Champion Homes, Inc.

Good morning and welcome to Skyline Champion Corporation's second quarter fiscal 2024 earnings call. The company issued an earnings press release yesterday after the close. I would like to remind everyone that today'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 the company's expectations and projections. Such risks and uncertainties include the factors set forth in the earnings release and in the company's filings with the Securities and Exchange Commission. Additionally, during today's call, the company will discuss non-GAAP measures, which it believes can be useful in evaluating its performance. A reconciliation of these measures can be found in the earnings release. I would now like to turn the call over to Mark Yost, Skyline Champions President and Chief Executive Officer. Please go ahead.

Thank you for joining our earnings call, and good morning, everyone. I am pleased to be joined on this call by Lori Huff, EVP and CFO. Today, I will briefly talk about our second quarter highlights and then provide an update on activities so far in our third quarter, including with thoughts on the balance of the year. We saw healthy demand from end consumers through our captive and independent retail channels. Community REIT channel softness continued as expected through the September quarter as our REIT partners worked through their backlog of existing new home inventory before placing new orders. This pause in the community ordering combined with the absence of FEMA-related sales that were in the second quarter of last year drove our year-over-year declines in both production and revenue. Backlog as of September 30th was $258 million compared to $260 million at the end of the June quarter as sequential quarterly unit increases were offset by decreases in price. Average lead times of eight weeks have normalized within our historical range of four to 12 weeks and are consistent with lead times at the end of the first quarter. Order volume during the quarter increased again sequentially, and we are seeing the expected decrease in home prices as consumers shift to smaller homes or homes with fewer features and options given the current interest rate environment. Shifting to some of our strategic actions we have taken recently. On September 26th, we closed our investment in ECN Capital and the establishment of our new and financing. We believe that the formation of a captive finance company will unlock home volume growth and bring value for our key stakeholders by providing broader and more attractive financing options and services to our customers. It will enable us to provide a comprehensive home buying solution while becoming more deeply connected with our channel partner customers and the end consumers who purchase our homes. The investment aligns with our longer-term strategic view on offering digital configuration and selling to homebuyers. As we continue to ramp up champion financing, we believe the benefits will create a deeper connection with our dealers and end consumers. As we drive more volume to ECN, which will help to increase the diversity of capital sources that will accelerate the growth of the industry overall. Additionally, in October, we closed on the acquisition of Regional Homes, the fourth largest HUD manufacturer in the United States, the largest independent retailer, and the company we have long admired. We are confident that the addition of Regional Homes to the Skyline Champion platform will allow us to accelerate profitable growth through the expansion of our retail and manufacturing distribution across the southeastern United States. Regional Homes has a customer-centric selling approach and is dedicated to providing an exceptional home buying experience to its customers, which directly aligns with Skyline Champion's core values and our strategic initiative to enhance customer buying experience. In coordination with the closing of the acquisition, I'm excited to welcome Heath Jenkins to the Skyline Champion leadership team, as he will serve as president of our captive retail operations. Heath brings years of industry retail experience and strong leadership capabilities, but most importantly, exhibits an unwavering commitment to put the customer first. Altogether, these investments represent an exciting opportunity as we strengthen our efforts to support the long-term growth and solidify Skyline Champion's market positioning as a leading provider of attainable housing solutions, for which the market is in tremendous need of today. Moving to the third quarter outlook, we continue to see stronger order rates from our retail and builder-developer channels. And while some customers have returned to the market, as others are continuing to destock as we move into our normally seasonally slower period. We expect the third quarter revenue to be up mid to high single digits as a result. We have seen orders strengthen five quarters in a row by the growing need from consumers for affordable housing. We anticipate this need for housing to be longer in duration than we initially anticipated due to recent indications from the Federal Reserve. Additionally, this need is driving more regulatory tailwinds for our products that give us increasing confidence in the long-term growth potential of our housing solutions. With our long-term strategic investments into retail, financing, digital, and automation, we are adding value and enhancing the buying experience for the end consumer and our channel partners. I will now turn the call over to Lori to discuss our quarterly financials in more detail.

