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Q3 2008 Earnings Call Transcript

Published: 20 Nov 2008

[Operator:]

Good morning and welcome to Champion Enterprises third quarter 2008 conference call. All participants will be in a listen-only mode until the question-and-answer session of the call. This call is being recorded at the request of Champion Enterprises. If anyone has any objections, you may disconnect at this time. I would now like to turn the call over to Ms. Laurie Van Raemdonck, Vice-President for Investor Relations. Laurie, you may proceed.

[Laurie Van Raemdonck:]

Thank you and welcome to Champion’s third quarter 2008 conference call. This morning, the Company issued a press release with results for the quarter ended September 27, 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 the conclusion of the call and through Friday, November 14, 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 involves 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 limitations, its reports on forms 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. All forward-looking statements are based on information available to Champion today and the Company assumes no obligations to update such statements. With that said, I would like to turn the call over to Phyllis Knight.

[Phyllis Knight:]

Thank you, Laurie. I will begin today with the review of our financial results for the quarter then I will cover the amendments to Champion’s senior credit facility that was announced last week. Clearly, 2008 has not unfolded the way we anticipated it coming into the year. After a rough start, our markets had become even more difficult. As we worked our way through our traditionally strongest third quarter, it became increasingly apparent that credit market conditions and negatives economic in housing market trends were taking a heavy toll on our business. For the quarter, total revenues decreased 27.5% to $259.5 million compared to $357.7 million in the third quarter of 2007. The Company reported a loss before income taxes of $8.1 million compared to pretax income of $15.5 million in the third quarter of 2007. This quarter’s pretax loss included a $6 million charge to write down the value of inventory at our retail segment in California to estimated fair market value. Because we expect to be in a cumulative pretax loss position for the three-year period ending in 2008, we recorded a $150.8 million non-cash charge to establish a valuation allowance for 100% of our US deferred tax asset. After this non-cash charge, Champion reported a net loss for the quarter of $161.5 million or $2.08 per diluted share compared to the net income of $12.9 million or $0.17 per diluted share for the same period of the prior year. Our federal net operating loss carry-forwards, which comprise a significant portion of our deferred tax assets, will continue to be available to offset future taxable income in the US until they expire in the beginning of 2023, irrespective of the valuation allowance which was required by GAAP. Going forward, domestic deferred tax assets will continue to require a 100% valuation allowance until the Company has demonstrated their realized ability through sustained profitability in the US. In the meantime, our tax provisions will consist of income taxes on the earnings of our foreign operations and certain state income taxes but generally will not include any federal tax provisions relating to US operations. Our expected statutory tax rates are approximately 28% in the United Kingdom and 30% in Canada. Turning to segments, our North American manufacturing segment net sales totaled $195.1 million this quarter, a decrease of 25.1% compared to last year’s $260.4 million after a 28% drop in unit sales. Compared to our second quarter of this year, segment sales decreased $16.2 million or 7.7% and 2.8% fewer unit sales. We shipped 2445 units in the US this quarter, down 36% from last year’s third quarter, or 1% better than the second quarter. Canadian unit sales increased 41% to 621 homes for the quarter as the result of our late 2007 acquisition of SRI Homes but fell 15% from the second quarter. Because SRI implemented Champion’s revenue recognition policy in the first quarter 2008, it delayed the recognition of certain sales transactions and, therefore, elevated its second quarter sales. In addition, our Canadian retailers, faced with increased carrying costs, appear to be reducing inventory levels in the current environment. Revenues from the sale of modular homes totaled $50 million, down 38% from $80 million a year ago and essentially flat to last quarter. The average HUD-Code unit price for the quarter was $44,500, essentially flat to last year and down slightly from last quarter’s $45,400 and the average selling price for modular units was $68,400 compared to $77,000 last year and $70,800 last quarter. Manufacturing segment income totaled $8.8 million this quarter compared to last year’s $20.2 million and $13.6 million last quarter. The segment margin for the quarter was 4.5%, down from last year’s 7.8% and 6.4% last quarter. The decline in margins, compared to the second quarter, was partially the result of fewer Canadian sales but also impacted by both increased raw material cost and difficult competitive pressures in the US as well as further significant declines in California, Arizona and Florida. Capacity utilization for the third quarter was approximately 45% for our US plants compared to 44% last quarter and 58% during the third quarter last year. For the total segment, capacity utilization is 47% compared to 48% last quarter and 60% last year. Manufacturing segment backlogs at the end of the quarter totaled $40 million compared to $64 million reported a year ago and $42 million last quarter. However, backlogs as of the end of last week were close to 50% lower than at quarter end and this compares to a decrease of about 35% over the same period last year. In our international segment, revenues declined 33% from $85.3 