Earnings Call Transcript - CVCO Q3 2021

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Third Quarter Fiscal Year 2021 Cavco Industries Inc Earnings Conference Call and Webcast. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. As a reminder, today's program may be recorded. I would now like to introduce your host for today's program, Mark Fusler, Director of Financial Reporting and Investor Relations. Please go ahead, sir.

Mark Fusler, Director of Financial Reporting and Investor Relations

Good day, and thank you for joining us for Cavco Industries' third quarter fiscal year 2021 earnings conference call. During the call, you'll be hearing from Bill Boor, President and Chief Executive Officer; Paul Bigbee, Chief Accounting Officer; and myself. Before we begin, we'd like to remind you that the comments made during this conference call by management may contain forward-looking statements under the provisions of the Private Securities Litigation Reform Act of 1995, 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. Some factors that may affect the company's results include, but are not limited to, the impact of local or national emergencies, including the COVID-19 pandemic and such impacts from state and federal regulatory action that restricts our ability to operate business and the impacts on customer demand and the availability of financing for our products, our supply chain and the availability of raw materials for the manufacture of our products, the availability of labor and the health and safety of our workforce, our liability and access to capital markets, the risk of litigation or regulatory action, potential reputational damage that Cavco may suffer as a result of matters under inquiry, adverse industry conditions; our involvement in vertically integrated lines of business including manufactured housing, consumer finance, commercial finance, and insurance; market forces and housing demand fluctuations; our business and operations being concentrated in certain geographic regions; loss of any of our executive officers, additional federal government shutdowns and regulations affecting manufactured housing. This conference call also contains time-sensitive information that is only accurate as of the date of this live broadcast, Friday, January 29, 2021, and Cavco undertakes no obligation to revise or update any forward-looking statements, whether in oral or written form to reflect events or circumstances after the date of this conference call, except as required by law. Now I would like to turn our call over to Bill Boor, President and Chief Executive Officer. Bill?

Bill Boor, President and Chief Executive Officer

Welcome, and thank you for joining us today to review our results for the third quarter. I want to start today by saying that we've made good progress pushing our production level up toward pre-COVID levels, and our intention is to keep pushing beyond those levels. We increased capacity utilization to 75% for the quarter, up from 65% in Q2. This is despite a resurgence in COVID that is directly driving absenteeism in the plants and despite continuing supply challenges that are as serious today as they have been over the past year. These gains are the result of our plans staying focused, working hard to hire, retain, and build skills and managing the supply disruptions very well. As indicated, we intend to keep pushing beyond pre-COVID utilization levels. We need to in order to address the extremely high backlogs, which continued to build during the quarter. These backlogs now stand at $472 million, up 47% from last quarter. Based on current production levels, that equates to approximately 26 to 28 weeks. This is a continuing story of exceedingly high demand. We estimate that production challenges have added about three weeks to that backlog or said another way, if we had no production disruptions over the last three quarters, orders are such that the backlog would still be more than 23 weeks. Last quarter, we reported that order rates were up 65% year-over-year. That continued through the third quarter; it's up 65%. It's widely understood that the cost of supplies have gone up considerably. After a brief drop in the October and November time frame, lumber and OSB have shot up again. On lumber, the SPF, spruce pine fir, indicator price ended the quarter up 150% from April, and OSB was up 200% over that time frame. Our plants have done an outstanding job of keeping up with these cost increases with higher average selling prices. This is a disruptive and difficult process for the plants, dealers, and ultimate home buyers. And the process continues with more price increases going into effect during the fourth quarter. On a percent basis, gross margin typically gets squeezed during periods of rapid cost escalation, and that's what we've seen in the third quarter. Our intention is to maintain our overall dollar profitability in an environment of very volatile input costs that aren't limited to materials, but also include labor. And as I said, so far, we've been able to keep up. Our retail operations are performing very well. One of the advantages of having Palm Harbor Villages as part of Cavco is that we understand firsthand the impact of price increases and long lead times. Our owned retail operation is subjected to the same dynamics as our independent dealers. They have more opportunities than houses to sell. From day one in the pandemic, the retail operation shifted gears, and they've done a great job of generating leads and supporting homebuyers through phone ups and e-leads. And the story is much the same as last quarter; continuing strong demand. We've seen traffic and sales follow a seasonal pattern with slowing over the holidays, but that pattern has been at a significantly higher level year-over-year. We also had a very strong quarter in financial services. Generally, financing is available to qualified buyers and rates that stay very low through the quarter. As a result, both mortgage and home-only originations are strong. And on the insurance side, policy counts are up. Unlike last quarter, when the number of storms was unusually high, this quarter, claims were seasonally low. So, very strong results in that regard. I want to avoid stealing all the financial headlines from Paul and Mark, but I will say that we continue to generate a significant amount of cash. We believe we have good prospects for investing in growth, both organically and through acquisitions. I will preempt the question regarding the share repurchase authorization from the Board, which occurred in the mid-quarter by reporting that we did not execute any repurchases before the earnings window closed. As we said when the authorization was announced, this is an important tool for us regarding our balance sheet. And to the extent we repurchase shares over time, we don't expect that to limit our ability to strategically invest in the business. Again, we feel it was a good quarter when all of our operations did a very good job of managing through disruption and uncertainty. Progress in increasing throughput has been encouraging, and that continues to be our focus. With that, I'll turn it over to Paul to discuss the financial results in more detail.

