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Q1 2008 Earnings Call Transcript

Published: 16 Apr 2008

[Operator:]

Good morning and welcome to Champion Enterprises first quarter 2008 conference call. I would now like to turn the call over to Laurie Van Raemdonck-Vice President of Investor Relations. Laurie, you may proceed.

[Laurie Van Raemdonck:]

Thank you and welcome to Champion’s first quarter 2008 conference call. Yesterday the company issued its press release with results for the quarter ended March 29, 2008. A copy of the release is available on our web site at www.championhomes.com and on many financial web sites. A telephone replay of the call will be available approximately two hours after the conclusion of this call and through Friday April 25, 2008. Telephone and webcast replay information is available in our press release, and will be provided at the end of the call. This morning I am joined by Bill Griffiths, Chairman, President, and CEO and Phyllis Knight, Executive Vice President, and CFO. They will make some initial remarks regarding our results and current business trends and then open the call to questions. In addition, as a reminder, comments made during this conference call may contain forward-looking statements that involve risks and uncertainties. Listeners are cautioned that these statements are only predictions and may differ materially from actual future events or results. Please refer to the documents filed by Champion with the FCC including, without limitation, its reports on Form 10-K and 10-Q, which identify important risk factors that could cause actual results to differ from those contained in the forward-looking statements, including statements regarding our recent acquisitions, capacity utilization rate, back logs and pending orders, future tax rates, business strategies and opportunities, revenue shipments, cash flow and other financial projections and market conditions and projections. All forward-looking statements are based on information available to Champion today and the Company assumes no obligation to update such statements. With that said, I would like to turn the call over to Phyllis Knight. Phyllis.

[Phyllis Knight:]

