Earnings Call Transcript - SKY Q1 2021

Operator, Operator

Good morning, and welcome to Skyline Champion Corporation's First Quarter Fiscal Year 2021 Earnings Call. The company issued an earnings press release yesterday after the close. I would now like to introduce your host for today's call, Sarah Janowicz, the Company's Director of Investor Relations and External Reporting. Sarah, you may begin.

Sarah Janowicz, Director of Investor Relations and External Reporting

Good morning, and thank you for participating in our earnings call to discuss our first quarter results. Joining me on today's call is Mark Yost, President and CEO; and Laurie Hough, EVP and CFO. I would like to remind everyone that yesterday's press release and statements made during this call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. Such risks and uncertainties include the factors set forth in the earnings release and in our filings with the Securities and Exchange Commission. Additionally, during today's call, we will discuss non-GAAP measures, which we believe can be useful in evaluating our performance. A reconciliation of these measures can be found in the earnings release. I would now like to turn the call over to Mark.

Mark Yost, President and CEO

Thank you, Sarah and good morning, everyone. Today, I will briefly talk about our first quarter results, progress on our strategic initiatives and then provide you with an update on activity so far in our second fiscal quarter and thoughts about the balance of the year. Let me begin by saying that I am pleased to report better results for our first fiscal quarter than I was originally expecting when we last reported results in May. Despite a 26.5% reduction in revenue, the team adapted well and executed well to take care of our people and our customers. As a result, we preserved margins and operating cash flows during these unprecedented times. As we mentioned on our last earnings call, we temporarily idled many plants late in March and resumed operations at all but one of our facilities by Memorial Day. As we moved through the back half of the first quarter, demand improved even as some of our geographies lagged and our order volumes increased. We have seen a steady increase in production levels since the beginning of the first quarter and we're back to approximately 90% of last year's levels in June. During the month of July, strong order rates have continued, exceeding prior levels by over 50%. Recently we have seen significant increases in orders across most of our markets due to pent-up demand caused by government-ordered shutdowns early in the spring selling season, strong demand for affordable housing, as well as lower comparisons last year due to inventory destocking and manufactured housing insurance. Our backlog grew by $65 million during the first quarter from $127 million at the end of March 2020 to $292 million. As a basis of comparison, our backlog grew $10 million during the same period of the previous year. There are two factors contributing to the increase in backlog, notably strong demand and lower production levels due to labor constraints. First, on the demand side, our sales team is doing a phenomenal job, responding to product inquiries and quoting requests from our customer channels. Under normal conditions, we would fully ramp up production activities to meet increased demand. However, we have moderated labor activity levels. Like many manufacturing operations, we have experienced the expected side effects from the supplemental federal unemployment assistance provided by the CARES Act. As natural employee attrition occurs and as we seek to replace and add headcount to our facilities, recruitment has been more challenging. Once the CARES Act supplemental unemployment benefits expire, we expect to see an uptick in qualified candidates and expect to increase our labor force to accommodate the increased demand for housing. However, we are prepared to manage any of the various forms that the next round of government