million in the third quarter of 2007 to $56.9 million driven by reduced prison sector revenues and to a lesser extent, a lower exchange rate, which accounted for approximately $4 million of the decline. International segment income totaled $2.7 million for the quarter, down from $6.4 million last year and the segment margin was 4.7% compared to 7.5% in last year’s third quarter. The segment margins and income were negatively impacted by higher SG&A expenses including additional business development resources and cost related to our new Driffield site, combined with lower revenue in the quarter. Modular UK began its operations in one of the three leased facilities at Driffield during the third quarter while the remaining two facilities are now available for future expansion. For the nine-month period ended September 27, 2008; our UK operations reported revenues of $237.8 million which is 26% higher than $188.7 for the same period last year. The segment reported income for the year-to-date period of $15.0 million and a 6.3% margin compared to income of $13.9 million and a 7.4% margin last year. International segment backlog grew during the quarter with contracts and order spending contracts under framework agreements totaling approximately $235 million at the end of the quarter compared to approximately $205 million at the end of last quarter driven primarily by increased military sector business. Despite these backlogs, we are concerned about the short-term impact of the credit markets and the UK economic contraction on this business. Further, exchange rates have fallen significantly since the end of the quarter, and at current rate, could result in a 20% decline in segment revenue and income in 2009. As a result, our outlook for this business over the next several quarters has been tampered and it is likely that we will continue to see year-over-year declines. Our retail segment recorded revenues of only $10.6 million this quarter, a 41.8% decrease from $18.2 million from in the year-ago quarter. Before the $6 million write-down of inventory, the retail segment reported a loss of $1.2 million, down from income of $700,000 last year. We have continued to reevaluate our cost structure in this business and have reduced the number of sales offices to 14 from 17 at the beginning of the year and we have also continued to reduce the level of inventory period which has dropped to approximately 11% this year, before the effects of write down. Our general corporate expenses of $6.1 million for the quarter were down $600,000 or 8.5% from last year’s $6.7 million primarily due to reduced incentive compensation accruals. Intangible asset amortization totaled $2.3 million in the quarter, up from $1.5 million in the third quarter of last year as the result of the SRI Homes acquisition. The net interest expense for the quarter increased 6.3% to $4.1 million from $3.9 million last year primarily as the result of reduced interest income on lower invested cash balances. We generated $1 million of cash from operations in the quarter compared to $4.7 million in the prior year. During the quarter, the Company settled its obligation for $12.3 million of contingent considerations related to Caledonian's fiscal 2007 performance, approximately $5.9 million of which was previously recorded as compensation expense and the reduction this quarter to cash from operations. During the quarter, we borrowed $25 million on our revolving line of credit. We ended the quarter with $99.7 million of cash in short-term investments compared to $91.3 million at the end of last quarter and $111.3 million at the end of the third quarter of 2007. With that, I will turn to the credit facility a moment. As a result of the difficult market conditions and significant uncertainties we face rather than use existing liquidity to reduce our senior debt and maintain compliance with our debt covenants for the third quarter, we sought to amend the facility in an effort to preserve liquidity and provide for additional operating flexibility through the end of next year. To summarize, the amendment has three primary provisions. First, each of the three previous EBITDA-based financial covenants was eliminated during the amendment period in lieu of minimum liquidity and minimum trailing 12-month EBITDA requirements both tested quarterly. Second, the pricing of the facility was increased to LIBOR plus 650 basis points with an opportunity for reductions in the event that we make additional prepayments. And third, we agreed to prepay $23.5 million of outstanding term debt and to repay $10 million of the $25 million we borrowed under our revolver at the end of the third quarter. Together with the revolver draw, these actions resulted in a net debt reduction of $8.5 million. While it is clearly a difficult and expensive environment in which to obtain an amendment, we are satisfied with the result and believe that the time period covered by this amendment will afford us the opportunity to evaluate a full-range of alternatives without pressure to take immediate action in the current climate. Looking forward, at current exchange rates and LIBOR levels, we expect that annualized rate of interest expense to increase from a run rate of approximately $20 million through the first three quarters of 2008 to approximately $22 million as the result primarily of the amendment but favorably impacted by the lower UK exchange rate. In addition, letter of credit fees and amortization of deferred financing costs which are included in the SG&A are expected to increase by approximately $3.5 million as the result of the amendment in 2009. Adjusting the quarter end numbers for the amendment related debt reduction, Champion’s cash and total liquidity stood at approximately $66 million and $79 million, respectively, after giving consideration to revolver availability. We are pleased to have been able to maintain this strong liquidity position in these difficult times. And with that, I will turn over the call to Bill.