Thanks, Laurie and good morning everyone. To begin, I’ll review of Champion’s financial results, and then Bill will follow with further discussions on results and comment on market conditions, strategy, and outlook. After that we’ll open the call for your questions. I’ll start off by reviewing the significant adjustments that were recorded during the quarter, then get into the operating specifics. First, we took a number of steps during the quarter to further streamline our operations in light of continuing weakness in US housing markets. We closed our manufacturing facility in Oregon and consolidated our operations in the Midwest by idling the last of four plants at our LaGrange, Indiana complex and transferring the production to our near by multi-plant complex in Topeka, Indiana. In addition, we reduced our North American manufacturing regional overhead structure by limiting two regional offices. These actions resulted in pretax charges totaling $9.8 million, with $9.3 million allocated to the manufacturing segment and $500,000 included in general corporate expenses; of the $9.8 million, $7 million represents non-cash fixed asset impairment charges and the remaining $2.8 million comprises of severance and other costs. Next, we have recorded foreign currency transaction loses totaling $2.3 million related to intercompany loans among our various international subsidiaries. Late in 2007 we made a change to our legal structure in order to more effectively use our non-US cash balances for more acquisitions and investments in a tax efficient manner. In connection with the SRI homes acquisition, intercompany loans were made among certain of our US, UK and Canadian subsidiaries. Because these loans are considered short term in nature, the accounting rules require that the currency related gains and losses, be reflected in the income statement rather than as a component of other comprehensive income in shareholders equity. As the relative exchange rates of the US and Canadian dollars and the British pound fluctuate, we will continue to record gains and losses each quarter, until these intercompany loans have been repaid. Our retail segment recorded lower of cost to market inventory allowance during the quarter of $1.8 million, to write down the value of certain inventory, primarily located in southern California, to realizable market value. Finally, we realized that $100,000 gain on the sale of an idle plant. Together, on a pretax basis, these items total $13.8 million. Before these items, our operating loss for the quarter was $3.2 million, representing an improvement over a similarly computed loss of $5.8 million last year. Total revenues for the quarter increased 14.2% to $296.7 million, compared to $259.8 million in the first quarter of 2007. The company reported a net loss for the quarter of $20.5 million, or $0.26 per diluted share compared to a net loss of $7.2 million or $0.09 per diluted share for the same period in the prior year. Turning to the segments, our North American manufacturing segments net sales totaled $181.5 million in this quarter, a decrease of 8.9% as compared to last years $199.3 million, after a 14.1% drop in unit sales. [inaudible] and other segment revenues decreased 2.8% to $132.5 million for the quarter while revenues from the sale of modular homes totaled $49 million, down 22% from $63 million a year ago. With the addition of SRI homes, our western Canada based acquisition that took place near the end of 2007, Canadian units shipped during the quarter increased 64% to 564 homes. We anticipate a further contribution from SRI in future quarters, as its reported sales this quarter were limited by timing differences from the implementation of Champion’s revenue recognition policy. The average HUD-CODE unit selling price was flat to last year at $45,500 and up slightly from last quarters $45,000.The average selling price for modular units was $69,100 compared to $77,200 last year and $73,000 last quarter. This decline is attributable to the completion of our Fort Lewis military housing project where the average unit size was about six floors. Excluding the affects of this project, the average selling price in the first quarter was flat to the average selling price in 2007. The manufacturing segment reported a loss of $9 million for the quarter compared to segment income of $100,000 in last years first quarter. The second loss was driven by the $9.3 million of net restructuring charges that I mentioned previously. Last years segment income was reduced by restructuring charges, net of property sale gains of $500,000; including these items, manufacturing segment income would have been $200,00 this year compared to $600,000 last year on an approximately 9% overall decline in segment revenues for the quarter. Capacity utilization for our US plants stood at only approximately 38% this quarter, down from 50% last quarter, 44% during the first quarter of last year. The total segment capacity utilization was 40%, down from 52% last quarter and 45% last year. We expect our utilization rates to improve from this low level as we head into seasonally stronger quarters with our capacity further reduced by the two additional first quarter plant closures, both of which continued to operate through the end of the first quarter. Manufacturing segment backlogs at the end of the quarter totaled $25 million, compared to the $42 million reported a year ago and $56 million last quarter. As I mentioned previously, in 2007 we completed a military housing project at the Fort Lewis Army Post in the state of Washington, causing a significant portion of the year-over-year decline in modulated revenues and approximately $8 million of the year-over-year decline in backlog. As noted in our press release, backlogs have improved significantly in the first two weeks of April. This increase brings backlogs back in line with last years level and is an encouraging sign as we enter the traditional spring selling season. In our international segment, sales grew 137%, from $46.5 million in the first quarter of 2007 to $110.4 million, driving a 14.2% increase in our consolidated revenues. International segment income grew to $8.4 million for the quarter from $3.1 million last year, on increased sales and improved segment margin of 7.6 % compared to 6.7% in the first quarter of 2007. International segment backlog remains strong, with contracts and orders pending contracts under framework agreements totaling approximately $210 million at the end of the quarter, compared to $250 million at the end of both last quarter and the first quarter of last year. Our retail segment reported revenues of only $9.0 million this quarter, compared to $18.1 million in the first quarter of 2007. The $41.8 million write down in inventory, the retail segment reported a loss of $1 million for the quarter, down from income of $900,000 last year. Our retail business continues to be affected by pressures from the generally weak housing markets through out California. The inventory write down resulted from adjusting the value of our inventory of spaces in manufactured housing communities to reflect today’s lower retail prices, primarily impacting southern California. In addition, our concerns about the California market escalated some with Origins recent announcement that they would cease further loan recommendations. While Origin has an important share of the financing for new home sales into California communities, we are working to transition this business to other local and national lenders. Net interest expense for the quarter totaled $3.9 million, down slightly from $4 million last year. General corporate expenses of $8.6 million for the quarter included approximately $500,000 of restructuring charges. Before these costs, corporate expenses totaled 8.1 million, down $1.2 million or 13% from last years$ 9.3 million, primarily as a result of reduced legal, confining [inaudible]. The income tax for the quarter was recorded at an effective tax rate of approximately 5%, but the recorded income tax benefit was reduced by a small adjustment recorded during the quarter. This effective tax rate of approximately 5% reflects our current estimated annual effective tax rate for the full year, so this could be significantly impacted by Champion’s domestic versus international earnings over the next three quarters. The low effective tax rate results from our expected pretax loss position in the US, offset by estimated income from foreign jurisdiction. We ended the quarter with $105.4 million in cash and short-term investments, compared to $135.4 million at the end of 2007 and $76.6 million at this same time last year. Cash used in operations totaled $26.3 million for the quarter, compared to cash provided of $6.9 million for last years first quarter. Significant drivers of this year-over-year decline in first quarter cash flows included an approximately $16 million negative swing in working capital out of our UK operation. As we’ve seen in prior quarters, there can be a significant timing issue with respect to contract receivables, which increased $37 million in the quarter and were not fully offset by increased payables in customer deposits during the quarter in the UK. In addition to that, our Canadian operations made first quarter tax payments totaling approximately $7 million during the quarter and otherwise networking capital in the manufacturing segment were about flat to year end. This compares against a very strong first quarter last year with the manufacturing segment, improved networking capital by approximately $10 million and the international segment improved by a further $12 million. All in all, while the negative cash flow in the first quarter was disappointing, it is neither abnormal to be in a negative position in our seasonally slow first quarter, nor an insurmountable obstacle to our full year 2008 goals for free cash flow. Our operations remained focused on generating a similar level of pre-cash flow for the full year in 2008 to that of 2007. And with that, I’ll turn the call over to Bill.