support may take. On the operation side, we continue to monitor, manage, and execute our enhanced safety and sanitation protocols at our facilities and adhere to CDC guidelines for social distancing and other measures to reduce the spread of COVID-19. We have continued to refine and adapt our manufacturing processes to maintain a safe environment for our employees. Encouragingly, we have found that these adjustments are not significantly impacting our productivity or efficiency levels as the production teams have acclimated to incorporating these protocols in their day-to-day activities. Our Western Canadian plants have followed a pattern similar to our U.S. plants. Sales volumes were down about 36% in the first quarter of fiscal 2021 as compared to the same period last year. We temporarily idled these plants at the end of March 2020 and reopened them at reduced production levels during the June quarter. We saw a steady increase in orders in the back half of the first quarter and backlog is growing as orders outpaced production levels. U.S. retailers continue to see increased closing ratios on their sales leads, which are coming more from online channels than walk-in traffic. While walk-in traffic is still below pre-COVID levels due to various levels of operating restrictions throughout the U.S., those coming to look for homes are ready and able to buy. Talking with dealers, financing is strong and inventory levels are lean. Even through the challenges presented by COVID, our team was able to continue to make progress on our long-term objectives. The traction of our Genesis brand launched earlier this year at the IBS Show in January continues to build. We have seen success with smaller subdivision developments and we are now working towards finalizing a few deals with mid-sized subdivision developments. With the continued social distancing and safety challenges, we continue to invest in our standardization, automation, and digital solutions to make us a better partner to our customers. While we're very encouraged by the strong order rates and growth in backlog, we remain cautiously optimistic about the broader macro environment. The housing industry is experiencing strong demand overall due to trends that support long-term growth opportunities in single-family housing. Our optimism is tempered by the short-term supply and demand challenges presented primarily by the expiring CARES Act and new programs that the U.S. government is considering. We believe demand will continue to be robust over the longer term but would not be surprised if there's choppiness in the home industry shipments in the near term. Given the volatility in the economy and the disruption to normal business operating conditions, it is more difficult to predict how volumes will trend in the next few months. However, we anticipate the industry volume will be in line with recent homebuilding projections of being down 10% in 2020. Off-site manufactured housing demand could outpace the overall housing industry, depending on its ability to increase production, as well as the length and magnitude of the government programs. We remain very bullish on the longer-term potential tailwinds for the housing industry, specifically with off-site construction opportunities and the need for innovation and attainable housing. We believe that there will be a migration from crowded city environments to suburban or rural areas, which could provide meaningful secular growth as manufactured homes have better market penetration in rural and suburban geographies. As companies and individuals contemplate potential long-term work-from-home arrangements, we anticipate changes in the types of floor plans and amenities desired by homeowners. Finally, for people who aren't ready to move or undergo extensive home remodeling projects, turning to blow-in units offers a compelling value proposition for additional space in an existing backyard. I will now turn the call over to Laurie to discuss our quarterly financials in more detail.

