciliations of segment sales to consolidated net sales and segment income to consolidated income from continuing operations before income taxes follow:

	Three Months Ended
	October 1, 2005			October 2, 2004
Net sales	(In thousands)
Manufacturing	$	310,239		$	269,498
Retail		36,789			34,251
Less: intercompany		(11,300	)		(26,800	)
Consolidated net sales	$	335,728		$	276,949

Income from continuing operations before income taxes: Manufacturing segment income	$	27,023		$	22,092
Retail segment income		2,176			2,017
General corporate expenses		(9,875	)		(6,505	)
Mark-to-market charge for common stock warrant		—			(2,300	)
Interest expense, net		(3,360	)		(4,086	)
Intercompany eliminations		200			200
Income from continuing operations before income taxes	$	16,164		$	11,418

	Nine Months Ended
	October 1, 2005			October 2, 2004
Net sales	(In thousands)
Manufacturing	$	840,572		$	748,437
Retail		100,731			82,030
Less: intercompany		(44,200	)		(76,300	)
Consolidated net sales	$	897,103		$	754,167

Income from continuing operations before income taxes: Manufacturing segment income	$	62,880		$	44,313
Retail segment income		6,045			4,246
General corporate expenses		(26,675	)		(19,374	)
Mark-to-market credit (charge) for common stock warrant		4,300			(3,500	)
Loss on debt retirement		(901	)		(2,776	)
Interest expense, net		(10,867	)		(13,250	)
Intercompany eliminations		1,800			(500	)
Income from continuing operations before income taxes	$	36,582		$	9,159

11. Discontinued operations include the Company’s traditional retail operations, excluding its California non-traditional retail operations, and its former consumer finance business that was exited in 2003. For the three and nine months ended October 1, 2005, revenues from discontinued retail operations were $0.4 million and $25.6 million, respectively. For the three and nine months ended October 2, 2004, revenues from discontinued retail operations were $38.7 million and $104.7 million, respectively. Losses from discontinued operations for the three and nine months ended October 1, 2005 and October 2, 2004 consist of the following:

	Three Months Ended						Nine Months Ended
	October 1, 2005			October 2, 2004			October 1, 2005			October 2, 2004
	(In thousands)
Loss from retail operations	$	(872	)	$	(557	)	$	(4,159	)	$	(1,405	)
(Loss) income from consumer finance business		(28	)		(73	)		(50	)		1,044
Total loss from discontinued operations	$	(900	)	$	(630	)	$	(4,209	)	$	(361	)

The assets and liabilities of discontinued operations consisted of the following:

	October 1, 2005		January 1, 2005
	(In thousands)
Assets:
Accounts receivable, trade	$	26	$	598
Inventories		2,096		33,964
Other current assets		692		901
Current assets of discontinued operations		2,814		35,463
Property, plant, and equipment, net		580		5,064
Other non-current assets		1,824		2,683
Non-current assets of discontinued operations		2,404		7,747

Liabilities:
Floor plan payable	$	—	$	11,835
Accounts payable		516		2,043
Other current liabilities		3,145		9,533
Current liabilities of discontinued operations		3,661		23,411
Long-term liabilities		18		432

On July 19, 2005, the Company’s remaining ten traditional retail locations were sold. Loss from discontinued retail operations for the nine months ended October 1, 2005 included an operating loss of $2.3 million and a net loss of $1.9 million related to sales of 40 retail locations. In connection with the sales of retail businesses during 2005, intercompany profit of $2.4 million, which had been previously eliminated in consolidation, was recognized in the consolidated statement of operations and was not classified as discontinued operations. Retail assets sold in 2005 consisted primarily of new homes and other inventory. During 2005 the aggregate sale price for the sold operations was cash of approximately $30.6 million and the buyers’ assumption of certain liabilities totaling approximately $3.4 million. In connection with these sales, the Company paid down $10.9 million of floor plan borrowings.