[William Griffiths:]

Thank you, Phyllis. On our year-end call two months ago, we articulated the following about our expectations for 2008

[Operator:]

We will take our first question from Ian Zaffino with Oppenheimer & Co

[Ian Zaffino-Oppenheimer & Co:]

Great, thank you very much. Good quarter, despite the seasonality here.

[William Griffiths:]

Thank you, Ian.

[Ian Zaffino-Oppenheimer & Co:]

I just have a couple questions. As far as the SRI acquisition, if there was no accounting issues there, how much more would Canada’s sales have been up? If you could give us an idea of that, and then I have a follow up.

[Phyllis Knight:]

That’s a crafty way to stir the question up there Ian. I think in terms of unit sales out of SRI, we got about half of a normal quarter in the first quarter. So hopefully that helps you do the math.

[Ian Zaffino-Oppenheimer & Co:]

Okay. Then as far as the outlook, you’re saying that that is relatively unchanged. Are you more positive that the negative, given that we sort of see HUD up actually 2% where a lot of us were looking for it to be roughly flat, to roughly down a little bit. If you could kind of elaborate on that, that would be helpful too.

[William Griffiths:]

Yes, Ian. I am more positive now than I was at the beginning of the quarter because, quite frankly, this quarter turned out pretty much as we expected it to and I think all the indications are that our statements, which may have sounded overly optimistic at the end of the year, I think now perhaps have a little more context around them. I mean clearly the business in the south for HUD-CODE is very strong even though, as we’ve said, it’s one of the weaker markets, for our sale plants down there are clearly seeing stronger business. We’re seeing a favorable trend right now; it’s still early of course, but a favorable trend in the Midwest and northeast. Obviously we continue to be concerned about California and Arizona. On the modular side, if you exclude the Fort Lewis impact, the decline in our modular shipments this quarter was actually only about 10%, which is half of the decline on average through last year, so we consider that to be a positive trend as well. So all in all and of course Canada and the UK we continue to have high expectations and they continue to deliver. So, as we said, it’s very easy in the depths of winter to be very pessimistic about the future, but we’re encouraged. As we’ve said before, we think the recovery will be slow, but it has to start somewhere and 2.2% is at least moving it in the right direction.

[Ian Zaffino-Oppenheimer & Co:]

Okay, very good. Thank you very much and again, good quarter.

[Operator:]

We will take our next question from John Diffendal of BB&T Capital Markets.

[John Diffendal-BB&T Capital Markets:]

Yes, good morning.

[William Griffiths:]

Good morning, John

[John Diffendal-BB&T Capital Markets:]

Just kind of a follow up on Ian’s question on HUD-code. I guess your overall HUD-code unit shipments were down 28 and as you said, the first couple months up a couple percent. Now I understand that there’s more concentration in some of those weaker markets. Do you have a sense that, given you’ve made some capacity changes, at what point your shipment will start to more represent what’s going on in the industry. Any thoughts about when that starts to trend together?