Laurie Hough, EVP and CFO

Thanks, Mark, and good morning everyone. I will begin by reviewing our financial results and backlog position, followed by a discussion of our balance sheet and cash flow. I will also briefly discuss some margin headwinds we're expecting in the near term. Net sales decreased by 26.5% to $273 million in the first quarter. We saw revenue declines of $82.7 million in the U.S. factory-built housing segment as well as declines in our Canadian factory-built housing segment of $8.5 million. The decline in U.S. factory-built revenue was primarily driven by a corresponding decrease of 26%, or 1,420 homes compared to the same quarter last year. A 1.5% increase in the average selling price per U.S. home sold to $61,800 partially offset the decrease in volume. The increase in the average selling price was due to a shift in product mix between our retail and home sales channels. Canadian revenue decreased 36% to $15.2 million, driven by a 33% decline in the number of homes sold in the quarter. Average home selling prices decreased by 5% to $79,100 due to a shift in product mix to more single-section home sales in Canada versus the same quarter last year. Our Canadian business continues to be impacted by oil-related industry dynamics in Western Canada. Consolidated gross profit decreased to $54 million, down 29% versus the prior quarter. Our U.S. housing segment gross margins were 19.5% of segment net sales, down 110 basis points from the first quarter last year. Gross margins were impacted by the reduced leverage of the fixed costs, which was a result of the sales volume decline. In addition, we continue to support our employees by providing extended benefits, including increased sick pay as well as continuing healthcare benefits for furloughed employees, both of which totaled $1.9 million during the quarter. SG&A in the first quarter decreased to $40.8 million versus $51.7 million in the same period last year. The decrease was primarily due to a reduction in variable incentive compensation, elimination of non-essential travel and marketing costs, and deferral of controllable expenses in order to minimize cash spend as we continue to evaluate the near- and longer-term impact of COVID-19. We also saw favorability in SG&A costs due to the benefit of not incurring expenses related to the acquisition integration activities of $1 million, as well as not having to record a charge for a fair value adjustment on an asset classified as held for sale of $1 million that we experienced in the prior year. We recorded other income of $4.2 million during the period related to a combination of subsidies from Canada's Emergency Wage Subsidy and the United States CARES Act enacted in response to the pandemic. Canada’s Emergency Wage Subsidy was initially scheduled to run through August 2020 but there has been a proposal to extend the program through December 2020. We will continue to monitor our eligibility to apply for financial assistance in any government programs. Net income for the first quarter was $11.9 million or $0.21 per share compared to net income of $74 million or earnings of $0.31 per share during the same period in the prior year, driven by a combination of lower gross profit which was partially offset by reductions in SG&A and the benefit of the government-sponsored subsidies. On an adjusted basis, we generated $0.22 per net share compared to $0.35 in the same quarter a year ago. The company's effective tax rate for the three months ended June 27, 2020 was 27.7% versus an effective tax rate of 27.6% for the fiscal 2020 first quarter. Adjusted EBITDA for the quarter was $22.5 million, a decrease of 29.7% over the same period a year ago. The adjusted EBITDA margin compressed by 40 basis points to 8.2%, largely due to lower production volumes and an increase in employee benefit costs that were partially offset by government-sponsored wage subsidies. Without the benefit of the wage subsidies, our adjusted EBITDA margin would have been 6.7%. At the end of June 2020, our consolidated backlog was $192 million compared to a backlog last June of $153 million. Current U.S. backlogs are averaging eight weeks of production at the end of June, as labor availability and fees affected our ability to ramp production to match the pace of incoming orders. We have also seen an uptick in Canadian backlog levels, primarily in the British Columbia market. We will continue to evaluate and modify production schedules as we navigate the current environment. As of June 27, 2020, we had approximately $237 million of cash and cash equivalents and long-term borrowings of $77 million with no maturities until June 2023. We generated $32 million of operating cash flow during the first quarter of 2021, compared to $27 million during the same period last year. The increase in operating cash flow is due to our effort to closely manage non-essential spending and working capital during the period, as well as a cash flow benefit from government programs. Under the CARES Act, employers are eligible to defer the employer portion of payroll taxes until December 2021. As of the end of the first quarter, we deferred almost $4 million of U.S. payroll taxes and have received almost $2 million from the Canadian wage subsidy program. In addition, our customer and commercial deposits are up versus the same quarter last year. The cash inflows from these transactions were partially offset by the decrease in operating income. We plan to utilize our cash to reinvest in the business and focus on executing on our strategic growth and operational initiatives. Shifting to our outlook for the second quarter, we believe our financial results will continue to be impacted by labor constraints. These labor constraints may cause us to consolidate product offerings from multiple facilities into one facility at campuses with more than one production line. Currently, and as of the end of our June quarter, we have two plants temporarily idled. Both of these locations have a campus-style layout, so we have consolidated production to one building on each campus to best use the available labor and effectively manage production efficiency. Shifting to our input costs: the demand for labor and OSB has increased, along with the strength in the broader homebuilding and building products industries, while we've generally been able to pass on material cost increases. These pricing actions are delayed when backlogs increase, therefore creating some margin exposure. While we've seen reductions in voluntary attrition and absenteeism compared to this time last year, we may continue to incur elevated levels in employee benefit costs to maintain employee retention, health, and well-being in the wake of the pandemic. While we're prepared to take additional actions if needed to control costs, we are also prepared to respond to growth opportunities and continue to drive our strategic initiatives. I'll now turn the call back to Mark for some closing remarks.