Thanks, Mark, and good morning, everyone. I'll begin by reviewing our financial results for the second quarter, followed by a discussion of our balance sheet and cash flows. I will also briefly discuss our near-term expectations. During the second quarter, net sales decreased 42% to $464 million compared to the same quarter last year, in which we recognized $118 million in FEMA unit sales. The decrease in net sales reflects a 15% year-over-year decline in average selling price for U.S. homes due to FEMA unit sales last year, which vary a higher ASP than our core product due to the complexity of build. In addition, our core product ASP declined due to product mix and the decrease in material surcharges. During the quarter, we sold 4,842 homes in the U.S. compared to 7,274 homes in the prior year period. U.S. home volume was down year over year due to the absence of FEMA-related sales and reduced production schedules to align with order rates. On a sequential basis, U.S. factory-built housing revenue was in line with the first quarter, consistent with expectations that demand would remain relatively flat. An increase in the number of homes sold was partially offset by a decrease in the average selling price per home as core customers opt for smaller and less optioned homes in an effort to maintain affordable monthly payments in the current interest rate environment. Capacity utilization decreased to 53% compared to 56% in the sequential first quarter of fiscal 2024. Capacity utilization is being adversely impacted by newly opened plants and a right sizing of production rates at certain plants that serve end markets in which current order trends remain softer. Canadian revenue decreased 25% to 29 million compared to the second quarter last year, primarily due to a 23% decline in the number of homes sold driven by swelling demand. The average home selling price in Canada decreased to $126,100 compared to $129,400 in the prior year period, primarily due to the fluctuation in the translation of the Canadian dollar to the U.S. dollar for the year-over-year period. Consolidated gross profit decreased 58% to $116 million in the second quarter, and gross margins contracted by 890 basis points versus the prior year quarter. On a sequential basis, we saw gross margins decline 280 basis points. Our U.S. housing segment gross margins were 24.5% of segment net sales, down 950 basis points from the same quarter last year, primarily due to higher margin steaming unit sales in the prior year quarter, as well as lower core product sales volume and a mixed shift to homes with less features and options, allowing the homeowner to hit their monthly payment price point given higher interest rates. Gross margins were also negatively impacted by lower production rates as we are choosing to operate plants at lower run rates in order to be prepared to quickly ramp upon the return to normal order volume. SG&A in the second quarter decreased $19 million to $64 million, primarily due to lower incentive compensation expense on reduced sales activity. Net income for the second quarter decreased 68% to 46 million or 79 cents per diluted share compared to net income of 144 million or earnings of $2.51 per diluted share during the same period last year. The decrease in EPS was driven by the decline in sales and reduced operating leverage on lower volume. Diluted EPS for this quarter includes approximately $0.03 of transaction-related costs incurred for the acquisition of regional homes. The company's effective tax rate for the quarter was 24.5% versus an effective tax rate of 25.0% for the year-ago period. Adjusted EBITDA for the quarter was $59 million compared to $197 million in the prior year period. Adjusted EBITDA margin of 12.7% compared to 24.4% in the prior year period reflects a return to more normal profitability levels. In the near term, we remain focused on maintaining efficient production lines as channel conditions improve and order activity returns to a more regular cadence. The structural improvements and investments made in our business have strengthened our operational capabilities, protecting profitability in periods of lower output. That said, we reiterate our expectation that the mixed shift by customers looking to maintain affordable monthly payments in the current interest rate environment will continue for the remainder of fiscal 2024. We expect margins to compress further in the sequential third and fourth quarters due to product mix shifts, newly added production capacity continuing to ramp, and the purchase accounting implications of the regional homes acquisition. As of September 30, 2023, we had $701 million of cash and cash equivalents. and long-term borrowings of $12 million with no maturities until 2029. We generated $54 million of operating cash flows for the quarter compared to $231 million for the prior year period. The decrease in operating cash flows is primarily due to lower net income and the working capital impact of producing FEMA units in the prior year. During the quarter, we allocated $143 million of our capital for the strategic purchase of common and preferred shares of ECN capital. Subsequent to quarter end, we used $318 million of cash to purchase regional homes. In addition, we assumed $93 million of debt primarily related to inventory floor plan liabilities. We remain focused on executing on our operational initiatives and given our favorable liquidity positions, plan to utilize our cash to reinvest in the business and for opportunities that support strategic long-term growth. Since closing on the ECN investment, we've been working to develop the business plan for the strategic partnership with Triad Financial Services, including the rollout of Champion Financing branded floor plan programs for our retail and community channel partners, as well as tailored retail loan programs for our retail network. We are targeting launching these programs in January 2024. As a reminder, the partnership is an asset-like structure leveraging Triad's existing origination and servicing infrastructure and ECN's funding capabilities, which include relationships with community banks and leading institutional investors with no loan risk on the Skyline Champion balance sheet. We will be reporting the impact of the ECN common stock investment and the results of the captive financing partnership on a quarterly way. We began the integration of regional homes upon closing of the transaction in mid-October. The teams have been meeting to share best practices and to begin to capture synergies. As a reminder, we anticipate synergy capture of 10 to 15 million over the next two years, including manufacturing procurement synergies, leveraging our national footprint, and operational improvements from sharing of best practices across production and sales. The regional balance sheet, including retail finished goods inventory, will be revalued to its fair value and will negatively impact the company's consolidated gross margin in the next several quarters as those homes are retail sold. In addition, SG&A will increase for the amortization of intangible assets generated from the acquisition. I'll now turn the call back to Mark for some closing remarks.

