Executive Overview

We are one of the nation's leading manufacturers and marketers of factory-built homes. We market nationwide through vertically integrated operations, encompassing manufactured and modular housing, financing and insurance. As of September 25, 2009, we operated nine manufacturing facilities that sell homes through 78 company-owned retail sales centers and builder locations and over 140 independent retail dealers, builders and developers. Through our subsidiary, CountryPlace, we currently offer conforming mortgages to purchasers of factory-built homes sold by company-owned retail sales centers and certain independent retail dealers, builders and developers. The loans originated through CountryPlace are either held for our own investment portfolio or sold to investors. We provide property and casualty insurance for owners of manufactured homes through our subsidiary, Standard Casualty.

The prevailing economic uncertainties and depressed housing market have continued to challenge our industry and our business in the second quarter of fiscal 2010. Our revenues for the quarter are indicative of the constrained demand for factory-built housing products resulting from a more restrictive financing environment and an over-supply of discounted site-built homes. While our year over year revenues declined 32.4% and retail deliveries were down 27.3% as compared with the second quarter of fiscal 2009, the year-to-date national industry shipments declined 43.6% for HUD-code products and 50.4% for modular products. The major portion of this decline continues to be from the key states of Florida, Arizona and California.

With the expected reduction in revenues, we have continued to streamline our operating costs. As a result of our improved manufacturing efficiencies, gross margin for the second fiscal quarter was 24.1%, which was unchanged from the prior year. We effectively lowered our quarterly selling, general and administrative expenses by 20.7% from the same period a year ago. We believe this will better position us to sustain a continued downturn and at the same time, benefit from any market improvements when it occurs. We are also pursuing innovative ways to both expand our product offering and reach new distribution channels to further drive revenues. We have focused on the commercial and military markets for modular products to provide a new growth opportunity at higher price points than the residential market. We were the winning bidder on a $13.5 million military project that will be completed in calendar year 2010 and we will continue to aggressively bid on additional future projects. Finally, our financial services segment continued to deliver profitable results in the second quarter of fiscal 2010.

Our floor plan agreement is with Textron who announced during the third quarter of fiscal 2009 that they are in the process of an orderly liquidation of their housing inventory finance business. In April 2009 (with an effective date of January 26, 2009), we agreed to an amendment which included a committed amount of $50 million, an expiration date of March 31, 2010, an interest rate of LIBOR plus 7.00%, and new financial covenants. In June 2009, as discussed in Note 6 to our condensed consolidated financial statements, we agreed to a further amendment which extended the expiration date to June 30, 2010 and lowered the committed amount from $50 million to $45 million and further lowers it to $40 million upon the earlier of the sale of certain assets or December 31, 2009, among other things.

In light of the current challenging business conditions, we are focusing a significant amount of effort on cash generation and preservation, including the exploration of various alternatives to generate additional liquidity. These alternatives include the possibility of raising new debt or equity capital or completing strategic asset sales. However, there can be no assurance that these efforts will be successful or will generate cash resources adequate to fully retire the Textron floor plan facility at maturity. In this event, there can be no assurance that Textron will consent to a further amendment or extension of the floor plan facility agreement.

                                         Three Months Ended                               Six Months Ended
                                September 25,           September 26,           September 25,           September 26,
                                    2009                    2008                    2009                    2008
Net sales                               100.0 %                 100.0 %                 100.0 %                 100.0 %
Cost of sales                            75.9                    75.9                    76.3                    75.7

Gross profit                             24.1                    24.1                    23.7                    24.3
Selling, general and
administrative expenses                  33.0                    28.1                    31.2                    25.9

Loss from operations                     (8.9 )                  (4.0 )                  (7.5 )                  (1.6 )
Interest expense                         (5.4 )                  (4.1 )                  (5.7 )                  (3.9 )
Gain on repurchases of
convertible senior notes                   -                      0.7                      -                      1.6
Other income                              0.3                     0.5                     0.3                     0.5

Loss before income taxes                (14.0 )                  (6.9 )                 (12.9 )                  (3.4 )
Income tax benefit
(expense)                                 0.1                    (0.2 )                  (0.1 )                  (0.1 )

Net loss                                (13.9 )%                 (7.1 )%                (13.0 )%                 (3.5 )%

The following table summarizes certain key sales statistics as of and for the three months ended September 25, 2009 and September 26, 2008.