Paul Bigbee, Chief Accounting Officer

Thanks, Bill, and good afternoon, everyone. So I'm going to go through the results of operations for the third quarter of fiscal 2021, and then I'll turn it over to Mark to discuss the balance sheet. Net revenue for the third quarter of 2021 was $288.8 million, up 5.5% compared to $273.7 million during the prior year's third quarter. As you would expect, most of this was within the factory-built housing segment, where net revenue increased 5.3% to $270.8 million from $257.1 million in the prior year quarter. The increase was due to a 13% increase in average revenue per home sold, primarily from product pricing increases to pass along changes in material costs and a product mix that shifted slightly more toward double wide homes. Pricing increases were partially offset by a 6.8% decrease in units sold. Additionally, we had home production challenges around high factory employee absenteeism, hiring, and building material supply shortages. In the financial services segment, net revenue increased 8.4% to $18 million from $16.6 million, mainly as a result of higher home loan sales volume and more insurance policies in force compared to the prior year. Additionally, the third quarter included $1 million more unrealized gains on equity investments in the insurance subsidiaries portfolio in the prior year period, which had $300,000 in unrealized gains. These increases were partially offset by declines in interest income from the formerly securitized loan portfolios that continue to amortize as expected. Consolidated gross profit in the third quarter as a percentage of net revenue was 20.5%, down from 21.9% in the same period last year. The decline resulted mainly from the factory-built housing segment decreasing to 17.4% in the third quarter of 2021 versus 19% in the prior year quarter, where the higher material costs impacted the margin percent. Each factory has been implementing product price increases at a rate that has covered input cost increases. However, gross margin percentages have not yet been maintained. Lower factory-built housing gross margins were partially offset by improved gross margins in financial services, which was aided by lower weather-related claims and higher unrealized gains on marketable equity securities. SG&A expenses in the fiscal '21 third quarter as a percentage of net revenue was 12.3% compared to 13.5% during the same quarter last year. The decrease was primarily from the D&O insurance premium becoming fully amortized with no expense in the current quarter compared to $2.1 million in the prior year period. Additionally, during the quarter, the company received $400,000 in insurance recovery of prior legal expenses related to the SSC Inquiry resulting in a net expense of $300,000 compared to last year’s quarter's $900,000 cost. These positive year-over-year comparisons were partially offset by higher corporate-related charges. Other income net this quarter was flat at $2.2 million. The current quarter did include unrealized gains of $800,000 in corporate equity investments, higher than the $300,000 in the prior year quarter. This increase was offset by reductions in interest income earned on cash and commercial loan receivables, given lower interest rates. Pretax profit was up 4.9% this quarter to $25.9 million from $24.7 million for the prior year period. The effective income tax rate was 23.9% for the third fiscal quarter compared to 15.5% in the same period last year. The lower effective tax rate in the prior year was primarily the result of $1.7 million in tax credits from the 2020 Appropriations Bill. The 2021 Consolidated Appropriations Act was signed in late December 2020, the day after our quarter closed, and therefore, this will be reflected in the fourth fiscal quarter. Net income was down 5.7% to $19.7 million compared to net income of $20.9 million in the same quarter of the prior year. Net income per diluted share in this quarter was $2.12 versus $2.25 in last year's third quarter. Now I'll turn it over to Mark to talk about changes in the balance sheet.