Mark Yost, President and CEO

Thanks, Laurie. While first quarter results were significantly impacted by COVID-19, we are encouraged by the improvements that we saw as we progressed through the quarter and more recently in July with demand trends and order activity. We are prepared to manage through the continued variability in the coming months but remain very confident in the long-term attractiveness of the market and Skyline Champion's ability to remain a market leader. I continue to be impressed with the way our organization has responded in the current environment as our employees adapt and work hard to continue to provide the market with affordable housing solutions for our customers and end consumers. With that operator, you may now open the lines for Q&A.

Operator, Operator

Thank you. Your first question comes from Greg Palm with Craig-Hallum Capital Group. Please proceed with your question.

Greg Palm, Analyst

Yes, thanks. Good morning. Really good results, given everything going on, I guess, Mark, just to clarify something you said earlier in the call. I think you talked about July orders up 50%, 5 0. Did I hear that right? I mean presumably that would mean that backlog since quarter-end has increased pretty significantly. Am I thinking about that right?

Mark Yost, President and CEO

Yes. I think you're thinking that right. Our orders in July are well over 50%. So, our backlogs have been continuing to grow, correct?

Greg Palm, Analyst

That's up 50% on a year-over-year basis, correct?

Mark Yost, President and CEO

Yes. It's actually over 50% growth on a year-over-year basis.

Greg Palm, Analyst

Okay, I mean, do you have any insights on who these buyers are? Are they individuals who previously lived in rentals in cities? Has there been any change in demographics? It seems everyone is trying to understand the demand for housing. Do you have any perspective on how this relates to manufactured housing?

Mark Yost, President and CEO

Yes. I think you're seeing several trends kind of converge. One, obviously we're starting to see a pickup in financing. You've seen the overall built housing financing improve. And you're seeing a pickup there. Spreads with manufactured housing have been even more favorable. So while we've seen traditional mortgages improve by 50-plus basis points, I'd say the spread differential for chattel lending has been double the improvement. So you've seen a much better favorability in spreads in chattel lending because of the newfound competitiveness in the chattel lending market. That's one driver. Second driver, I would say is just a little bit higher activity level in rural areas and rural demand. Millennials are currently buying homes in the marketplace, and I think you're also seeing a trend where mid-price-point buyers or renters are looking to buy, but they're doing so at a step-down price. So I think you're seeing that as well, just out of caution and wanting to lower their future payments in a somewhat concerned market. But overall demand is very strong.

Greg Palm, Analyst

Okay. Good. I guess, we'll probably know more in the coming weeks about labor availability. But what's your expectation for production volumes in the September quarter? I mean, could they be on par with last year? Would you expect continued lag? Do you have the maybe production volumes in or the utilization in July versus June? I think you mentioned that June was up to 90%?

Mark Yost, President and CEO

I would expect our production levels to decrease by about 5% to 10% compared to last year's figures in the quarter. We plan to increase our labor force, but that will likely happen toward the end of the quarter. We are closely monitoring the new government aid packages and their impact on evictions, unemployment, and related factors, as these elements influence the supply-demand balance in our market outlook. This will shape our strategy regarding labor. We have developed several scenarios for ramping up production, but our approach will depend on the nature of the government aid aimed at boosting production and balancing supply and demand.

Greg Palm, Analyst

Okay, makes sense. And if I could sneak one last one in here. I think Laurie, you talked a little bit about labor costs and OSB. Given the expectation of significantly higher volumes in the September quarter relative to June, does that help offset some of the sort of the cost increase that you're seeing? I'm just trying to get a sense of that 19.5% U.S. manufacturing gross margin mix between orders, backlog, production volume and then what ultimately shifts, because I think with the orders and backlogs there's been some volatility over the past as backlogs got worked down then started to normalize higher. So I guess when we're thinking about just what is your expectation for shipments in the September quarter? Is that what should match that production down five to 10%? Is that what you're saying shipment should trend towards or how should we think about that?

Mark Yost, President and CEO

Yes. I think that's the correct view. I think we knew that shipments during the quarter will follow in line with production levels.