                                           Three Months Ended                       Six Months Ended
                                   September 25,        September 26,       September 25,       September 26,
                                        2009                2008                2009                2008
Homes sold through
company-owned retail sales
centers and builder locations                  596                 828               1,176               1,737
Homes sold to independent
dealers, builders and
developers                                     170                 312                 319                 596
Total new factory-built homes
sold                                           766               1,140               1,495               2,333
Average new manufactured home
price - retail                    $         67,000     $        74,000     $        68,000     $        75,000
Average new manufactured home
price - wholesale                 $         51,000     $        53,000     $        53,000     $        52,000
Average new modular home
price - retail                    $        168,000     $       171,000     $       168,000     $       172,000
Average new modular home
price - wholesale                 $         73,000     $        67,000     $        74,000     $        73,000
Number of company-owned
retail sales centers at end
of period                                       74                  83                  74                  83
Number of company-owned
builder locations at end of
period                                           4                   4                   4                   4

Net Sales. Net sales decreased 32.4% to $74.8 million in the second quarter of fiscal 2010 from $110.7 million in the second quarter of fiscal 2009. This decrease is primarily the result of a $35.9 million decrease in factory-built housing net sales. Financial services net revenues were essentially flat compared to the second quarter of fiscal 2009. The decline in factory-built housing net sales is primarily due to a 32.8% decrease in the total number of factory-built homes sold coupled with decreases in the average selling prices of new manufactured and modular homes. The decrease in the total number of factory-built homes sold reflects the severe state of the factory-built housing industry, the prevailing economic uncertainties, credit crisis and general consumer paralysis that has kept potential homebuyers on the sidelines. Homes sold to independent dealers, builders and developers decreased 45.5% in the second quarter of fiscal 2010 largely due to slowdowns in sales to lifestyle communities in the three key states of Florida, California and Arizona, which historically were some of our most profitable states. The decrease in the average selling prices is the result of our customers moving down market and buying smaller, less expensive homes.

Gross Profit. As a percentage of net sales, gross profit was flat at 24.1% in the second quarter of fiscal 2010 as compared to the second quarter of fiscal 2009. In dollars, gross profit decreased to $18.0 million in the second quarter of fiscal 2010 from $26.6 million in the second quarter of fiscal 2009. Gross profit for the factory-built housing segment decreased to 18.0% of net sales in the second quarter of fiscal 2010 from 20.4% in the second quarter of fiscal 2009. Factory-built housing margins were impacted by competitive pressure in the current housing market, somewhat offset by improved manufacturing efficiencies. Gross profit for the financial services segment increased $0.3 million in the second quarter of fiscal 2010 due to decreased net revenues as explained above in the net sales section.

Selling, General and Administrative Expenses. In dollars, selling, general and administrative expenses decreased $6.4 million to $24.7 million in the second quarter of fiscal 2010 from $31.1 million in the second quarter of fiscal 2009. Of this $6.4 million decrease, $5.4 million related to the factory-built housing segment, $0.6 million related to general corporate expenses and $0.4 million related to financial services. The decline in selling, general and administrative expenses related to the factory-built housing segment resulted from a reduction of nine operating sales centers and two factories versus prior year, in addition to a decrease in the fixed expenses of our ongoing operations. As a percentage of net sales, selling, general and administrative expenses increased to 33.0% of net sales in the second quarter of fiscal 2010 as compared to 28.1% of net sales in the second quarter of fiscal 2009.

Interest Expense. Interest expense decreased 9.8% to $4.1 million in the second quarter of fiscal 2010 from $4.5 million in the second quarter of fiscal 2009. Interest expense decreased due to decreased interest expense of $0.2 million related to securitized financings, $0.1 million related to convertible senior notes and $0.1 million related to floor plan payable.