Thanks, Lori. As we manage through the rebalancing of our channels, we believe Skyline Champion is well positioned due to our affordable price points, strategic positioning, and our core initiatives. The long-term outlook for demand is supported by the channel opportunities with community REITs, manufacturer rent, and builder-developer growth, as well as helping our retail partners adapt changes in consumer demographics. In addition, the need for affordable housing continues to grow each and every day, and we believe that the elevated cost of housing will drive more traditional slate-pilt buyers to our homes. Before we open the lines for Q&A, I want to take a moment to thank our people. The entire Skyline Champion team has our consistently strong performance as a result of the amazing things they make happen each and every day.

With that, operator, you may now open the lines for Q&A.

Thank you. We will now be conducting our question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. The confirmation tone will indicate that your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question is coming from Greg Palm with Craig Hallam Capital Group. Please proceed with your question.

Hey, good morning. Thanks for taking the questions here. I wanted to start with, you know, gross margin. It sounds like in the quarter, you know, that maybe the weaker than expected result was more of a function of some of these plant operating costs, you know, versus maybe increased competition or discounting. So I just wanted to make sure that was Going forward, is the thought process that you're maybe keeping more employees on or keeping more shifts in preparation for that return of demand? Is that one of the reasons why gross margin is going to maybe stay a little bit subdued here in the near term?

Yeah, Greg, I think that you summed it up pretty well. You know, we are definitely seeing, in addition to the things that you mentioned, a product, that product mix shift that we were anticipating, but to a greater degree as well. So, yeah.

And just in terms of maybe quantifying a little bit more relative to, you you know, what kind of compression should we expect, you know, over the next quarter or two?

Yeah, for the next few quarters, we're definitely, you know, it's going to be, there's a lot of moving parts. So we're going to continue to see the product mix shift with the consumer trying to reach a more affordable monthly payment with interest rates where they are today. and as well as the ramping plants and then the impact of the regional purchase accounting on gross margin. So we're expecting it you know probably around 200 basis points.

And the purchase accounting was kind of 40 to 60 basis points correct?

Yeah, I did mention that last quarter. We're still working through all the numbers based on the closing balance sheet.

