Cavco Industries, Inc. Q2 FY2024 Earnings Call

Good day. And thank you for joining us for Cavco’s second quarter fiscal year 2024 earnings conference call. During the call, you will be hearing from Bill Boor, President and Chief Executive Officer; Allison Aden, Executive Vice President and Chief Financial Officer; and Paul Bigbee, Chief Accounting Officer. Before we begin, we would like to remind you that comments made during this conference call by management may contain forward-looking statements, including statements of expectations or assumptions about Cavco’s financial and operational performance, revenues, earnings per share, cash flow or use, cost savings, operational efficiencies, current or future volatility in the credit markets or future market conditions. All forward-looking statements involve risks and uncertainties, which could affect Cavco’s actual results and could cause its actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of Cavco. I encourage you to review Cavco’s filings with the Securities and Exchange Commission including without limitation the company’s most recent Forms 10-K and 10-Q, which identify specific factors that may cause actual results or events to differ materially from those described in the forward-looking statements. This conference call also contains time-sensitive information that is accurate only as of the date of this live broadcast, Friday, November 3, 2023. Cavco undertakes no obligation to revise or update any forward-looking statements, whether written or oral to reflect events or circumstances after the date of this conference call, except as required by law. Now I’d like to turn the call over to Bill Boor, President and Chief Executive Officer. Bill?

Welcome and thank you for joining us today to review our second quarter results. I thought I’d jump right in with some perspective on what we are seeing in the market. As we previously reported, the dealer inventories that created a big drag on wholesale orders through the first half of the year are now generally under control and our company-owned stores and broadly throughout our independent dealer network, homebuyer interest as reflected in online leads and store traffic is healthy. However, as everyone knows, the macroeconomic environment is not providing any relief for those prospective buyers. Having said that, we continue to see quarter-to-quarter order improvement, that trend is largely coming from street dealers with community still lagging as expected and discussed last quarter. Looking forward, as those community operators work through their inventories, that would be another positive for wholesale manufactured housing orders. Against that backdrop, we continue to operate at a reduced level. Production was down from last quarter as certain plants dealt with the lack of orders and continued to slow production. In line with production capacity utilization was down slightly, but still in the range of 60%, with the already mentioned order improvement, we hit a balanced point at the current overall production rate. As a result, our backlogs were consistent with last quarter. We ended the period at $170 million, which equates to five weeks to seven weeks of production. Clearly, we are anxious and prepared to move plants back to full schedules as soon as the market supports. In the meantime, our plants have done an outstanding job in maintaining healthy profitability and cash flow through the market challenges. In the second quarter, our housing gross margin was 23.2%, down 1.6% from last quarter and 3.6% from a year ago when we were running full schedules and 80% utilization. Allison will go into the gross margin shifts, but the point here is that reducing shipments about 17% year-over-year to match lower demand and still maintaining margin to that extent only happens through discipline and operational excellence. Our retail business has performed exceptionally well. They adjusted quickly to the changing market conditions last year and stayed committed to their winning processes. On a same-store basis, excluding the added volume from Solitaire retail, homes sold through our company-owned stores were up slightly from the previous period. More importantly, the manufacturing and retail teams are working cohesively on product decisions and selling strategies to produce optimal results across the operations. This teamwork has demonstrated itself as we brought the Solitaire stores into the retail operation and filled out product offerings to improve inventory turns. Overall, our revenues were down sequentially from $476 million to $452 million and pretax income was $52 million, compared to $61 million last quarter. We generated strong cash flow, returned $47 million through share repurchases and added $25 million to our cash balance. We remain convinced of the dire need for our homes over time and our strong balance sheet enables us to pursue investments in organic and external opportunities, despite the near-term conditions. With that, I’d like to turn it over to Allison to discuss the financial results in more detail.