[William C. Griffith:]

Thank you, Phyllis. It is now obvious to everyone that the global financial crisis has serious negative impact on every statement of an already reeling housing industry in the third quarter. Single family housing starts dropped to further 39% in Q3 and we expect a similar decline in modular shipments when data is available. HUD-Code shipments were down 7.4% in the first half of the year and fell a further 15.5% in the third quarter. This accelerated decline was once again led by California, Arizona and Florida where shipments dropped by almost 34% in Q3 compared to 31% in the first half of the year. Our diversification strategy has not been immune to this crisis which is now starting to affect our Canadian and UK businesses. In Canada, volume is starting to weaken somewhat from their peak levels of last year but this market is still very robust. Over 4400 units were shipped in the four western provinces in 2007 compared to a 20-year shipment average of 3100 units. Through the first nine months of this year, 3350 have been shipped and that in 2008 is expected to have the highest shipment level in over 25 years. Margins remained strong, aided by a lower Canadian dollar which is making this a less attractive market for US producers. Canada will continue to be our most attractive market for the foreseeable future. The UK is also being hit hard by the financial crisis which is causing a slowdown in public spending. We have been notified that delays in several projects which will further depress revenues over the next three quarters. We have seen no cancellations, however, and the backlog remains strong at $235 million, below 27% of this backlog will not ship until after 2009. Even with the delays in public spending, the underlying demand for military accommodations, school, prisons, healthcare facilities, and student housing has not changes and will rebound when financing becomes available. Returning to the US, which is clearly our weakest market, it is unrealistic to assume that will see any improvement for the next two quarters and it is still uncertain whether we will see any meaningful recovery in 2009. For this end, we must focus on the things we can control. Therefore, early in October, we reduced the corporate staffing levels by 35% and together with the curtailment of a number of marketing systems and business development programs; we will reduce total SG&A by over $10 million in 2009. None of these reductions will permanently affect the execution of our long-term diversification strategy. It will simply delay it. In addition to corporate SG&A cut, our plans continue to work on cost reduction efforts in every element of our business. The individual plans are also working on product repositioning specific to their local market. In some cases, this means resurrecting lower-price point single wide, in other, a greater focus on multi-family and commercial project work. This strategy is particularly important in California, Arizona and Florida where performance continues to drag down our overall result. The six plants in these three states had aggregate capacity utilization for the quarter of only 21%, down from 28% in the second quarter. Over the same period, the remaining US plants in the aggregate had improved capacity utilization as well as higher volumes and margins. Well, short-term performance in California, Arizona and Florida is problematic and will continue to negatively impact our result, we are firmly committed to these states in the longer term as we believe that these will always be core HUD-Code where affordable housing alternative in a recovery scenario will be critical. In summary, the next two quarters will be challenging and beyond that, no one really has any specific visibility. However, the housing markets will eventually recover and affordable housing alternatives, which we have, will be more important in this next cycle as we compete on a level playing field with the site built. In the meantime, we will continue to develop alternate products in local markets with particular emphasis on multi-family and commercial project. In addition, while no longer at their peak levels of last year, our business units in Canada and the UK are solidly profitable, cash flow-positive and have not, and are not likely to see, the level of deterioration that we are experiencing in the US. Finally, we will manage through this short-term crisis. We will do so with increased focus on day-to-day operational performance but we will do so also with one eye on the long-term because this is still a business with tremendous future potential. With that, I would like to open the call for questions. Operator?