Yep, okay. And then I don't know if you can maybe talk a little bit more about Champion Financing and what that looks like over the next one or two years. I know ECN, the partner here, they've publicly stated the expectation of that JV contributing you know, 40 million of pre-tax income per partner in calendar 25. I think maybe they said at least 40 million, if I remember right. Is that something you want to bless as well? And if that's the case, just kind of curious, you know, what that ramp might look like over the next couple of years.

Yeah, Greg, I think the ramp, you know, is out there. I think ECN mentioned 12 to 24 for their 50%. So I think that's where you're looking at that piece for that You know, the JV is obviously in a great position. We're very excited about that, especially given the banking conditions that we're seeing today. I think the fact that ECM has capital flow partners from Blackstone and Carlyle is tremendous in today's market. We've already seen two or three banks start to, regional and community banks, start to exit out of the lending space for our customers. And as there's further pressure, and we anticipate some further pressure on regional and community banks, making sure our customers have access to liquidity is very important for our dealers and obviously our community partners and builder developers, as a matter of fact. So I think having that partnership with ECN is vital, especially with the strong relationships they have with Blackstone and Carlyle who committed an additional $1.3 billion for the capital. So infusing liquidity into the market with community and regional banks. So that really is a strong leg forward to us. So as Lori mentioned, we're getting things set up right now. We anticipate we'll have the systems and other things ready to go by January time period. And so we'll really start to ramp it in the calendar year of 24. And so I think everything's on track for that, and the teams are working very well together.

Yep, makes sense. And just to be clear, I was talking calendar 25. I think they mentioned 12 to 24 in calendar 24. Is that right? Yeah, that's correct. Yep, okay. Makes sense. Okay, I will leave it there. Thanks. Thanks, Greg.

Thank you. Our next question is coming from Daniel Moore with CJS Securities. Please proceed with your question.

Yes, thanks. Good morning, Mark. Good morning, Lori. First off, just wanted to clarify the comments, Mark. I think you said fiscal Q3 revenue up mid to high single digits sequentially. Is that correct? And if so, is that organically or inclusive of regional?

You know, that's inclusive of regional, Dan, in that number. Yeah, we expect somewhere at least in that range, mid to high single digits at least for the quarter. sequentially.

Got it. And it sounds like some communities returning, some still destocking. Are there any discernible differences, be it regional or other, that you can sort of identify? Or is it more community versus community by community?

It's really more community by community. We've seen actually a handful of communities return. They've been starting to order and, you know, get back on a normal cadence. Others are still in that destocking process. So, you know, I don't want to say it's 50-50, Dan, but it's definitely there's a split between the communities that are starting to move and others are still kind of in that pause mode.

Got it. And what can you say just in terms of kind of longer-term progress that the Genesis solution is making? You know, we focus on those top 100 builders, but Even beyond that, in terms of converting to your solution, I recognize it takes years, not quarters, but what's the momentum or cadence of those dialogues?

The momentum is phenomenal, actually. I think now that interest rates have stayed up a little bit and they're forecasted to stay up a little longer, according to the Fed, It's really causing builders to take a look at what that outlook is. Right now, a majority of builders are buying down loans to really drive their volumes. You know, I look at our and I look at our quarter. We had order growth of 20% sequentially and orders year over year grew by 250%. And that's with no buy downs, no real incentives to drive volumes. So I think the affordable price points there, and with their cost capital for small to mid-tier builders kind of ranging in that 14% range for development, that really can drive, that's a huge incentive for them to switch to our solutions to where we can save them, you know, nine to 12 months of cost capital time. So it's tremendous. So I'd say the momentum is definitely picking up, especially now that people are looking at the fact that buy-downs can't last forever and the Fed's extending longer. I think that really is a motivation for builders to look at an alternative because they can't do it otherwise.

