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Q2 2008 Earnings Call Transcript

Published: 17 Jul 2008

[Operator:]

Welcome to Champion Enterprises second quarter 2008 conference call. (Operator Instructions) I would now like to turn the call over to Laurie Van Raemdonck, Vice President Investor Relations.

[Laurie Van Raemdonck:]

This morning, the Company issues its press release with results for the quarter ended June 28, 2008. A copy of the release is available on our website at www.championhomes.com. A telephone replay of this call will be available approximately two hours after its conclusion and through Friday, July 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. Also, as a reminder, comments we make 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 SEC, including without limitation it’s 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 statement. 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 Knight:]

Thank you, Laurie; and good morning, everyone. To begin, I’ll review Champion’s financial results, then Bill will follow with further discussion of our results and comment on market conditions, strategy, and our outlook. Needless to say, the environment we’re operating in in the United States continues to deteriorate. The credit markets have continued to tighten making capital expensive to access and customer financing for home purchases increasingly difficult to obtain. Our core domestic housing markets is California, Arizona, and Florida continued to lose ground during the quarter putting further pressure on our U.S. results while top line growth in our non-U.S. markets in the U.K. and Western Canada helped to offset some of this pressure. Total revenues for the quarter decreased 12.5% to $289.2 million compared to $330.4 million in the second quarter of 2007. Net income for the quarter totaled $3.4 million or $0.04 per diluted share compared to net income of $7.5 million or $0.10 per diluted share for the same period of last year. Turning to our segments, the North American manufacturing segment net sales totaled $211.3 million this quarter, a decrease of 18.2% as compared to last year’s $258.3 million after a 24.8% drop in unit sales. Domestic housing market weakness was evidenced by our shipment of only 2,421 units in the U.S., 36% less than last year’s second quarter and only 7% better than our typically much slower first quarter. In 2007, our second quarter U.S. shipments exceeded the first quarter by 28%, a more typical seasonal pattern historically. Meanwhile, with the addition of SRI homes acquired in late 2007, Canadian unit sales increased 70% to 733 homes for the quarter. HUD-Code, Canadian, and other segment revenues combined decreased 9% to $162 million for the quarter while revenues from the sale of modular homes totaled only $49 million, down 39% from $80 million a year ago. The average HUD-Code unit price for the quarter of $45,400 was essentially flat to both last quarter and last year. The average selling price for modular units was $70,800 compared to $75,000 last year and $69,100 last quarter. Manufacturing segment income totaled $13.6 million this quarter compared to last year’s $17.2 million. Strong margins at our five plants in Canada and previous capacity adjustments in the U.S. resulted in a segment margin for the quarter of 6.4%, down only slightly from last year’s 6.7% and a significant improvement over the first quarter, which was just over breakeven before restructuring charges. Even after several recent plant closures, capacity utilization for our U.S. plants stood at only approximately 44% this quarter, up from 38% last quarter, but down from 58% during the second quarter of last year. For the total segment, capacity utilization was approximately 48% compared to 40% last quarter and 60% last year. Manufacturing segment backlogs at the end of the quarter totaled $42 million compared to the $68 million reported a year ago and only $25 million last quarter. During the first two weeks of July, U.S. backlogs have increased 32% compared to an increase of 17% over the same two-week period last year. As a result after the recent plant closures, our U.S. backlogs currently stand at approximately 18 days of production, which is actually slightly better than last year at this time. In our International segment, revenues grew 24% from $56.9 million in the second quarter of 2007 to $70.5 million. International segment income totaled $3.9 million for the quarter, down from $4.5 million last year; and the segment margin was 5.5% compared to 7.8% in last year’s second