Gain on Repurchases of Convertible Senior Notes. During the second quarter of fiscal 2009, we repurchased $3.6 million principal amount of our convertible senior notes, which had a book value of $2.9 million net of debt discount, for $2.2 million in cash. We recorded a gain of $0.7 million in connection with the repurchases.

Other Income. Other income decreased 63.8% to $0.2 million in the second quarter of fiscal 2010 from $0.6 million in the second quarter of fiscal 2009. This decrease is primarily due to a $0.3 million decrease in interest income.

Income Tax Benefit (Expense). Income tax benefit was $91,000 in the second quarter of fiscal 2010 as compared to expense of $184,000 in the second quarter of fiscal 2009. The tax benefit in the second quarter of fiscal 2010 resulted from additional benefits for a reduction in Texas margin tax for prior tax years and was offset by taxes payable in various states we do business.

Net Sales. Net sales decreased 34.7% to $157.2 million in the first six months of fiscal 2010 from $240.7 million in the first six months of fiscal 2009. This decrease is primarily the result of an $81.5 million decrease in factory-built housing net sales and a $2.0 million decrease in financial services net revenues. The decline in factory-built housing net sales is primarily due to a 35.9% decrease in the total number of factory-built homes sold coupled with decreases in the average retail selling prices of new manufactured and modular homes. The decrease in the total number of factory-built homes sold reflects the severe state of the factory-built housing industry, the prevailing economic uncertainties, credit crisis and general consumer paralysis that has kept potential homebuyers on the sidelines. Homes sold to independent dealers, builders and developers decreased 46.5% in the first six months of fiscal 2010 largely due to slowdowns in sales to lifestyle communities in the three key states of Florida, California and Arizona, which historically were some of our most profitable states. The decrease in the average selling prices is the result of our customers moving down market and buying smaller, less expensive homes. The decrease in financial services net revenues reflects a decline in the average consumer loans receivable balance from $233.7 million for the first six months of fiscal 2009 to $187.9 million for the first six months of fiscal 2010, resulting from the sale of approximately $51.3 million of loans in April 2008.

Gross Profit. In the first six months of fiscal 2010, gross profit decreased to 23.7% of net sales, or $37.3 million, from 24.3% of net sales, or $58.6 million in the first six months of fiscal 2009. Gross profit for the factory-built housing segment decreased to 18.2% of net sales in the first six months of fiscal 2010 from 20.1% in the first six months of fiscal 2009. Factory-built housing margins were impacted by competitive pressure in the current housing market, somewhat offset by improved manufacturing efficiencies. Gross profit for the financial services segment decreased $2.2 million in the first six months of fiscal 2010 due to decreased net revenues as explained above in the net sales section.

Selling, General and Administrative Expenses. In dollars, selling, general and administrative expenses decreased $13.2 million to $49.0 million in the first six months of fiscal 2010 from $62.3 million in the first six months of fiscal 2009. Of this $13.2 million decrease, $12.0 million related to the factory-built housing segment, $1.0 million related to financial services and $0.3 million related to general corporate expenses. The decline in selling, general and administrative expenses related to the factory-built housing segment resulted from a reduction of nine operating sales centers and two factories versus prior year and a major decrease in the fixed expenses of our ongoing operations. The decline in selling, general and administrative expenses related to the financial services segment is due primarily to decreased compensation expense resulting from a reduction in headcount. As a percentage of net sales, selling, general and administrative expenses increased to 31.2% of net sales in the first six months of fiscal 2010 as compared to 25.9% of net sales in the first six months of fiscal 2009.

Interest Expense. Interest expense decreased 3.8% to $9.0 million in the first six months of fiscal 2010 from $9.4 million in the first six months of fiscal 2009. Interest expense decreased $0.4 million due to decreased interest expense of $0.5 million related to securitized financings, $0.5 million related to convertible senior notes, and $0.1 million related to floor plan payable. These decreases are offset by noncash interest expense of $0.8 million related to warrants issued in connection with $4.5 million of short term Promissory Notes.