Got it. Helpful. And last for me, just circling back to the gross margin, appreciate the color and commentary. You know, 200 pips, kind of back down to the 23% range, maybe a little conservative, we'll see. Just talk, Laurie, about, you know, when we get through the purchase accounting and get to maybe back to 60%, 65% utilization, where you see margins leveling off even at this new, let's say, if it's a new norm for a longer period of time in terms of lower price points, mix, etc., where you sort of see us leveling off over the next, you know, four to eight quarters. Thanks.

Yeah, Dan, thanks for the question. You know, we still think that our long-term structural margin targets are, you know, in that mid-20% range. So I do believe that we're going to get back to, you know, the targets that we talked about historically. It's just going to be bumpy for the next few quarters.

All right, very helpful. I'll jump back with any follow-ups. Thanks.

Thank you. Our next question is coming from the line of Phil Ng with Jefferies. Please proceed with your question.

Hey, Mark. You sound pretty excited about this direct-to-builder channel. Certainly, you have some excess capacity right now with a softer demand backdrop. What's your ability to kind of pivot to serve that channel a little more fuller? Is there anything you've got to do on the labor front or the facilities?

No, thanks for the question, Phil. No, part of the reason we're running, you know, this quarter we ran at 53% capacity utilization. Part of the reason we're choosing to run at kind of less than optimal capacity utilization is really to make sure we have that available capacity to enter that channel. You know, right now is that pressure point, and I think a lot of builders have been buying down rates, doing that, in view that it would be a short term. They just need to do it for a few quarters to get through to keep their sales up. I think now that it's more of a marathon, less than a sprint of rate buy downs, I think they're starting to reconsider. So I think we've got this infrastructure in place to move into that channel very quickly, which is why I think the pipeline is shaping up the way it is for us.

Okay, that's helpful. And then how do you see this ECN integration rolling out and progressing, call it, in the next six to 12 months? Any big mile marks you want to achieve ahead of spring selling season? And you called out how having this partnership now gives you better access to liquidity, especially in an environment where credit's a little tougher. Does it help on the rate side of things as well? Do your consumers get a more competitive rate now versus when you didn't have this partnership previously?

Yeah, Phil, we haven't done anything to drive rates in a different way. There are some benefits, I think, to our partners in terms of rate that we can look at, especially with our turnkey solutions that we're offering, Phil. I think if they're buying from us, if they're using our construction services, they're using our floor plan and other things, I think overall we can look at it from a DVD or a volume discount basis that will definitely help them in some ways. I really think the benefit for them is going to be a few fold. One, it's access to liquidity. Two, it is the the speed that we're going to deliver. So we're working hand-in-hand with ECM in the champion financing program really to deliver great customer experience, faster turnaround times, better offerings in terms of what we can deliver to them. And then I think the third piece is really just, like I said, a suite of services to where they have one partner they can deal with for multiple needs. And obviously, you know, competitive rates to the end consumer is really what it's all about.

Super. And just one last one for me. How do you kind of see your sales cadence kind of wrapping up in the fourth quarter? You talked about 3Q. It's just kind of a noisy year, so it would be helpful to kind of get your perspective on how the shape of the year wraps up. And do you expect pricing and mix to kind of stabilize here, or there could be some further degradation in the back end?

Yeah, I think there's going to be a little bit of noise. I mean, we're going to have some choppiness as we integrate regional. They have a different price point and other things that we'll have to bring in here. But I would see revenue up sequentially and then continue to grow into spring as the market ramps and some of the community customers continue to come back. I really think it's... positioned very well. ASPs are going to be a little bit noisy, to be honest, just because with the mix of retail versus manufacturing, you're going to see kind of volatility in rates, just in terms of a little bit of noise, which is not really price deterioration or increases. It'll be more mix-oriented, as Lori mentioned earlier.

And then regional mixes down or up? Or I just want to make sure you made some comment about integrating regional. Just want to make sure I flushed that out.