quarter. The segment margin and income were negatively impacted by both a shift in the mix of business and the impact of additional investments in selling, general, and administrative expenses in advance of an anticipated expansion of the business in 2009 and beyond. In addition, sharp increases in fuel costs during the quarter had a negative impact on margins as delivery costs increased as much as 40% relative to anticipated levels at the time effected contracts were bid. It is likely that these factors will continue to have a negative influence on margins throughout the remainder of this year. For the first half of 2008, our U.K. operations reported revenues of $180.9 million compared to $103.4 million for the same period last year. This segment reported income for the six-month period of $12.3 million and a 6.8% margin compared to income of $7.6 million and a 7.3% margin last year. While we still expect to record top line growth in net sales for the International segment for the full year 2008 as compared to 2007, our current outlook is for margins to be at a lower level for the remainder of the year and as such EBITDA growth will likely not keep pace with expected revenue growth. International segment backlog remains strong with contracts and orders pending contracts under framework agreement totaling approximately $205 million at the end of the quarter compared to approximately $210 million at the end of last quarter. Our Retail segment, recorded revenues of only $9.4 million this quarter compared to $21.4 million in the second quarter of 2007 resulting in a segment loss of $1 million for the quarter compared to segment income of $700,000 for the same period last year. Market conditions in California have continued to worsen even through the traditional spring and early summer selling season. Consumer financing for home purchases has tightened considerable with the withdrawal of Origin from the California market. While other lenders have stepped in a limited degree, our Retail operation continues to struggle to find suitable financing for many potential transactions. Our general corporate expenses of $7.1 million for the quarter were down $300,000, or jus over 4% from last year’s $7.4 million. Intangible asset amortization totaled $2.4 million in the quarter, up from $1.4 million in the second quarter of 2007 as a result of the SRI Homes acquisition. Net interest expense for the quarter increased 9.8% to $4.1 million from $3.7 million last year as the result of higher debt balances, partially offset by lower overall interest rates. The effective tax rate for the quarter was 5.7% compared to 25.3% in last year’s second quarter. The 5.7% effective tax rate, which was similar to last quarter, reflects our current estimated annual effective tax rate for the full year, excluding adjustments, so this could be significantly impacted in the second half of the year by Champion’s mix of domestic versus international earnings. The low effective tax rate results from our expected pretax loss position in the U.S. offset by estimated income from foreign jurisdiction. During the second quarter, our U.S. pre-tax results improved significantly versus the first quarter. Nonetheless, we remain in a year-to-date pre-tax loss position in the U.S. If our results and trends in U.S. markets do not improve in the second half, we may need to record evaluation allowance against our net deferred tax assets. Our current estimate is that this valuation allowance would total approximately $150 million. During the quarter, we repaid in full the $24 million note issued in connection with the SRI Homes acquisition at the end of 2007. After this $24 million debt repayment, we ended the quarter with $91.3 million of cash and short-term investments compared to $105.4 million at the end of last quarter and $104.8 million at the same time last year. We generated $14.1 million of cash from operations in the quarter, down from $23.6 million in the prior year, primarily as a result of reduced earnings. Finally, in the current economic environment with capital expensive and difficult to access, the acquisitions that perhaps made sense in a different environment look relatively expensive today. As a result, it is not likely that will be pursue further acquisitions of any significant size until the environment improves or prices are more rational in light of today’s market conditions. Rather, we prefer in this environment to preserve liquidity and we may choose to reduce our debt level some over the next couple of quarters. With that, I’ll turn the call over to Bill.