Gain on Repurchases of Convertible Senior Notes. During the first six months of fiscal 2009, we repurchased $14.4 million principal amount of our convertible senior notes, which had a book value of $12.2 million net of debt discount, for $8.5 million in cash. We recorded a gain of $3.8 million in connection with the repurchases.

Other Income. Other income decreased 62.3% to $0.4 million in the first six months of fiscal 2010 from $1.2 million in the first six months of fiscal 2009. This decrease is primarily due to a $0.4 million decrease in interest income.

Liquidity and Capital Resources

Cash and cash equivalents totaled $17.3 million at September 25, 2009, up $5.0 million from $12.4 million at March 27, 2009. Net cash provided by operating activities was $13.0 million in the first six months of fiscal 2010 as compared to $60.0 million in the first six months of fiscal 2009. The decrease in net cash provided by operating activities is primarily attributable to $57.4 million of consumer loans sold in the first six months of fiscal 2009.

Net cash provided by investing activities was $5.2 million in the first six months of fiscal 2010 as compared to $1.2 million in the first six months of fiscal 2009. Net cash provided by investing activities in the first six months of fiscal 2010 was primarily the result of $4.3 million in net cash received from divesting of investments and $0.9 million resulting from net disposals of property, plant and equipment. Net cash provided by investing activities in the first six months of fiscal 2009 was primarily the result of $2.6 million in net cash received from divesting of investments, offset by $1.5 million resulting from net purchases of property, plant and equipment.

Net cash used in financing activities was $13.3 million in the first six months of fiscal 2010 as compared to $59.6 million in the first six months of fiscal 2009. Net cash used in financing activities in the first six months of fiscal 2010 was primarily the result of $4.9 million used to pay down the floor plan facility and $9.3 million used for payments on securitized financings. These cash outflows were offset by $0.9 million in proceeds from borrowings on the construction lending line. Net cash used in financing activities in the first six months of fiscal 2009 was primarily attributable to $42.2 million used to repay in full and terminate the warehouse borrowing facility, $15.1 million used for payments on securitized financings, and $8.5 million used to repurchase $14.4 million principal amount of our convertible senior notes. These cash outflows were offset by $6.2 million in net proceeds on the floor plan facility.

We have an agreement with Textron for a floor plan facility. During the third quarter of fiscal 2009, Textron announced that they are in the process of an orderly liquidation of certain of their commercial finance businesses, including their housing inventory finance business. On June 4, 2009, we agreed to an amendment that included the following modifications:

• extends the expiration date from March 31, 2010 to June 30, 2010;

• lowers the committed amount from $50 million to $45 million and further lowers it to $40 million upon the earlier of the sale of certain assets or December 31, 2009;

• alters the maximum quarterly net loss before taxes covenant of $10 million to exclude any interest expense reflected on the financial statements due to 2009 accounting changes; and

• requires a prepayment of principal equal to any amounts of cash and cash equivalents greater than $20 million as of March 31, 2010 no later than the earlier of 10 business days after closing our fiscal quarter ending March 31, 2010 or April 30, 2010.

The facility has an interest rate of LIBOR plus 7.0%, an advance rate of 90% of manufacturer's invoice and is principally secured by new home inventory and a portion of receivables from financial institutions. In order to borrow against the facility, we must comply with the following financial covenants: maximum quarterly net loss before taxes (as defined) of $10 million, minimum annualized inventory turn of 2.75, and a maximum borrowing base requirement of 60% of eligible finished goods inventory.

We were in compliance with our new financial covenants as of September 25, 2009. Quarterly net loss, after excluding any interest expense reflected on the financial statements due to 2009 accounting changes was $9.8 million, annualized inventory turn was 3.00, and our borrowings were lower than 60% of eligible finished goods inventory.

We are focusing a significant amount of effort on cash generation and preservation, including the exploration of various alternatives to generate additional liquidity. These alternatives include the possibility of raising new debt or equity capital or completing strategic asset sales. However, there can be no assurance that these efforts will be successful or will generate cash resources adequate to fully retire the Textron floor plan facility at maturity. In this event, there can be no assurance that Textron will consent to a further amendment or extension of the floor plan facility agreement.