Thank you, Bill. Net revenue for the second fiscal quarter of 2024 was $452 million, down $125.4 million or 21.7%, compared to $577.4 million during the prior year. Within the factory-built housing segment, net revenue was $434.1 million, down $125.5 million or 22.4% from $559.6 million in the prior year quarter. The decrease was primarily due to a decline in base business homes sold and a decrease in average revenue per home sold, partially offset by the Solitaire Homes acquisition, which contributed $35.6 million in the quarter. The decrease in average revenue per home was primarily due to more single-wides in the mix and to a lesser extent product pricing decreases. Factory utilization for Q2 of 2024 was approximately 60%, when considering all available production days, that was nearly 70% excluding scheduled downtime for market or weather, consistent with our last two quarters. Financial Services segment net revenue increased 1.1% to $18 million from $17.8 million, primarily due to more insurance policies in force and higher insurance premium rates, partially offset by fewer loan sales. Consolidated gross profit in the second fiscal quarter as a percentage of net revenue was 23.7%, down 360 basis points from the 27.3% in the same period last year. In the factory-build housing segment, the gross profit decreased 350 basis points to 23.2% in Q2 of 2024 versus 26.7% in Q2 of 2023, driven by lower average selling prices, partially offset by lower material cost per floor primarily due to lower lumber prices. Gross margin as a percentage of revenue in Financial Services decreased to 35.9% in Q2 of 2024 from 44.6% in Q2 of 2023 from multiple severe storms in Texas and in Arizona. Selling, general and administrative expenses were $61.5 million, compared to $66.9 million during the same quarter last year. The decrease in these expenses was primarily due to lower third-party support costs and lower incentive compensation costs, partially offset by the addition of Solitaire Homes SG&A costs. Interest income for the second quarter was $5.8 million, up 214% in the prior year quarter. This increase is primarily due to higher interest rates and greater invested cash balances. Net other income this quarter was $0.7 million, compared to $0.5 million in the prior year quarter. Pretax profit was down 44.3% this quarter at $51.7 million from $92.8 million for the prior year period. Net income to Cavco stockholders was $41.5 million, compared to net income of $74.1 million in the same quarter of the prior year, and diluted earnings per share this quarter was $4.76 per share versus $8.25 per share in last year’s second quarter. Now I will turn it over to Paul to discuss the balance sheet.

Thanks, Allison. I will cover the balance sheet changes from September 30, 2023, compared to April 1, 2023. The cash balance was $377.3 million, up $105.9 million from $271.4 million at the end of the prior fiscal year. The increase is primarily due to a few factors; first, net income adjusted for non-cash items such as depreciation and stock compensation expense; and secondly, working capital changes related to inventory decreases of $19.7 million from lower raw materials at our manufacturing facilities and less finished goods at our retail locations, decrease in prepaid and other assets of $17.8 million, increase in accounts payable and accrued liabilities of $9.9 million, and decreases in consumer and commercial loans. These cash inflows were partially offset by common stock repurchases of $47.2 million. Restricted cash increased from cash collected on serviced loans in our Financial Services segment in excess of what was distributed. Consumer and commercial loans decreased from loan sales and the pay down of associated loans and fewer new loan originations. Prepaid and other assets decreased from lower prepaid income taxes and a reduction in delinquent Ginnie Mae loans, as well as the normal amortization of prepaid expenses. Property, plant, and equipment net is down from the sale of unutilized equipment acquired with the Solitaire Homes acquisition we completed last January. Accrued expenses and other current liabilities were up slightly from higher insurance losses in warranty reserves, partially offset by lower customer deposits. Lastly, stockholders’ equity exceeded $1 billion, up $43 million from $976.3 million as of April 1st, 2023. With that, I will pass it back to Bill.

Our results this quarter highlight the ability of our organization to manage costs and generate cash even when conditions are challenging. Everyone at Cavco is ready for the inevitable return of demand, so we can help more families get the homes they need. Abigail, can we please open the line for questions?

Thank you. Good morning, Bill, Allison, and Paul. I appreciate the time and taking the questions. Maybe I will start with just the order trends, Bill. Obviously it ticked a bit higher, which is nice to see. That said, we are entering the typically slower period seasonally. Just maybe talk about your expectations for orders and shipments in fiscal Q3 relative to Q2 and when you expect to be in a position to start to increase production rates?

Thank you, Dan. You are absolutely right. We are entering a period around November and December, which usually indicates a slowdown in shipments if we focus on seasonal patterns. However, in some years, this effect is overshadowed by macroeconomic factors that play a more significant role. We are closely monitoring the situation and currently not speculating on how it will unfold. We have seen a few positive signs, such as several quarters with order increases quarter-over-quarter, and this quarter continued that trend, which is encouraging. Additionally, I want to emphasize that we've managed to stabilize the backlog, so we feel balanced going into this period, with more attention on macroeconomic influences than on seasonality. If we navigate through the winter months successfully, it will be a strong positive indicator.