[William Griffiths:]

Thank you, Phyllis. As we close out the first half of 2008 and look forward to the second half, it is clear that a recovery of any significance in the U.S. housing market is becoming less likely. As a result, we will continue to balance our resources so that while we continue to contain costs in our weaker, yet strategically important markets, we will invest further in new market segments as we continue to diversify our revenue-base. At Caledonian, we are adding resources to develop further the education and health care markets, increase our penetration into the student accommodation and social housing markets, and to fully staff our new Driffield site. This investment in SG&A together with the mix change away from prisons will continue to pressure margins for the balance of the year, but they should fully recover in 2009. This investment, however, is already paying off in terms of new business as backlogs essentially remain flat at $205 million despite a significant decline in prison orders and a strong shipment quarter. In addition, the pipeline of orders under negotiation is very strong, reaffirming our belief that we will finish 2008 with high-single digit growth following by further growth in 2009 despite weaker overall construction markets in the U.K. In North America, as we all know, the residential markets show no sign of any recovery and many economists are now predicting that this may continue through 2009. Clearly our HUD-Code markets were weaker than expected, particularly in the second quarter. Despite my personal optimism earlier in the year, it is now hard to imagine that the industry will surpass its 2007 shipment level of 95,800. Similarly, the residential module market has been impacted more severely than expected as mortgages become increasingly more difficult to obtain, particularly with target markets. In light of this, we continue to streamline our operations and focus on opportunities to reduce costs wherever possible. Total head count was reduced by a further 25% in the first half of this year after a 21% reduction last year. Process improvement and waste elimination are at the forefront of our cost reduction efforts as we begin to see significant increases in the price of raw materials. No further plant closures are planned at this point despite worsening conditions in California, Arizona, and Florida where we have six plants and 28% of our U.S. capacity. These plants had an aggregate capacity utilization of only 28% in the second quarter. In current, we have average backlogs of less than one week. However, as we have said before, these plants are strategically important and will eventually recover and recover strongly. The difficult conditions in these states have been partially offset by continued strong performance in our five Western Canadian plants and by good operating performance across the rest of our U.S. plants where volumes, costs, and capacities are more in balance than there are in California, Arizona, and Florida. This allowed us to post North American segment margins of 6.4%. Excluding California, Arizona, and Florida, capacity utilization in the remaining U.S. plants was 49% and backlogs are now over four weeks on average. Despite double digit industry declines in both HUD-Code and modular, the Midwest continues to be our strongest region in the country and backlogs are now large enough that we’re in the process of reopening our idle facilities in Indiana. At the same time, we’re pleased to announce that our first home will roll off the line at the end of this month in our temporary plant in Dresden, Tennessee. This replaces the plant in Henry destroyed by fire earlier this year. In summary, we continue to adjust our North American operations as market conditions change. We will continue to focus on margin improvement despite material price escalation and difficult markets. We will continue to invest in developing other market segments in the U.K. and we will continue to seek out other high-growth international markets for future investment. In short, we remain committed to our diversification strategy. With that, I would now like to open the call for questions. Operator.

[Operator:]

Thank you. At this time, we will open the call to questions. (Operator Instructions) Our first call comes from John Diffendal of BB&T Capital Markets.

[John Diffendal:]

I wanted to maybe get your thoughts, as you noted, I mean your unit declines in HUD-Code in modular, I guess both down sort of the mid 30% area for the quarter. That’s obviously impacted by the capacity moves you made. If you try to sort of back that capacity changes out, I wonder if you have sort of a same-store sort of or same-plant basis decline you might be able to pass on there. I’m trying to back out the capacity moves relative to what’s going on in units.

[William Griffiths:]

I don’t off the top of our head, but we can certainly do the math on that, and Laurie can follow-up with you later. But to try and put it in perspective, John, if you look at the industry data for which there are now five months available, all of the increases are really limited to the eight southern states that are categorized. There’s been the Eastern West/South Central. In those eight states, unit volumes are up 13.6% and those eight states now represent because of Texas almost a half of all HUD-Code shipments, 46.5 in fact. That region is currently covered by one plant per Champion and 4.5% of our total U.S. capacity. If you go to California, Arizona, and Florida, as we’ve said before, it’s 28% of our capacity and industry shipments are down by 30% this year in the first five months. If you go the Midwest now, that represents 16% of our capacity and shipments are down 21%, whereas if you look at Champion’s HUD-Code shipments in the aggregate for the first six months of the year, they’re down 25%. So while it’s perhaps difficult to get your mind around, our view is that while on the face of it, it may appear that our unit volumes are declining at a much faster rate than the industry. I think when you put all the pieces together, you’ll find that that’s not really the case. But we clearly, I mean almost half of our capacity is in the Coastal space and the Midwest and almost none done in the South.

[John Diffendal:]

That’s very helpful. The Midwest, I think you indicated before, is getting a little better [inaudible] this quarter.

[William Griffiths:]

The industry numbers, at least for the first five months, still indicate that it’s down. In our case, we have certainly enjoyed better business than perhaps would have been anticipated and it’s certainly encouraging to be able to reopen an idle facility. So, yeah, business is pretty robust in the Midwest right now.

[Operator:]

Our next call comes from Katherine Thompson of Avondale Partners.

[Katherine Thompson:]

I want to first focus the question on backlogs. When you reported your numbers in mid April, mid to late April, you had also reported an improvement in backlogs specifically citing the Midwest and the Northeast were improving markets, but since then obviously sales were off grater than what was expected. How should we interpret the 33% or so increase since the end of Q2 in backlogs in light of your comments from the previous quarter?