[Operator:]

At this time, we will open the call to questions. (Operator instructions) Your first question comes from the line of Kathryn Thompson - Avondale Partners LLC.

[Kathryn Thompson:]

I just want to get a sense where your current covenant stand and where you stand as the quarter end based on the previous filings. It is my understanding that the debt and EBITDA covenant was eliminated and replaced with liquidity tests. But if you can give us just a little bit more color on that and on the timing of that will be helpful. Thank you.

[Phyllis Knight:]

Kathryn, the covenants for the third quarter were eliminated entirely so there really was no covenant requirement for the quarter that just ended. Going forward and for the next five quarters, all three of the previous EBITDA-based financial covenants were replaced with minimum liquidity and minimum EBITDA thresholds. Each of those covenants were stat based on private projections which have not been made public and they were made with a certain amount of cushion to the projections that we gave the lenders. I think what you saw if you read the amendment was, for example, the EBITDA covenant was set with $10 million of cushion to the projections that we provided.

[Kathryn Thompson:]

Alright. But really no, Q3 obviously is eliminated but no current read on this, if you feel like you are comfortably on track, at least, for the current quarter.

[Phyllis Knight:]

For the fourth quarter, absolutely. I mean they just got reset and we came into the amendment with a fairly high level of comfort in the projections that we gave to the lenders. Now, having said that, obviously, these are strange times and you cannot be certain about a whole lot right now. But we feel like with getting $10 million of cushion to the EBITDA covenant, for example, and having them be quarter end tests. So, we were pleased with the way that came out.

[Kathryn Thompson:]

Are you comfortable giving a breakeven level from a dollar standpoint?

[Phyllis Knight:]

Breakeven? Tell me what you mean by that?

[Kathryn Thompson:]

Just operating, like on an operating basis. Most companies, or at least within this industry, have been able to target a quarterly run rate, what would be breakeven on based on the dollar basis. Then, take into consideration, for instance, lower margins in a depressed environment. Also takes into consideration any plant closures made over the past 12 months of which you obviously have done.

[Phyllis Knight:]

Well, we can talk specifics with you at some point after the call. But the first thing for Champion is obviously corporate expenses and interest that you have to cover in order to get breakeven. And I just think in this environment, it is awfully difficult. You cannot really set margins aside or competitive environment aside and so now, our sales level, you have to make certain assumptions about exchange rates and margins in the US and what is going on with margins in Canada. So I do not think there is really a meaningful number other than to say that we have got to cover $22 million annual run rate of interest expense and corporate expenses which on a forward-looking basis should be reduced by the significant cuts that we just put in place.

[Kathryn Thompson:]

Okay, maybe taking in different angle, like you said, on a segment basis, where did you see Caledonian sales trending going into the next fiscal year, and also, where do you see margins trending for the remainder of this year and for the out year?