Maybe ask another way, so far in the quarter, production rates held pretty steady with what we saw in fiscal Q2?

I think generally they have, we have kind of hit a balance point here, which is what we are trying to convey to people and we would like it to be a balance point at a higher production level for sure, but it’s good to feel like orders are supporting, at least the current production levels. So I’d say that’s continued.

Okay. Excellent. And maybe just in terms of the gross margin, if you could dive into it a little bit more to rank order, sort of the impacts, obviously, on the Financial Services notwithstanding, focusing on just the housing segment, between input costs mix, fixed cost absorption, what were the kind of the key elements that may be pushed to lower sequentially and are you seeing any pricing or competitive pressures or is it more a function of those things that I have just mentioned?

I think maybe a way to think about margins this quarter to Q1 is really margins in this quarter were kind of the store is really more around cost and not really around price. We saw price hold fairly consistent, but we have seen inflationary pressures that’s driving up price per OSB, which as you know, is one of our larger inputs for materials. So that slight elevation is finding its ripple effect through the margin and obviously something that we will stay close to. We continue to be very efficient in our cost structures and our plans as we adjust to production levels and we can certainly see consistent leverage of fixed costs at the plant level and then also at the SG&A level.

Got it. Given the current situation and the observed OSB pricing, it's likely that this factor will remain stable at these levels, and the gross margin is expected to stay around these levels for possibly one more quarter. Do you anticipate seeing any increase beyond that?

We don’t typically project on gross margins, but we closely monitor pricing, which has remained consistent and rational. The primary materials we use are lumber and OSB, so as the costs of these contracts fluctuate, they impact our margins with about a 60-day lag. This information is available for review. Additionally, our overhead support is still being leveraged. Overall, as we keep tracking the developments in the OSB market, we should be able to incorporate that into our current position for Q2 as we look ahead to Q3.

Very helpful. One more. I will jump out. Are you seeing more of a mix shift to lower price point entry-level homes? Is that trend continued and just maybe talk about your expectations for ASPs as we look forward over the next couple of quarters?

We are observing a trend towards more single units. However, as we have mentioned previously, we believe that gross margin related to singles and multis primarily depends on time and productivity within the plants, rather than being significantly influenced by the distinction between singles and multis at the gross margin level. There is, of course, a difference in price points at the revenue level.

Hey Dan, just to add to that. As you know, I've been following the industry for many years, and we've seen a trend towards multi-section homes in the mix. However, for several quarters now, that trend seems to have reversed. The change from quarter to quarter hasn't been significant, but there has been a slight shift back towards single-section homes. We believe this is a strong indication of the affordability challenges people are facing. Even though traffic for home shopping remains healthy, many buyers are coming to terms with the need to adjust their expectations for what they can purchase compared to previous years. This ongoing trend towards singles has been quite pronounced over the past year, though the shift in the last quarter was relatively mild.

Perfect. Okay. I will jump back with any follow-ups. Thank you.

Thanks.

Hey, everyone. Thanks for taking the questions. I wanted to follow up a little bit on kind of the community REIT channel and figure out whether your visibility has improved, changed at all, relative to a few months ago?

This is an important topic to discuss. I briefly mentioned that they haven't returned yet. Currently, the street dealers are shouldering the burden. Much of that, as we've discussed before, is primarily driven by communities with available spaces and inventory, but they are struggling to place it as quickly as they would like. My conversations with community operators indicate that the issue is not about resident demand; it’s more about having inventory available, similar to the previous challenges faced by street dealerships concerning the speed of placing their products. We noted last quarter that we expected this situation to persist throughout the calendar year, and I believe that remains true. I am uncertain whether we will fully resolve it this quarter or if it will extend into next year, but once it does clear, just like when street dealer inventories got balanced, it will positively affect our orders. Greg, I want to mention another topic we've discussed over time. I think everything I've stated holds true for existing communities. Recently, in public statements from certain REIT operators, there are indications that if capital costs keep rising, new development projects may be postponed. While it's concerning to hear, it makes sense that as interest rates increase, those operators will weigh the decision to invest in new developments against preserving capital or reducing debt. This hasn't been a consistent message and hasn't been loudly communicated, but it's something we should watch. It doesn’t directly affect our inventory conversation, but it's a point to consider for the future.