[William Griffiths:]

Well, I think while we certainly saw a big up tick at the end of last quarter between when the quarter ended and when the call took place, I think as we said then, we cited potentially weather conditions right at the end of the first quarter that perhaps just delayed order intake. In this quarter, I think everyone would agree the so called spring selling season didn’t really take place in the spring. May’s numbers, as we all know, were a big disappointment. I suspect that June’s numbers when they’re published will not be particularly exciting either, but we thought it was notable that July got off to a pretty good start despite the 4th of July weekend being in there as well. The reason we started to quote backlog in terms of days of production, I think we feel that’s perhaps more meaningful given the major changes that we’ve made to capacity. I think clearly if backlogs outside of California, Arizona, and Florida represent four weeks on average of production, I think you can feel somewhat encouraged because we feel four weeks of backlog is a good enough backlog to be able to plan adequately and run plants at a pretty efficient level. So we actually are pretty enthusiastic. Given the overall conditions in the United States, we’re pretty enthusiastic the backlog levels are that good. But keep in mind, if we continue to see deterioration in California, Arizona, and Florida that’s going to offset that somewhat.

[Phyllis Knight:]

Katherine, I think you also have to keep in mind that in an environment like this, backlogs don’t always mean sales are up. We have, as Bill said earlier, taking huge staffing reductions in all of our plants and really geared them down to be profitable at 50% or below capacity utilization, and it’s a much healthier situation to be able to run a plant with a three- or four-week backlog even if you’re with a lower staffing level. I think what you see is the impact in the quarter, obviously sales were not what we have liked them to be, but the margin certainly recovered. That’s an indication that you’re running the factors with more backlog at a lower throughput level.

[Katherine Thompson:]

It’s a two-part question for International. First, on the margin side for Caledonian was off by over 200 basis points year-over-year. What is the feasible target margin rate for ’08; and is 8.25 still feasible for ’09? Then the second part of the question is

[William Griffiths:]

Let me kind of take those in different stages. First of all, it is really too soon for us to put a hard number out for 2009 in terms of margins. It’s also premature at this point to put a hard number on the back end of the year. But to try and put Caledonian’s situation in perspective, let me say this

[Katherine Thompson:]

Since your managing for liquidity, what would be your free cash target for this year? Is it I mean $50/$60/$70$80 million?

[Phyllis Knight:]

Well it’s certainly, Katherine, lower than the high end there. It’s probably in the $40 to maybe just over $40 million range. Obviously this is a very difficult market to do a lot of forecasting in, so it’s prudent for us to be cautious. The capital markets, not just for companies like Champion but indeed for most anybody out there, are incredibly unfriendly right now. There’s really virtually now ability to go out and access the capital markets. So in order to do an acquisition that requires even partial financing just really isn’t something that makes sense for us right now even despite the cash on the balance sheet and the generation of free cash flow.

[Katherine Thompson:]

Just one final question

[William Griffiths:]

No, we’ve made no efforts to sell it. We made a commitment to our employees and that commitment continues. They’re obviously going through some very, very difficult times right now. But, as we all know, that market is going to rebound. It’s only a question of when. It was a good business before California went in the tank and it’ll be a good business when it comes out.

[Operator:]

(Operator Instructions) Our next call comes from James Mccanless of FTN Midwest.

[James Mccanless:]

Wanted to ask first the currency loss on the income statement, was that a function of repurchasing the SRI notes?

[Phyllis Knight:]

I guess not directly, Jay. I think we talked a little bit in the last quarter about setting up a new inter company tax structure where we have some inter company loans in and between our different subsidiaries and it really is tied to just currency moves on those inter company loans. Now those will lessen over time as funds that moved around to complete that acquisition sort of get repaid. Too, Jay, we had a gain in the quarter, not a loss.

[James Mccanless:]

Oh excuse me, okay. Then I guess sticking on that point, if you do have to take the valuation allowance on the deferred taxes this year, what should we expect for a tax provision?

[Phyllis Knight:]

Well that’s great question. Well you might imagine what would end up happening if we took that move would be that we would book no income tax provision in the U.S. earnings or losses, but we would still book full tax rate on all of our foreign source income. So you could certainly envision an environment where the effective tax rate on the income statement looks very, very high if the relative U.S. earnings are low or if you’re incurring U.S. losses. But I’m not going to put a number on it because there’s just too many moving parts, but the effective tax rate answer would be a very unfriendly one.

[James Mccanless:]

Are we talking 38% to 40% of whatever the International revenues would be, somewhere in that area?