[William Griffiths:]

I think we’re starting to get to that point now. I mean, even though some of the comparisons are not accurate because of our closures, and I think you can clearly see that we’re not getting as much of the immediate uptick because only 7% of our capacity is in the sale and even that 7% was somewhat inhibited in the first quarter, because of course, we’re not producing out of the Henry plant, which was destroyed by fire, we’re in the process of getting that reopened, which I think is an indication of our commitment to those markets which we feel will rebound even stronger than they currently are. So, I think today we feel pretty good about our footprint. We are convinced that California and Arizona will rebound. Obviously we’re not seeing signs of that immediately, but we’re in those markets for the long haul. When they do come back, we expect them to come back rapidly and strongly. Historically, as you know, they’ve always been some of the better markets in the US, so we have no intentions of further rationalizing capacity in those markets, even though current short-term economics would say that that might be a smart thing to do. We’re there for the long term and we feel good about our footprint now in the northeast and the Midwest.

[John Diffendal-BB&T Capital Markets:]

Okay and just one last question. I’m still confused a bit about the impact of SRI during the quarter. I know it was a transitional quarter, but in terms of what really drove through here, were there some revenues? Anything you can do to help us try to understand whether this was a plus or minus in the quarter and where it really sort of fell.

[Phyllis Knight:]

John, it was certainly a plus. I think the point we’re trying to make is it was less of a plus than it should be in future quarters. And as I said in response to Ian’s questions, I think if you look at the unit numbers and the same would be true for revenues, we probably got half of a normal quarter. So, in otherwards, one and one-half months out of the three months we didn’t really get any shipments because of the transition to the more stringent revenue recognition rules.

[John Diffendal-BB&T Capital Markets:]

I see, thanks.

[Phyllis Knight:]

Yes.

[Operator:]

We’ll take our next question from Kathryn Thompson of Avondale Partners.

[Kathryn Thompson-Avondale Partners:]

Hi, thanks. My first question is on Caledonian. You indicated that high single-digit growth year over year, but in Q1 you had better than expected, at least from our standpoint by sequentially and year-over-year. Does this imply that you’re going to have a steady decline in year-over-year comps as we progress through the year? How should we think about modeling those revenues as the year progresses?

[William Griffiths:]

Yes, clearly I think this quarter is going to represent peak and as we said, there is uncertainty in the next phase of prison orders right now. We really just are coming to the end of the last phase. We’re not in a position to say that there will be more prison business or that there will not be, it is currently undecided. One thing is clear, the prison population in the UK continues to grow, that we know. There are still concerns in the UK about how to house this increasing population, but it’s clearly in the hands of government policy and funding as to whether there will be a similar amount of business that we saw last year, released again this year. It’s not as though there is going to be no prison business, but we have always anticipated that that segment would start to slow down in 2008 and as a result backlogs would start to tail off. Obviously we’re working very hard in the other segments and we’re transitioning modular UK as fast as possible, so we make up for those short falls, but I think the prudent thing to do now is to look for high single-digit year-over-year improvements in the aggregate ’08 over ’07 and then model out a steady decline over quarters 2, 3 and 4.

[Kathryn Thompson-Avondale Partners:]

Okay. On a previous call you had said that, you’d indicated that your international run rate for going into ’09 or ‘10 could hit around 400 to 500. Do you still have confidence in that number?

[William Griffiths:]

Yes, I mean we have a number of things that have to be put in place of course. We’re just preparing the first factory at Driffield for our modular UK to move into, that should take place in the month of May. We’re then fitting out the other two factories, and at the same time our business development and they’re all out in the field, obviously trying to fill that capacity. We do not expect to see really an impact from in 2008, but it will certainly allow us to, for a step change, and we still believe that the run rates could in fact get to $400 million and $500 million as we exit ’09 and go into ’10.

[Kathryn Thompson-Avondale Partners:]

Okay. As far as seasonality with Canadian revenues, I assume that the peak would be in Q2 and Q3, but I just want to…

[William Griffiths:]

Yes, correct. This is typically their weakest quarter as well, and as you know, it was a pretty tough winter up there this year.

[Kathryn Thompson-Avondale Partners:]

And just reconfirm, the 43% increase and north American backlog since quarter end was more driven by HUD-code or and how much was Canada with that 43% increase?

[William Griffiths:]

It is mostly driven by HUD-code and mostly in the United States, unfortunately excluding west.