[William C. Griffith:]

I think currently with the combination of a slowdown in public spending in the UK and we have been notified that some projects that were scheduled to ship in the fourth quarter have already been pushed in to the first and second quarter of next year. What we are seeing a decline clearly in the fourth quarter. We are likely to see, probably at this point, decline now in 2009 versus 2008, contrary to what we have been saying previously. But keep in mind, there has been a very significant exchange rate recently which will have a pretty serious impact on that. As far as margins are concern, margins will continue to be pressured for the next two or three quarters in the lower levels that will actually to some of the cost structure in that business, as we speak though in the light of the latest information. Also, the backlog is still are very strong. There had been no project cancellations. We have had discussions with all our major customers and there is no indication that there will be any project cancellations, but clearly there are going to be delayed.

[Kathryn Thompson:]

In other words, you previously have targeted a high single digit margin for your Caledonian operation but it now seems like for a mid-single digit operating margin is more reasonable for fiscal year 2008.

[William C. Griffith:]

I think that is probably reasonable to assume for the next few quarters.

[Katherine Thompson:]

Ok. Alright. Do you have a free cash flow target for fiscal 2008? I know you talked about in the past, but conditions have changed pretty meaningfully since then. Do you have a revised free cash flow target?

[Phyllis Knight:]

I am not really in a position to provide that kind of guidance right now. I just think that with the uncertainties in the environment and the higher interest costs that we have got in the fourth quarter and the unknowns with respect to sharp drops in the exchange rates, it would be better off not providing a forecast right now.

[Kathryn Thompson:]

Fine. And you talked about trying to divest your California retail group but at the same time, also you talked about potentially buying companies near to Canada and UK and obviously, a lot has changed since then. What is your status, what is your thought on acquisitions? What is your thought on divesting your retail group?

[William C. Griffith:]

Well, we have said pretty clearly that the retail group is not for sale. We are not trying to divest it. We were approached by somebody well over a year ago and the deal fell apart.

[Kathryn Thompson:]

Sure, sure. Ok, that is fine. I just wanted to double-check on that just because things have changed, which is really what I was saying.

[William C. Griffith:]

There is no changed there, as far as acquisitions are concerned, this is not a great environment for acquisitions. Most everybody in the target range is struggling with their numbers and nobody is really prepared to sell at bottom. And in our case, we are clearly going to manage very conservatively with our cash here until it is pretty clear the current financial and housing crisis that is behind.

[Kathryn Thompson:]

And just finally, I know that you closed the plants recently. I assume you are expecting additional plant closures as we had into the seasonally slow period.

[William C. Griffith:]

No, if you recall, just to make sure that the facts are straight, we closed our LaGrange facility in the early part of this year, and consolidated it into our other Indiana facility in Topeka. So, each facility has three plants on that campus, two of which were operating. We reopened the third one to handle the increased backlogs and business that came over from the LaGrange and we recently idled, not closed, the facility for the winter. Our expectation is that that is sort of a foster plant that will open and close because as you know in the Midwest, the seasonality is pretty severe. It was actually idled. We expect to reopen it near spring.

[Operator:]

(Operator’s instructions) Your next question comes from the line of James McCanless - FTN Midwest.

[James McCanless:]

I wanted to ask on the $13 million savings that you talked about in the prepared text. Should I offset that against, I believe you said $2.5 million of extra cost associated with the new credit facility? Is that correct?

[Phyllis Knight:]

Actually, it is correct but I said $3.5 million.

[James McCanless:]

Okay, $3.5 million, the $13 million I am assuming is spread over the next five quarters whereas the $3.5 million is spread out over all of 2009?

[Phyllis Knight:]

That is correct.

[James McCanless:]

Okay, okay. The floor plan issue that you are talking about for Canada, is it similar to what we are seeing in the US? Or is there more pressure on Canadian dealers? Can you talk about a little bit more about that?