Yeah, so regional is seeing the mix shift that we're seeing more broadly across all of the plants. So where last year they had higher prices, their prices are coming down as well just due to the mix shift in the monthly payment price point that the customer is driving. So we do expect ASPs to come down, you know, just generally sequentially from the second quarter to the third quarter and probably stay, you know, in that range for the next few quarters as we work through that leveling of mix.

Okay. Makes sense. Excellent.

Thank you.

Thank you. Our next question is coming from Mike Dahl with RBC Capital. Please proceed with your question.

Hi, it's actually Chris Claude on for Mike.

Just to follow up on the regional discussion, now that the deal is closed, is there any more specifics you could provide in terms of expected unit contribution in the next quarter and into 4Q, just given the additional color you have now?

Yeah, we don't, Chris, thank you for the question. We don't break out regional separately in terms of the guidance. I think they're wrapped up in our overall statement of, you know, how we see the third quarter shaping up.

Got it. Understood.

And then just me shifting on, shifting towards the many changes in the core, in your core customer dynamics following the move up higher in rates. I mean, have you seen a change in order trends in the last month or two? How has the financing environment shifted in response to the move higher? Have spreads expanded? Any color you could provide on the health of the core image consumer today relative to a few weeks back and the financing changes?

Yeah, thank you, Chris. I think, you know, I'm actually fairly confident in the consumer right now. You know, we've seen, like I said, one thing I look at very, you know, directly is the fact that our unit volumes and our order rates have picked up 20% sequentially. And like I said earlier, I think 250 year-over-year percent. And that's without incentives. So I think that we're seeing that drive to affordability. We're seeing customers look for a better alternative And we don't really have to drive huge financial incentives to capture that customer base. So I think that outlook is shaping up very well for us in terms of that. Our customers right now are seeing probably, we're seeing rates, probably the best rates we're seeing right now for channel are about 8.5%. I would say the average is probably closer to, you know, 8%, 9%. You know, if they're a poor credit, they're in the, you know, 10%, 11%, 11.5%. So, you know, but it's a great spread right now. In some cases, you know, 50, 100 basis points we're seeing for chattels, which is very competitive in the marketplace today. So it's a great value for our consumers.

Thanks for taking the questions.

Thank you. We do have a follow-up question coming from the line of Greg Palm with Craig Hallam Capital Group. Please proceed with your question.

Yeah, thanks for taking the follow-up. Apart from the, you know, excluding this purchase accounting, you know, will regionals gross margins be accretive? Are they kind of, you know, in line with kind of that mid-20s gross margin? I forget whether you've talked about that before, but maybe you can remind us.

Yeah, Greg, they're a little bit lower, so we've got to work on bringing in the synergy capture over the next couple of years to bring that up.

Okay, got it. So maybe that's part of the mix shift as well. And then just thinking longer term, I know, Lori, you mentioned kind of getting back to mid-20s, but why wouldn't it be – you know, higher, whether it's in that kind of 26% to 27% range that you were talking about previously or even somewhere in the higher 20s, just, you know, under more normal capacity utilization levels. You mentioned the synergy capture. It just feels like, but I just wanted to maybe, you know, flesh that out a little bit more if I could.

Yeah, Greg, the 26%, 27% is still certainly doable here. at normal capacity levels, and obviously as volumes increase, you know, there's some upside potential there too. So, you know, we see it in that range, 25 to 27, whatever.

Okay, so it doesn't sound like anything's sort of changed, you know, in terms of getting back to that level or long-term versus what we were thinking last quarter.

Not from a long-term perspective, no.

Yep, okay. All right, understood. Thanks for taking the follow-ups. Yeah, thanks.

Thank you. It appears we have no further questions at this time, so I'd like to pass the floor back over to Mr. Yost for an additional closing remarks.

I'd like to thank everyone for participating in today's call. We appreciate the time and your continued interest. We look forward to updating you on our progress on our third quarter call. Thank you and have a great day.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. Once again, we thank you for your participation and you may disconnect your lines at this time.