[Kathryn Thompson-Avondale Partners:]

Okay. That’s all I have for right now. I’ll hop back in the queue, thank you.

[William Griffiths:]

Thanks.

[Operator:]

Our next question comes from Kathy Johnson, state of New Jersey.

[Kathy Johnson-state of New Jersey:]

Yes, could you talk more about the demand side of the HUD-code? How are your end consumers finding financing? Is there a point at which you step back in?

[William Griffiths:]

We absolutely will not step back in. That is not part of our business plan and we will not get back into the financing. There are still a number of regional banks, some national banks, the Clayton’s organization is getting more and more aggressive in trying to increase their market share, as some of these privates struggle, so while we’re seeing some hiccups in the short term and obviously we have concerns about the availability of financing, I don’t think we can say at this point that there is a long-term concern that it will not be there.

[Kathy Johnson-state of New Jersey:]

What’s the income of your typical end buyer?

[William Griffiths:]

It’s kind of all over the map.

[Phyllis Knight:]

I think probably if you were to take an average it’s in the $50,000 range, but I think what can really be deceiving about averages is this business tends to get a lot of retirees, a lot of first-time home buyers, so you really get kind of both ends of the spectrum in the business. So, HUD-code is probably maybe a little bit lower than the $50,000 number and modulars probably a little bit higher, but somewhere in that ballpark.

[Kathy Johnson-state of New Jersey:]

Okay. And do you see any hope for the Midwest?

[William Griffiths:]

Yes. I mean we’ve obviously, dramatically reduced our footprint there as the economy has slowed, but we continue to have a very, very strong market position in the Midwest and there are some signs of encouragement this spring and in addition, we are using a lot of our Midwest capacity now for light commercial, we’re doing more and more of that work out of the Midwest. We’ve still things to be robust with the kind of things we’re doing — hotels, banks, retail outlets, mixed use residential commercial plazas, those kinds of things.

[Kathy Johnson-state of New Jersey:]

Do you have any prison opportunities in the US?

[William Griffiths:]

No. The prison market in the US is really predominantly concrete modular as opposed to steel modular. And while we have a very, very strong position in the UK, we looked at the market early on in the US and came to the conclusion that trying to displace the concrete modular guys, who are very, very well entrenched in that space, we’d be better off to go for other opportunities.

[Kathy Johnson-state of New Jersey:]

Thank you.

[Operator:]

All right, our next question comes from Jay McCanless-FTN Midwest.

[Jay McCanless-FTN Midwest Securities Corp.:]

Hey good morning everyone.

[William Griffiths:]

Good morning, Jay.

[Jay McCanless-FTN Midwest Securities Corp.:]

I wanted to ask you a question again on the backlogs for North America. Did you all do the same type of push out on the SRI backlogs that you did on Moduline, I believe it was about a year ago, and is that part of the reason that the backlogs declines?

[Phyllis Knight:]

There really wasn’t a jump in authorized backlogs. I mean they do have sort of a production allocation system in place similar to our Moduline that happened a year or so ago, but it wasn’t a change during the quarter.

[Jay McCanless-FTN Midwest Securities Corp.:]

Okay. My other question is on the taxes. Could you explain again whey the tax rate, especially for the US was so low this quarter and what does that imply for future quarters? Should we model much lower tax rates going forward, I believe that’s what you said in your prepared comments, but I just wanted to make sure I heard all that correctly.

[Phyllis Knight:]

Sure. It is certainly confusing and a bit difficult to explain without giving a forecast. The 5%, it showed up in the quarter closer to 2%, but that was due to the result of a small tax adjustment that we’ve made, so the effective tax rate that we’re forecasting for 2008 is in the area of 5% and that’s the reason it got booked at 5% in the first quarter. So, absent a change from what we’re expecting in terms of the mix of earnings between the US, Canada, and the UK, 5% if kind of our best estimate for the full year 2008. It’s difficult, Jay, to give a lot of specifics, as I said, without giving a forecast by current or by jurisdiction. Clearly we’re in a US tax loss position right now after the impairment charges and on top of that one of the things to keep in mind is that we get a double interest deduction. We have UK, we have Sterling denominated debt related to our Caledonian acquisition, which we also get to deduct in the US, which makes our taxable income, or in the case of this year loss, even bigger than what you see from a book standpoint. And the thing that really makes it confusing is the tax rate in the US is the highest of the three countries, and so we’ve got losses in the US and we use about a 43% tax rate in the US, being offset by the income in Canada where we’re using about a 33% tax rate and in the UK where we’re also using about a 33% tax rate and so you kind of put all those things together and against our forecast for losses in the US and income in the other two countries and that’s where the 5% effective tax rate estimate comes from. Keeping in mind that all of our interest is in the US, except for the piece we also deduct in the UK, our entire corporate expense burden is in the US. So, the US plants are being burdened with a lot more than the Canadian or UK operations.