Greg Palm, Analyst

Got it. Okay. And is there some future catch-up in terms of the acceleration based on these orders? Or are these orders really just kind of replenishing the backlog and the shipment trends, albeit essentially volatile around the economic outcome, should be less robust than what those recent order trends suggest?

Mark Yost, President and CEO

No, I think the backlog levels are building, sales are very strong, demand is exceptionally good. What I view is we're going to see some of the outcomes of some of the government programs. And as I mentioned on the prior call, some of our view is shaped based on where we see a pause in the housing market depending on what happens with evictions and unemployment. Does that create a pause in the housing market? If we see a wave of evictions happening over the next period, if it doesn't get extended, is that going to create a pause as renters and people are trying to backfill those vacant properties? So you could see a slight pause in home demand ordering. So actually having backlog currently is part of our view on how we want to manage forward, depending on how the outcome of the remainder of the year plays out. If we see that things get extended and things aren't as choppy towards the tail end of the year, then we'll take strategies to continue to ramp production and shipments will outpace later in the year.

Greg Palm, Analyst

Got it. Okay. And then, my next question is sticking with kind of demand or shipments. But what are you seeing in terms of trends from your large developer customers versus, versus smaller, your retail channel?

Mark Yost, President and CEO

You know, I'd say, the retail channel is extremely strong right now. Most of the retailers are having record months or record demand levels and sales periods. So, I think the retail channel is extremely strong, probably similar to what you're seeing in the difference between site-built build-to-order and on-site ready-to-go product. So, we're seeing the same thing with retail. People are walking into sales centers, actively buying and moving off the shelf, and then retailers are selling as quickly as they can. On the builder-developer channel, I think we see a tremendous amount of activity because of the supply-demand imbalance in housing and the shortage of affordable housing. Obviously, those have a longer lead time. I am encouraged, as I mentioned on the call, that we've seen the traction with our Genesis brand, where we've had very good success with a handful of smaller subdivision builders to date, and now we're getting into and finalizing agreements with builders in the 100 to 500 units subdivision levels. So it's starting to progress into larger scale developments. And I think there's a lot of activity in that market.

Greg Palm, Analyst

That's great. Thanks. And if I could squeeze one more in for you. I think you said that, ex some of the wage subsidies, your margins would have been 150 basis points lower in the quarter. As you evaluate the different stimulus proposals in Congress today, do you have a sense of kind of what the continuing support could be relative to that or how to think about that as we cycle through the rest of this year and into next?

Laurie Hough, EVP and CFO

Yes. Labor retention is really important. So, I do believe that we're going to continue to support our employees anyway we can to retain them despite what the government subsidies are. Just given the demand, we need our labor to get our production up.

Operator, Operator

Your next question comes from the line of Matthew Bouley with Barclays. Please proceed with your question.

Matthew Bouley, Analyst

Hey, good morning, everyone. Thanks for taking the questions. I think Mark you mentioned, some positive trends in the financing environment to an earlier question and obviously just mortgage rates being so low and all the strong demand on the site-built side and clearly you guys are feeling that as well. Any thoughts as to kind of the relative cost of financing for manufactured housing versus clearly how strong things have been for traditional mortgages and sort of, how that's playing into these recent orders? Thank you.

Mark Yost, President and CEO

Yes, I think right now the spreads are ranging depending on credit scores, anywhere between 2.25% and 4%. So somewhere in that range. Our current spreads versus traditional mortgages have come down quite a bit, anywhere between 70 basis points to 180 basis points over the recent time period versus traditional mortgages which has gone down about 50 basis in the same time period. So it really depends on the lender in the situation, but we've seen that spread compress. So that's been a very positive trend.

Matthew Bouley, Analyst

Interesting. Okay, that's helpful. Thank you. And then just secondly with the demand environment improving somewhat here and I hear you loud and clear around, you know, some choppiness in the back half. But is there any thoughts to reinstating the margin targets if we're at a point where, you know, yes, there might be some volatility, but clearly the volumes are trending in the right direction?