[Phyllis Knight:]

There is really a pressure on US and Canadian dealers right now. We have seen floor plan interest rates go up across the board in the US and Canada. We have seen other disruptions or expect other disruptions to be coming in terms of floor planning in the US. So, it is certainly not just in Canada.

[William C. Griffith:]

Jay, just to put that in perspective, the rights went up a similar amount. The difference is, as you are well aware in the US, retailers have been reducing inventory levels all year long whereas in Canada, that has not been the case. And it appears that is just about the increase in rights of that of course then just start taking inventory levels down, which have been sort of a historically high level because business has been much better there.

[James McCanless:]

That makes sense. My last question is on the short-term debt. I am assuming that part of that increase from second quarter to third quarter is a result of the credit facility. Could you breakout the components of the short-term debt and give us an idea when those different components are due?

[Phyllis Knight:]

The bulk of the short-term debt was the prepayments that we did in October. So related to the amendment, we pay down $33.5 million total as a result of the amendment. The $23.5 million prepayment on the term loan and the $10 million in the revolver paid back down. Then, on top of that, you have just under $7 million senior notes, kind of a stub piece that was left over from the refinancing we did a year ago, that will be paid off in May. That was really the bulk of the short-term debt.

[James McCanless:]

And then, I did have one other question. I know that the new FHA Title One is supposed to go into effect at the beginning of 2009. Are you all seeing any more interest in doing manufactured housing lending from larger national companies or what do you see as the finance picture right now at the retail level?

[William C. Griffith:]

Certainly, we do not see that. There is really no change. In the current financing environment, everybody is skittish and everybody is pulling their horns.

[Operator:]

(Operator’s instructions) Your next question comes from the line of Michael Corelli - Barry Vogel & Associates.

[Michael Corelli:]

Just two questions about cost-cutting and capacity. I know that you talked about in the past that Florida, California, Arizona are important long-term strategic markets. But you have had capacity utilization at some really very extremely low levels here. So, my first question, is there any thoughts about doing anything about that capacity in those markets? And secondly, in the UK, I believe, you are adding some costs and anticipation of some further growth there which is obviously not going to be happening at least in the short term. Are there any opportunities for cost-cutting or cost-saving there?

[William C. Griffith:]

Yes, there is and that is being worked on as we speak. I do not have specifics as of this time but the details are not finalized yet. It is a project that is in work right now. With respect to capacity in California, Arizona and Florida, we are firmly committed to those states. We really do believe they will come back fully faster than the broader housing market. They have always been very profitable and very successful up-coast states. There is no reason that that will change in the future. We monitor individual client performance monthly. Those clients have worked very, very hard to reduce their breakeven points to very, very low levels. And so, it is our judgment right now to continue to stay the course and softness in tough times in those six plants but with a view to the future. It is very difficult to reduce capacity without abandoning pretty significant segments of the market. And we want to be first guys to go in.

[Operator:]

(Operator Instructions) Your last question comes from the line of Thomas Haynes - [Empirical] Capital.

[Thomas Haynes:]

Yes, this is a housekeeping question. What was your CapEx number for the quarter? Small, I imagine.

[Phyllis Knight:]

Our forecast for the full year is right around $13 million, $5.7 million in the quarter. And most of the number for the quarter was for the completion of three new facilities in the UK, which we talked about.

[Thomas Haynes:]

Okay, and then, on the revolver, did you say how capacity you have left on the revolver at this time?

[Phyllis Knight:]

Approximately, $13 million.

[Operator:]

Thank you. I am showing no further questions at this time. Ladies and gentlemen, this concludes Champion’s third quarter 2008 conference call. I would like to remind you that a telephone replay of the call will be available approximately two hours from now through Friday, November 14, 2008. To access telephone replay, please call 888-203-1112 for domestic callers or 719-457-0820 for international calls. The pass code is 1979624. The webcast replay will be available on the Company's website under the Investors link at least 90 days. You may now disconnect. Thank you and have a great day.