[Jay McCanless-FTN Midwest Securities Corp.:]

Okay. Then following on that, is there any concern that we need to have or any conversations that you had with your auditors regarding your deferred tax assets as to whether or not you’d need to take some type of valuation allowance against those because of the loss situation in the US?

[Phyllis Knight:]

Yes there is, that is certainly a risk for us as the year progresses. We talked some about this in the end of the year conference call. For the US tax standpoint we came out of 2007 with 2006 and 2007 combined at about break even. So, there is certainly a risk that if we continue to incur tax losses in the US that we could have to put up an allowance for our US tax assets. If that were to happen, one of the unfortunate consequences is, a 5% effective tax rate looks disappointing in a quarter where you have a loss. It will be kind of a nice thing in profitable quarters, but if we were to have to put up an allowance against our US tax assets, the effective tax rate all of a sudden goes to an abnormally high number, because we would be providing foreign taxes against foreign earnings, but not having the benefit of off setting tax benefits in the US. So that would create just more confusion around our effective tax rate. We’ll have to look hard at it in the second quarter and I think a lot will depend on the outlook for the rest of the year, the outlook for 2009, whether or not we’re seeing progress in terms of off setting some of the loss that we took in the first quarter, so kind of all those things put together will have an impact. And, obviously any acquisition that we could get done in the US could have an impact on that as well.

[Jay McCanless-FTN Midwest Securities Corp.:]

Okay, great. Thank you.

[Operator:]

We have a follow-up question from John Diffendal-BB&T Capital Markets.

[John Diffendal-BB&T Capital Markets:]

Not to push to hard on the tax thing, but what was that adjustment you mentioned in the quarter? I mean I know you made an adjustment to tax reserves a year ago quarter.

[Phyllis Knight:]

It was about half a million dollars, so very small and it just related to accounting around restricted fat ramps where, as time passes we sometimes have to make adjustments for what the prices of shares were when they were issued versus what it was when the shares were actually awarded. So that was the adjustment that was made in the first quarter. Relatively small, but because of the small tax rate, it can have a big impact.

[John Diffendal-BB&T Capital Markets:]

And it was a net negative?

[Phyllis Knight:]

Net negative about half a million, so the effective tax rate started at around 5%.

[John Diffendal-BB&T Capital Markets:]

Got it, and interest expense going forward, I see the $3.9 million in the quarter. Is that, any thoughts relative to the timing or anything and how that might go forward on a quarterly basis?

[Phyllis Knight:]

It should go forward, John, in that kind of ballpark. You know around $4 million a quarter. We’re estimating around $16 million for the year.

[John Diffendal-BB&T Capital Markets:]

Okay, and Caledonian, just to go back for a second. I hear you talking about the revenue growth, still consistent. Your target margin there, I guess in the past, has been about 8.5%; it was a little less than that in Q1. Any update relative to that number?

[William Griffiths:]

I mean at this point, still think of it in the sort of the 8% to 8.5% range. We’re starting to see some price increases in materials, which we’re actually going to be traveling there next week for an operations review, so we’ll get a little more clarity on that. But, there is the possibility as we go through the year that there may be some slack, modular compression, because of the materials, but it’s still too early to really say yet. So, I think for modeling purposes still think in the 8 to 8.5% range.

[John Diffendal-BB&T Capital Markets:]

And the transition of moving the production, as you say, into some of that new area. Is there some cost there that also is a factor?

[William Griffiths:]

No. That should not be an issue and it should not be material if there are some transition costs there.

[John Diffendal-BB&T Capital Markets:]

Great, thank you.