Yeah. That makes sense, won’t be a huge surprise. In terms of order rates coming through when they are ready, would you expect them at kind of similar levels as retail, has placed those orders post destocking or will there be any change in how the community REIT channel places orders versus what you have seen in retail over the last two quarters?

I don’t think so. I think once they get cleared of the inventory that they are trying to work through, we talked with the street dealers on the concept of one-to-one, right? They sell a house, they need a house and I think we will see the same thing. And communities are a meaningful portion of the overall, we kind of in this discussion, I am grouping developers communities kind of as one package, but it’s a meaningful part of the overall demand. So we typically talk about that being 30%, 33% of the market and they haven’t been carrying the 33% or so of the current orders. So we will see it pick up once that continues to clear. I am not sure…

Yeah. … I know you have kind of characterized this as kind of a challenging time and Cavco as a company is fortunate, good balance sheet and all, and there’s a lot of operators out there that probably don’t have any backlog, they don’t have a good balance sheet. And so I am curious, does this change your appetite for M&A? Have you seen additional opportunities hit the pipeline? What’s just kind of your visibility level there?

I wouldn't say there's been a significant impact at the moment regarding people being distressed and needing to seek alternatives in manufacturing related to M&A activities. We consistently engage in discussions to stay connected with potential targets. I haven't observed many distress situations. It's important to consider that losing your backlog could present challenges, but pricing remains stable, indicating that industry margins are generally healthier than they would be during periods when manufacturers are close to failing.

Yeah. That’s a good point. Okay. I will leave it there. Best of luck.

Thanks, Greg.

Thanks.

Hey. Good afternoon, everyone. So, actually, Bill, I was going to ask you the pricing question, too. So it sounds like things were holding up. You haven’t had to be really aggressive on cutting price?

Yeah. We haven’t seen. I mean, I would say it’s been consistent over the last couple of quarters where there are markets where you see a little bit of price competition, but it’s been a little bit and you see other markets where it really hasn’t been a factor at all and you can see in our average selling price that we reported has a lot in it with retail and mix and everything else. But you can see that prices just haven’t materially dropped. So we always say it’s a local business. So when we talk to all of our plants and kind of check in with how things are going, we hear slightly different stories from plant-to-plant and region-to-region. But where it’s been noticeable that there’s a little price competition, it hasn’t been very dramatic.

That’s good to hear. Could you talk about where chattel rates are now and what type of availability you think is out there in the market on the chattel side?

Yes. On the rate side right now, they have held pretty steady from last quarter, so they are still about 9% to 9.5%.

Availability is fairly consistent. If you have a good credit score and a favorable loan-to-value ratio, we strive to report that reliability. I wouldn’t say that having good credit means the availability has decreased.

My last question. So we have heard from one of your competitors that, there may be some people walking away from floor plan financing for street dealers. Can you talk about your appetite to maybe pick up some of that business, especially with having the sizable cash balance you do, even notwithstanding the buyback, still have a pretty healthy cash balance? Is that something where Cavco might want to go a little deeper?

I believe we mostly respond to the circumstances at hand. We have a significant portfolio of floor plan loans with our independent dealers, which allows us to remain aware of the credit landscape. Therefore, we are certainly willing to provide floor plan financing in the right circumstances and are not hesitant to engage in this market.

Thanks for the question about the revenue per module, which has remained relatively flat for the last 25 quarters. If the developers are transitioning, I assume they would operate at a more wholesale margin. Do you believe that could lead to an increase in revenue per module or might it enhance it in some way?

You are asking if, when we work with developers, we are selling at wholesale prices or retail prices. Is that the kind of question?

Yeah. I mean, if developers are moving out, I am assuming that they kind of get wholesale pricing. Is there any…

Yeah. I am not sure I am following unfortunately. I think you are right that there would be kind of a distribution partner in the sense they would be getting wholesale price. So the extent that picks up, we will see a little bit of a shift within our consolidated financials to more wholesale pricing. And as we have tried to explain through time about our average selling price, our average selling price is affected by the proportion of wholesale pricing to retail pricing. So in that case, as communities and developers come up, I think, I am getting to your question, you would see wholesale take a bigger portion and you might see our reported average selling price drop a little bit, right?