Mark Yost, President and CEO

Yes, Matt. We are just going to keep an eye on the environment. You know, so much is dependent on the broader economy and unemployment rate. So just keeping an eye on it.

Operator, Operator

Your next question comes from the line of Daniel Moore with CJS Securities. Please proceed with your question.

Daniel Moore, Analyst

Good morning, Mark. Good morning, Laurie.

Mark Yost, President and CEO

Good morning, Dan.

Daniel Moore, Analyst

Again, labor availability. Are you seeing the same or similar challenges across geographies, across the country? Are there specific areas where you're maybe being pinched a little bit more?

Mark Yost, President and CEO

No, I think it's really widespread. What we're seeing is that when we used to post a job opening, we would receive 20 or 30 resumes or applicants, but now we might only get zero or one for the same position. As the CARES Act unemployment benefits expire and change in the near future, we will monitor how we respond. Currently, there isn't a strong incentive for unemployed individuals to seek work, since the unemployment benefits are quite generous.

Daniel Moore, Analyst

Helpful. And just kind of looking at the supply-demand dynamics, obviously favorable position if orders are growing 50% and production is down 5% or 10%, backlogs clearly going to keep growing significantly. How much further can backlog grow before you may become a little concerned about losing potential sales to competitors or even to site-built?

Mark Yost, President and CEO

Yes, I think we're seeing backlog across the industry continue to grow, so I think vis-à-vis, there might be small competitors or other people who have different backlog levels on a certain geography basis. But overall, I see backlogs in the industry keeping pace fairly well. I view that the outcome of how we manage through this will be highly dependent on how we react and what the new programs rolled out by the government are. We don't want to take a certain action to increase employment levels if we then have a surprise reaction from the government that motivates employees a different way. So I think we've got a plan in place to increase production throughout the year and just really waiting for hopefully a week or so before putting some of those policies in place.

Daniel Moore, Analyst

Helpful. Okay. And then the focus on optimism rather than caution, is it more related to demand and concerns about rising unemployment and supplemental checks running out or is it supply, lack of available labor?

Mark Yost, President and CEO

Yes, I actually view that you're going to see almost like a union again type of structure here. Depending on what form the next aid package shares, if you continue the unemployment benefits that are currently expected from the CARES Act, I think it will put much greater pressure on the supply side, and we'll have to take one form of strategy to react to that. If we see that evictions are allowed and that there are no unemployment benefits extended and certain other factors, I think you're going to see a larger pause in the housing market. In that case, it will be a demand-side equation. That's one of the reasons we're looking at the backlog, specifically is because, if there is a pause from evictions or other things, we'll have the ability to remain resilient and produce through that downward cycle that will take probably two to three months to work itself through and resolve.

Daniel Moore, Analyst

Okay. And then, I apologize for asking a similar question. But you mentioned your Genesis brand, obviously starting to gain traction. More generally, what are you hearing from the community developers? Are they still sort of sitting on their hands, wait and see, or are you seeing more activity, interest, orders, etc.?

Mark Yost, President and CEO

Yes. I think the community channel is starting to return, and I expect it to continue to grow through the second half of this year. They’ve been very successful with collections and have good success with traction and activity, with many home buyers coming into rent. You’ve seen some of the public REITs out there and what they've commented on. I think they're very bullish on the outlook. So, I think REITs are starting to return very favorably in the communities. Thank you. And thanks everyone for joining the call today. Very proud of the team and how they've performed over this past quarter. It was a very challenging quarter. It just shows the resiliency of our people, which are the most important factor in taking care of the customers. With that, the outlook is very good, long-term demand and the tailwinds provided by not only the financing environment but the trend from urban to rural and housing affordability are going to be the key factors for us going forward. So, we look forward to taking care of our customers and our people. Thank you and have a good day.