Mark Fusler, Director of Financial Reporting and Investor Relations

Thanks, Paul. So comparing the December 26, 2020, balance sheet to March 28, 2020, the cash balance was $327.5 million, up from $241.8 million 9 months earlier. The increase was primarily due to five items, which include: number one, net income, net of noncash items; number two, changes in working capital, including greater accrued expenses and other current liabilities balances, which include higher customer deposits received as a result of higher order rates and longer lead times; number three, lower net commercial lending activity; number four, principal collection on consumer loans, which were all partially offset by purchases of property, plant, and equipment. The current portion of consumer loans increased from a greater number of loans classified as held-for-sale due to the timing of the loan sale. Investments increased from the recovery of the underlying equity markets during the period. Prepaid and other assets was higher from the assets recorded in regards to the loan repurchase option for delinquent loans that have been sold to Ginnie Mae; while we are not obligated to repurchase these loans, accounting guidance requires us to record an asset and liability for the potential of a repurchase. And that balance increased from additional loans in forbearance. Long-term consumer loans receivables decreased from principal collection on loans held-for-investment that were previously securitized. Operating lease right-of-use assets and related liabilities increased from a 5-year renewal of the lease at one of our manufacturing facilities. Accrued expenses and other current liabilities increased from higher customer deposits, which have grown with factory backlogs, as well as the delinquent loan repurchase option discussed above. Lastly, stockholders' equity was approximately $661.7 million as of December 26, 2020, up $54.1 million from $607.6 million as of March 28, 2020. Bill, that completes the financial report.

Bill Boor, President and Chief Executive Officer

Thanks, Mark. Jonathan, let's turn it over for questions.

Operator, Operator

Our first question comes from Daniel Moore from CJS Securities. Please go ahead with your question.

Daniel Moore, Analyst

Maybe I start with, in the past, when we've seen backlogs rise as quickly, dealers have tried to jump in line to make sure they get orders. Are you seeing any evidence of that? Just your confidence that there are indeed buyers behind the incremental orders? And second, with backlog stretching out close to 6 months, is there any risk or concern of losing some of those orders?

Bill Boor, President and Chief Executive Officer

Yes. It stands to reason. We had seen it in the past. So it's logical to think that there could be some of that, and we're going to keep our eyes on that over time. We can do things that help to kind of validate orders as far as checking that there is an actual retail or a homebuyer behind a retail sold order. So we're going to keep our eye on that regard. But I'd tell you, generally, that our feeling right now is that there's not a meaningful amount of that going on. And with your other question, I think, was that your backlog this long? Are people kind of losing orders basically, if I understood it right. And I don't think we're seeing a lot of that. And there are two points to be made there: one, if someone was looking at buying a home from Cavco and is frustrated with a long lead time, which we would certainly understand, I don't think they have places to go, unfortunately, to get a shorter lead time. We've kind of got a sense that area by area our competitors are facing similar long backlogs. And the other is that I really think it can't be lost on anyone that this demand is very real. We've talked about it in the past, that it's a result of a long period of underbuilding for general housing. The low interest rates are certainly a catalyst for that pent-up demand to come forward. So I don't think people are just deciding out of frustration over backlogs that they just won't buy now because it takes too long. I think they're interested in trying to get those interest rates. So those are risks that you're identifying that we'll keep our eye on. But from our perspective, this demand is very real.

Daniel Moore, Analyst

That's very helpful. Excellent. Switching to the margin profile with price increases that you put through. I guess, when you look at the factory-built housing side of the business, how long do you expect to take to get gross margins back to that more normal kind of 19%, 20% level? Are you still chasing price increases? Any color there would be helpful.

Bill Boor, President and Chief Executive Officer

Yes. Price increases are still occurring in the industry into the new year. Your question about how long until the percent gets back, you do have to keep aware of the fact that you can cover a cost increase and the percent will still drop as costs are going up this fast and prices are going up this fast. We told people in the past that this has been an unusual period of price increases because the industry, and us included, we really haven't protected orders in the backlog. I think this quarter was a great example of that because we achieved a pretty considerable increase in average selling price. So as far as how long until we recover to higher percent margins, the quickest way would be a cost drop. And I'm not sure I'm in a position to predict that.

Daniel Moore, Analyst

Understood. And maybe just in terms of capacity, what steps are you taking on the labor side, aside from just obviously raising wages to attract more labor and unlock capacity? And you mentioned your progress increasing throughput was encouraging. Can you elaborate or quantify that at all?

Bill Boor, President and Chief Executive Officer

Yes. It’s a lot of things. So it's hard to just point to one thing and say that's what's doing it. I really want to complement our folks out there that are working every day to make every house they can make. The wage work that we're doing, we do that on a local basis, but making sure our wages are appropriate. That's certainly important for hiring; it's also for retention. When we retain our people, the skills on our teams go up, and that makes a big difference in throughput. So, stating a little bit of the obvious, but that's the kind of work that I think is going on. I think we're having some success with hiring, but it's still a challenge. I can say that across the board. We're understaffed, even as we've been able to increase productivity. So we're doing some things that are kind of near-term and medium-impact stuff, I think, most notably, wages. We're also looking at this as a long-term dynamic. So we're not just addressing month-to-month labor challenges; we're setting up significant training programs that we think are already starting to impact retention. It's a lot of stuff. I wish I could just point out one thing, but I think the things that we're looking at are really starting to position us better as far as labor going forward.