Okay.

Am I understanding that correctly, Michael? Yes. We wouldn't view that as a negative since it would indicate increased volume compared to our current position. We would be pleased with that average selling price as a measure, but our focus remains on the bottom line.

No. Fair enough. And then just kind of on inventory levels, over the last couple of years, inventory turns have gone up, inventory days have come down, obviously, through the pandemic and everything it’s changed. Are those going to come back or what’s the time period that you would think that those would get back to levels that they were in, say, the 2019 area?

It's interesting because as we have addressed the inventory issue, this applies not only to the industry as a whole but specifically to our company-owned stores as well. Inventory turns are returning to good levels. Dealers are adjusting their inventory levels, especially considering that floor plan financing has increased in cost, which encourages them to carry less inventory and maintain solid turns. Looking at our own system, the turns are currently quite good because inventory is being effectively managed down.

Okay. Following up on the financing side, homebuilders have been maintaining volumes by essentially buying down yield. They're utilizing their balance sheets to boost volume. The larger companies have strong balance sheets for this. How do you approach this, or is it something you wouldn't consider in the chattel market due to the credit profile you encounter?

It's not typically a primary factor in how people market their products. Traditionally, sales teams in our industry collaborate with dealers focusing on price and product, with little emphasis on subsidizing consumer rates. However, it's always something we monitor as it could become relevant. I'm pleased with our position with Country Place because we can respond if an opportunity arises to increase volume through such programs. While it hasn't occurred frequently yet, our goal is to manage for integrated value, and we are open to seizing such opportunities when they present themselves. The discipline on that is important to explain. We have what is commonly referred to as an asset-light model in our lending business, which means we prefer not to hold loans. This creates a natural discipline requiring investors to purchase those loans, and they will seek to buy them at market rates. Therefore, if we reduce the rate, it reinforces this discipline since we are directly facing the economic implications of lowering that rate. I believe there is significant discipline in this approach.

Okay. I mean could you have... … put out some programs? I mean, even pre-booking or whatever, I’m sure it’s harder now with builders to do that.

I think you can consider everything you said as a duality here as far as managing for what works and what’s best. I wouldn’t have a clear answer right now. It’s market-driven. We stay in tune with what’s out there, but it’s something I think on the edge of being a tool that could become more relevant.

Okay. And then just kind of my last one, I mean, you guys in this quarter generated strong free cash flow, by any stretch of the imagination, in good times, you will obviously generate more. Do you have constraints on acquisitions or the volume of acquisitions you can make just because of the concentration of the industry? Because if you are going to do, give or take, $200 million in free cash flow and given at what you guys have been paying on price of sales, you guys could make…

Yeah. Yeah. I think, one answer to your question is we don’t feel constrained on acquisitions. We kind of maintain our balance sheet, so we can act strategically and acquisitions you can look through our history, have been an important part of that. So certainly don’t feel constrained with either the cash balance or the cash flow that we have been generating as you identify. So we want to make sure we get those deals at the right prices, I think is the limiting factor for us. We are always kind of looking to make sure it’s a fair deal for both sides. So we have obviously used repurchases as a balancing tool on our balance sheet. We have been pretty clear with folks that we want to maintain a responsible balance sheet and that’s where the repurchases come out back into play. They are not really speculating on price. They are more trying to keep our balance sheet appropriate for keeping the dry powder to do the deals you are talking about. So anyway, I think, the bottomline to your question is, we do not feel constrained and when we see good opportunities and acquisitions, we feel free to do them given our strong balance sheet.

And there’s no regulatory constraints to increasing your market share?

We haven’t gotten to that point yet and I think there’s a couple of things there. One is, as I said in my earlier remarks, it’s a local business and so that analysis really has to be done at a local business. And secondly, when you look at deals in this industry, I think we are part of the overall homebuilding industry, not just the manufactured housing industry. So we haven’t really felt that we are bumping up against any kind of regulatory constraint or in concentration.

Okay. Great. Thanks. That’s all my questions. Appreciate it guys.

Thank you.

Thank you for your participation in today’s conference. This does conclude the program. You may now disconnect.