12. During the quarter ended April 2, 2005, the Company issued 171,000 shares of common stock in payment of the final $2.0 million installment of deferred purchase price obligations. During the three and nine months ended October 2, 2004, the Company issued 214,000 shares and 683,000 shares, respectively, of common stock in payment of deferred purchase price obligations of $2.0 million and $6.0 million, respectively. In addition, during the second quarter of 2004, the Company issued 29,000 shares of common stock in payment of preferred stock dividends totaling $0.3 million. During the first quarter of 2004, the Company purchased and retired $13.5 million of its Senior Notes due 2009 and $13.5 million of its Senior Notes due 2007 in exchange for 3.9 million shares of Company common stock.

13. The following table provides information regarding current year activity for restructuring reserves recorded in previous periods relating to closures of manufacturing plants and retail sales centers.

	Nine Months Ended October 1, 2005
	2004 Closures			Prior Closures			Total
	(In thousands)
Balance at beginning of year	$	810		$	3,611		$	4,421
Cash payments:
Warranty costs		—			(675	)		(675	)
Other closing costs		(600	)		(379	)		(979	)
Reversals credited to earnings:
Other closing costs		(190	)		(16	)		(206	)
Balance at October 1, 2005	$	20		$	2,541		$	2,561

Period end balance comprised of:
Warranty costs	$	—		$	1,917		$	1,917
Other closing costs		20			624			644
	$	20		$	2,541		$	2,561

Warranty costs are expected to be paid over a three-year period after the related closures. Other closing costs are generally paid within one year of the related closures, though certain lease payments at abandoned retail locations are paid up to three years after the closures. The reversal of closing costs during the nine months ended October 1, 2005 consisted of an adjustment to accruals for employee severance.

14. Substantially all subsidiaries of CHB are guarantors and the Company is a subordinated guarantor of the Senior Notes due 2007. In addition, CHB is a guarantor and substantially all of its subsidiaries are guarantors of the Senior Notes due 2009 on a basis subordinated to their guarantees of the Senior Notes due 2007. The non-guarantor subsidiaries include the Company’s foreign operations, its development companies and certain finance subsidiaries.

Separate financial statements for each guarantor subsidiary are not included in this filing because each guarantor subsidiary is 100%-owned and the guarantees are full and unconditional, as well as joint and several, for the Senior Notes due 2009 and for the Senior Notes due 2007. There were no significant restrictions on the ability of the parent company or any guarantor subsidiary to obtain funds from its subsidiaries by dividend or loan.

The following condensed consolidating financial information presents the financial position, results of operations and cash flows of (i) the Company (“Parent”) and CHB, as parents, as if they accounted for their subsidiaries on the equity method; (ii) the guarantor subsidiaries, and (iii) the non-guarantor subsidiaries.

CHAMPION ENTERPRISES, INC.

Condensed Consolidating Statement of Operations

For the Three Months Ended October 1, 2005

							Guarantor			Non-guarantor			Consolidating
	Parent				CHB		Subsidiaries			Subsidiaries			Eliminations			Consolidated
	(In thousands)
Net sales	$	—		$	92,450		$	238,311		$	15,967		$	(11,000	)	$	335,728

Cost of sales		—			76,774			199,999			12,246			(11,200	)		277,819

Gross margin		—			15,676			38,312			3,721			200			57,909

Selling, general, and administrative expenses		—			11,496			25,329			1,560			—			38,385

Operating income		—			4,180			12,983			2,161			200			19,524

Interest income		1,715			1,585			875			105			(3,300	)		980
Interest expense		(1,715	)		(2,523	)		(3,401	)		(1	)		3,300			(4,340	)

Income from continuing operations before income taxes		—			3,242			10,457			2,265			200			16,164

Income tax expense		—			—			150			800			—			950

Income from continuing operations		—			3,242			10,307			1,465			200			15,214

Loss from discontinued operations		—			—			(900	)		—			—			(900	)

Income before equity in income of consolidated subsidiaries		—			3,242			9,407			1,465			200			14,314
Equity in income of consolidated subsidiaries		14,114			10,872			—			—			(24,986	)		—
Net income	$	14,114		$	14,114		$	9,407		$	1,465		$	(24,786	)	$	14,314

CHAMPION ENTERPRISES, INC.