Paul Bigbee, Chief Accounting Officer

One thing I would add to that is wage incentives. We have incentives at several of the plants where people get a bonus if they stay for a week. It’s a significant bonus just to get that retention per week and then add a month to get a little bit of a higher bonus. So, the incentives have been helpful as well.

Bill Boor, President and Chief Executive Officer

It's a great point. So we've definitely put in some of those kinds of attendance and retention bonuses that I think have been meaningful.

Daniel Moore, Analyst

Very helpful. I'll sneak one more and then jump back in the queue. But in terms of the ASPs, there was the 13% jump. Is it predominantly just pass-through of raw materials? Was there some mix shift as well?

Paul Bigbee, Chief Accounting Officer

Yes, it's primarily from the increase in the home sold price. The product mix shift to more double wide was a smaller portion of that. Most of it was the price per unit.

Operator, Operator

Our next question comes from the line of Greg Palm from Craig-Hallum Capital. Your question, please.

Greg Palm, Analyst

I guess just starting off with demand, I'm curious any significant difference in demand levels by geography? And then what about channel? I assume the strength is sort of across the board, but is it skewed more towards retail than community? A little bit more color would be helpful.

Bill Boor, President and Chief Executive Officer

Yes. Geographically, this is going to be a continuing theme from discussions we had in the past. If there was one area that was less extraordinarily strong for this experience over the last several quarters, it was kind of Florida, and it was a little bit more communities. But what I'll report on that is we are seeing that trending up. So we're seeing the community business kind of get back to trending toward levels that we would have expected. The rest of the country, from our perspective, has just been pretty strong overall. It's hard to really differentiate, and there certainly is an area, including Florida, we'd call weak. And then you're also asking about channel; again, the community business for the last couple years was growing more rapidly than street dealer business. When the pandemic started, that kind of shifted pretty abruptly when some of the community operators kind of just took a pause on orders. You'll remember that they didn't cancel orders, but they held them. That kind of shifted things. The majority of the strength we've seen over the last three quarters has really been back to the street dealer type retail business. That has been kind of the observation from a channel perspective, but the communities are coming back. I think last quarter, we reported that in the Southwest, where we do a lot of community business, we consider that to be back to normal.

Greg Palm, Analyst

Okay. It makes sense. I know you don't typically provide guidance, but just trying to get a little bit more color around your expectation and how that backlog gets converted to revenue, both kind of in the near term and then looking ahead? I mean, at what point, and some of this obviously hinges on the pandemic and scarcity of labor and whatnot. But what's your own sense of how that will progress over the next year?

Bill Boor, President and Chief Executive Officer

We're not seeing any weakness in any indicators of weakness in demand. I feel like a little bit of a broken record because I was talking about this before the pandemic started that I really believe that there's a huge amount of pent-up demand waiting for the opportunity to buy houses. So I don't think this is a short-term phenomenon, in my opinion. As far as how it gets met, I don't know how long orders will be 65% up year-over-year. We've now had two quarters of that level. We haven't seen it subside. But we're going to get as much as we can out of the plants we have. When we get into this kind of a situation, you have to consider where additional capacity can come from. So all of that—those are considerations that we're pretty active with right now.

Greg Palm, Analyst

Would you be disappointed if you didn't see volumes or production rates continue to increase at a gradual pace throughout calendar '21?

Bill Boor, President and Chief Executive Officer

It's going to be directly related to what kind of challenges we have. I guess I'm in very close conversation with our operating leaders, and we're watching that ebb and flow every week basically about attendance in our facilities, the ability to hire, and supply. We're very concerned about supply right now. I think, as I said in my comments, that's as much of an issue today as it has been through this entire experience, and maybe more. So disappointment, I think we're managing some moving dynamic situations. But yes, our intent is to just get better and better at this. It was an interesting quarter for that. I mean, one of my takeaways is this past quarter wasn't any easier than the previous two from an absent and supply perspective, yet the other plants have gotten significantly better at getting homes built. I'm pretty proud of that. And I think we'll be able to continue doing it. But if we have supply disruptions that could potentially shut our plants down, I’ll be disappointed; but I won't be disappointed in our ability to operate.