In 2004, Palm Harbor issued $75.0 million aggregate principal amount of 3.25% Convertible Senior Notes due 2024 (the "Notes") in a private, unregistered offering. Interest on the Notes is payable semi-annually in May and November. The note holders may require the Company to repurchase all or a portion of their notes for cash on May 15, 2011, May 15, 2014 and May 15, 2019 at a repurchase price equal to 100% of the principal amount of the notes to be repurchased plus accrued and unpaid interest, if any. During the first six months of fiscal 2009, we repurchased $14.4 million principal amount of the Notes, which had a book value of $12.2 million net of debt discount, for $8.5 million in cash. We recorded a gain of $3.8 million in connection with the repurchase. We did not repurchase any Notes in the first six months of fiscal 2010.

In January 2009, CountryPlace obtained a $10.0 million construction lending line to use for financing mortgage loans during the construction period. There is no expiration period for the agreement, but CountryPlace is obligated to repurchase individual loans within 180 days from the date of original purchase of each respective loan by the financial institution. Historically, the construction period has been approximately ninety days. The construction lender has full discretion to accept or decline each individual loan purchase requested by CountryPlace. The maximum advance for loans purchased is 92% of the loan amount. The interest rate on unpaid amounts advanced is 10%. CountryPlace had outstanding unpaid advances under the facility of $4.5 million as of September 30, 2009. The facility contains certain requirements relating to the documentation of the loans purchased and amounts drawn during the construction period of each individual loan, which are customary in the industry. CountryPlace funds the difference between the amounts advanced under the facility and the balance of any additional loan.

On April 27, 2009, we issued warrants to each of Capital Southwest Venture Corporation, Sally Posey and the Estate of Lee Posey (collectively, the lenders) to purchase up to an aggregate of 429,939 shares of our common stock at a price of $3.14 per share, which was the closing price of our common stock on April 24, 2009. The Black-Scholes method was used to value the warrants, which resulted in us recording $0.8 million in non-cash interest expense in the first quarter of fiscal 2010. The warrants were granted in connection with a loan made by the lenders to us of an aggregate of $4.5 million pursuant to senior subordinated secured promissory notes between us and each of the lenders (collectively, the Promissory Notes). The proceeds were used for working capital purposes. The Promissory Notes were

We believe that our cash on hand and the proceeds from floor plan financing, conforming mortgage sales, and any other available borrowing alternatives will be adequate to support our working capital needs and currently planned capital expenditure needs for the foreseeable future. However, our top priorities are cash generation and conservation throughout our operations to help support these cash needs as well. Because future cash flows and the availability of financing will depend on a number of factors, including prevailing economic and financial conditions, business, credit market conditions, and other factors beyond our control, no assurances can be given in this regard.

Forward-Looking Information/Risk Factors

Certain statements contained in this annual report are forward-looking statements within the safe harbor provisions of the Securities Litigation Reform Act. Forward-looking statements give our current expectations or forecasts of future events and can be identified by the fact that they do not relate strictly to historical or current facts. Investors should be aware that all forward-looking statements are subject to risks and uncertainties and, as a result of certain factors, actual results could differ materially from these expressed in or implied by such statements. These risks include such assumptions, risks, uncertainties and factors associated with the following:

If the current crisis continues for an extended period of time, or if the crisis worsens, we could face significant problems caused by a lack of liquidity.

We are currently experiencing an extreme crisis in the national and global economy generally as well as in the housing market specifically. This crisis has materially impacted liquidity in the financial markets, making terms for certain financings less attractive, and in certain cases has resulted in the unavailability of certain types of financing. Continued uncertainty in the credit and equity markets may negatively impact our ability to access additional financing at reasonable terms or at all, which may negatively affect our ability to conduct our operations or refinance our existing debt. Disruptions in the equity markets may also make it more difficult for us to raise capital through . . .