Condensed Consolidating Statement of Operations

For the Nine Months Ended October 1, 2005

							Guarantor			Non-guarantor			Consolidating
	Parent			CHB			Subsidiaries			Subsidiaries			Eliminations			Consolidated
	(In thousands)
Net sales	$	—		$	261,689		$	638,217		$	40,197		$	(43,000	)	$	897,103

Cost of sales		—			219,950			539,347			31,860			(44,800	)		746,357

Gross margin		—			41,739			98,870			8,337			1,800			150,746

Selling, general, and administrative expenses		(1	)		32,491			69,939			4,267			—			106,696
Mark-to-market credit for common stock warrant		(4,300	)		—			—			—			—			(4,300	)
Loss on debt retirement		—			901			—			—			—			901

Operating income		4,301			8,347			28,931			4,070			1,800			47,449

Interest income		5,173			5,043			2,389			293			(10,216	)		2,682
Interest expense		(5,173	)		(8,082	)		(10,509	)		(1	)		10,216			(13,549	)

Income from continuing operations before income taxes		4,301			5,308			20,811			4,362			1,800			36,582

Income tax expense		—			—			150			1,700			—			1,850

Income from continuing operations		4,301			5,308			20,661			2,662			1,800			34,732

Loss from discontinued operations		—			—			(4,151	)		(58	)		—			(4,209	)

Income before equity in income of consolidated subsidiaries		4,301			5,308			16,510			2,604			1,800			30,523
Equity in income of consolidated subsidiaries		24,422			19,114			—			—			(43,536	)		—
Net income	$	28,723		$	24,422		$	16,510		$	2,604		$	(41,736	)	$	30,523

CHAMPION ENTERPRISES, INC.

Condensed Consolidating Balance Sheet

As of October 1, 2005

	Parent		CHB		Guarantor Subsidiaries		Non-guarantor Subsidiaries		Consolidating Eliminations			Consolidated
Assets	(In thousands)
Current assets
Cash and cash equivalents	$	—	$	102,182	$	5,677	$	23,200	$	—		$	131,059
Restricted cash		—		294		215		—		—			509
Accounts receivable, trade		—		16,907		37,646		1,017		(3,324	)		52,246
Inventories		—		17,758		80,991		2,656		(2,700	)		98,705
Current assets of discontinued operations		—		—		2,814		—		—			2,814
Other current assets		—		8,495		5,700		643		(100	)		14,738
Total current assets		—		145,636		133,043		27,516		(6,124	)		300,071

Property, plant and equipment, net		—		26,254		61,780		2,520		—			90,554
Goodwill		—		—		157,678		835		—			158,513
Investment in consolidated subsidiaries		32,370		310,416		183,840		6,789		(533,415	)		—
Non-current assets of discontinued operations		—		—		2,404		—		—			2,404
Other non-current assets		566		1,338		3,677		7,631		—			13,212
	$	32,936	$	483,644	$	542,422	$	45,291	$	(539,539	)	$	564,754
Liabilities, Redeemable Convertible Preferred Stock and Shareholders’ Equity
Current liabilities
Accounts payable	$	—	$	12,652	$	28,615	$	2,230	$	(2,867	)	$	40,630
Accrued warranty obligations		—		7,553		23,978		834		——			32,365
Accrued volume rebates		—		11,483		19,357		2,152		—			32,992
Current liabilities of discontinued operations		—		—		3,661		——		—			3,661
Other current liabilities		2,586		28,164		61,871		622		(100	)		93,143
Total current liabilities		2,586		59,852		137,482		5,838		(2,967	)		202,791

Long-term liabilities
Long-term debt		89,273		95,764		6,457		—		—			191,494
Long-term liabilities of discontinued operations		—		—		18		—		—			18
Other long-term liabilities		—		8,125		29,108		123		—			37,356