[Phyllis Knight:]

Yeah, I mean you’re talking in the probably low 30% range if you took just the international income against the tax rates. But if you take a scenario, you said what if I’m making $50 million in the U.K. and Canada and I’m losing $20 in the U.S., I’m going to book a full tax rate on the $50 but get no benefit for the $20 lost. So it makes the effective tax rate look quite a bit higher than the actual rate you’re booking against those earnings, so 60%/70% in that kind of scenario. So really just depends on how the mix of earnings shapes up and obviously you understand this, I mean all of the corporate expenses, all the interest expense really goes against our U.S. operation.

[James Mccanless:]

Right. Then moving over to your Retail dealers, not California but your independents, what has been repurchase experiences in increasing? Do you expect it to increase? What’s the picture there?

[William Griffiths:]

The outlook is that there’s certainly much more activity. The actual repurchase numbers to date are still a consequential, but there is no question that activity is picking up.

[James Mccanless:]

I mean is it twofold over last year, threefold, how would you characterize it?

[William Griffiths:]

It’s maybe double last year.

[James Mccanless:]

Then my last question is more of a hypothetical question. With the growth that I think it part models is what others or other represents on the operating data… With the growth that you’ve seen there and with the industry trends still solidly moving I think toward single section homes, does it make sense to bring some of the old plans out and start doing more single wide to open another plant, potentially buy someone who’s doing more single wides than Champion. What’s your thinking there?

[William Griffith:]

There are certain markets where we are starting to get more single wide business. We are in the process of completing in a number of selected plants a revamp of product lines to develop lower end products to more satisfy market conditions. But we’re not doing that universally. As we’ve said many times before, we find that the Deep South where the biggest segment of that market is, we find that to be hyper competitive. But there are markets elsewhere in the country where we’re seeing increase single wide business. In fact, one of the reasons our business in the Midwest is improving is we’re seeing higher single wide sales up there. So hopefully that answers the question.

[James Mccanless:]

Sure, and then, sorry, I do have one more follow-on. In terms of Modular, do you see any reason to start closing some of the plants for Modular or is it a business you feel like you can stick out for now and wait for times to get better and maybe inventories to come down a little bit.

[William Griffiths:]

We’ll definitely stick out. There are no thoughts at all of closing any of the module plant. It is interesting, the biggest decline in modular units has actually been in the Midwest and it appears as though there’s a trend there that our HUD-Code business is actually improving while our modular business in the Midwest is declining.

[Operator:]

Our next calls from Ian Zaffino of Oppenheimer & Company.

[Ian Zaffino:]

Can you give us an idea of where SRI’s shipments were this time last year? I’m just trying to get an apples-to-apples on what the Canadian business has done.

[William Griffiths:]

I don’t think we actually have that data at hand, Ian, but I’d be happy to have Laurie get that for you and follow-up afterwards.

[Ian Zaffino:]

Could you give me their contribution in this quarter then, you just aggregate it in that fashion?

[William Griffiths:]

It’s just aggregated. I think we said all along, we’re not going to split SRI out as a separate entity. [Inaudible] business encounter continues to be very robust. As we predicted, it is not growing at the rate it grew last year, so we’re not seeing double digit growth. We’re seeing some growth, but it’s still very slight. We anticipate that will continue through the balance of the year, so we have no concerns that business will deteriorate in Canada. It’s gone pretty much exact as we thought it would.

[Ian Zaffino:]

What about the competitive environment there now?

[William Griffiths:]

We are seeing a lot of activity from U.S. competitors at low prices, but the increase in fuel costs is starting to temper that competitive activity because with the rapid increase in fuel, shipping homes even at a lower price from Indiana into Northern Alberta suddenly the transportation cost is half of the price of the house. So while it’s still competitive up there, the high fuel costs are actually helping to keep some of the U.S. competition out.

[Ian Zaffino:]

So you anticipate probably business to grow upper single digits then?

[William Griffiths:]

Yes, and margins are holding.

[Operator:]

With no further questions, this concludes Champion’s Second Quarter 2008 Conference Call. I’d like to remind you that a telephone replay of the call will be available approximately two hours from now through Friday, July 25, 2008. To access the replay please call 888-203-1112 for domestic callers or 719-457-0820 for international callers. The passcode is 4613006. The webcast replay will be available on the Company’s website under the Investor’s link. You may now disconnect. Thank you and have a good day.