Greg Palm, Analyst

Yes. And I probably should have started with a congratulations to you and the team because, yes, given all the puts and takes out there, the execution was really good. Last one for me, as it relates to just kind of margins, I'm thinking of the ahead, and we're all assuming or thinking at some point, commodity costs will normalize, who knows when. But if that's the case, and you were able to hold current pricing where it is, assuming that demand is still strong, what happens to margins in that scenario? Have you run the math? I mean, I'm assuming some were above pre-COVID levels if ASPs are 15% or 20% higher, but would love to kind of get your eye level thoughts?

Bill Boor, President and Chief Executive Officer

Yes. I think we all kind of have observed this through time, right, that you get compression when costs are going up and then after selling price kicks in, which we're seeing happen pretty quickly, the reaction time has been pretty quick. Then if costs subside, you’ve got a period with higher percent margins. This has been a pretty—I don't know if it's the right word, but a pretty violent increase in costs that we've seen. I mean, it's been dramatic, both in magnitude and speed. We've been able to pretty much follow that with pricing. So if costs subside, we will see some pretty significantly high gross margin percentages for a period of time. And we've got a long backlog. So there's just a supply and demand element to the pricing side.

Operator, Operator

Our next question comes from the line of Jay McCanless from Wedbush. Your question please.

Jay McCanless, Analyst

So with the new administration, I know we've seen press reports about potential first-time homebuyer tax credits and some other things designed to help housing. Are you guys hearing that manufactured housing might be included in any of those credits? And then are there any other highlights, either from a regulatory or from a demand standpoint that you've heard or seen from the administration that we should be watching?

Bill Boor, President and Chief Executive Officer

Yes. I'm not even sure as well up to date as I should be on a lot of it, to be blatantly honest. But I do think that, generally, we expect continuing support of the manufactured housing industry. It isn’t really on point to your question, but I think it's related to the industry or the administration change. We've had a really good four years with HUD, being smart about regulation as far as appropriate regulation, but not too much bureaucracy that doesn't add value. We've really made some headway with them as an industry. I don’t see any reason why we would be concerned about that necessarily. Anything that helps homebuyers, don’t get me wrong, we're all for that. Right now, the problem is supply. So trying to do things for manufactured housing like getting local municipalities to recognize zoning that keeps manufactured housing out would be helpful. Doing things that help us get our products out there would be the kind of things that really would make a difference.

Jay McCanless, Analyst

Yes. Absolutely. And then on the lending side, could you just talk about where chattel rates have moved during the quarter? And are you all still seeing really good availability on that front for chattel customers?

Bill Boor, President and Chief Executive Officer

Yes. As I said, if someone's qualified, they're not having any problem getting a loan right now. As far as kind of what's going on with the chattel market, generally, we talked last quarter, I believe that chattel rates dropped from their stable historical level of 7.5% to 8%, and they dropped down into the 5%, 5.5% range. It's kind of been there. It's still down at those levels. So right now, we see chattel lending as pretty supportive of the demand that we're seeing.

Jay McCanless, Analyst

Okay. That's great. And then any update on the SEC investigations?

Bill Boor, President and Chief Executive Officer

Not other than what we've already disclosed. I will acknowledge this is the first call since we reported and disclosed that we had a Wells Notice from the SEC on the company, which was kind of in the latter part of November. But similar to previous discussions, I view that as a step in the process; it's not something—I won't ever pretend like it's something that we wanted. But I also feel like it's a step forward from a process perspective. The Wells Notice, just to remind everyone, that basically means that the staff at the SEC is considering a recommendation to the commission of an enforcement action. We have to keep running the process out with them. We have to keep supporting their process and hope for a resolution, but I can’t speculate on when or what that might be.

Operator, Operator

This does conclude the question-and-answer session of today's program. I'd now like to hand the program back to Bill Boor for any further remarks.

Bill Boor, President and Chief Executive Officer

Yes. Thank you. I guess, just to wrap it up, we've kind of been beating this pretty hard, but demand is really beyond any expectation we had 9 or 10 months ago. I think we're doing a good job of operating through some very real challenges and risks, and the people that make up our company have stayed very focused on making a difference for our homebuyers; we do that with the homes we build, but also the loans and insurance we provide. So I'm pretty proud of all that. At the beginning of the pandemic, we rallied around that attention, and I believe it's really showing in our progress and strong results. So with that, I really want to thank everyone for your interest in Cavco. I hope that each of you and your families are staying healthy and safe. Thanks, everyone.

Operator, Operator

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.