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Executives

Joseph Stegmayer - Chairman and Chief Executive Officer

Dan Urness - Vice President and Chief Financial Officer

Analysts

David Walsh - Avondale Partners

Michael Ware - Praesidium Investment Management

James Mccanless - FTN Midwest

David Cohen - Midwood Capital

Cavco Industries Inc. (CVCO) Q2 2009 Earnings Call October 24, 2008 12:00 PM ET

Operator

Good day everyone and welcome to the Cavco Industries Incorporated second quarter fiscal year 2009 earnings call and webcast. This call is being recorded. With us from the company today is the Chairman and Chief Executive Officer, Joseph Stegmayer; please go ahead sir.

Joseph Stegmayer

Thank you Cecelia and welcome everyone to Cavco’s second quarter conference call. With me today as always is Dan Urness our Vice President and Chief Financial Officer and of course before we begin we respectfully remind you that certain statements will made on this call during our remarks or in response to questions may not be historical in nature and therefore are generally considered forward-looking.

All our statements and comments are made with the context of the Safe Harbor rules. Our forward-looking statements are subject to risks and uncertainties, many of which are beyond our control. Our actual results or performance may differ materially from anticipate results or performance. Cavco disclaims any obligation to update any forward-looking statements made in this call and investors should not place any reliance on any such forward-looking statements.

The challenges contained in this past quarter is total industry shipments of manufacturing homes remained and decline. Manufacturing housing has recently reported that national home shipments for the first eight months of the calendar year were down 10% for the industry is a whole. However aided by increased production of our Texas operation compared to last year, Cavco’s comparative change was an increase of less than 1%.

Looking specifically Arizona and California, our major markets, industry wide shipments were down 37% through August 2008, while Cavco shipments were down 34%. Industry shipment data is not yet available for September, however for July and August the first two months of Cavco’s second quarter, home shipments were down 18% nationally and 35% in California and Arizona.

We can’t add anything to all of news in recent weeks concerning the financial markets and general economy except to say that these problems certainly have an impact on our business. Wood buyers seem even more cautious, financing home has become a very slow process and many new development projects that planned to use factory-constructed homes are being delayed further.

While the near term outlook is not promising, we think there are reasons to be optimistic about the longer range and we will discuss this after Dan reviews the financial results; Dan.

Dan Urness

Thank you, Joe. Cavco’s net sales for the second quarter of fiscal year 2009 were down 22% to $30 million from the prior year’s net sales of $38.4 million. The lower sales figure was a result of reduce floor shipments, which were down 11.3% as well as the 4.1% lower average selling price for the floor of approximately $25,600 versus the same quarter last year.

The company’s gross profit margin for Q2 ’09 was $3.7 million or 12.3% of net sales versus $5.5 million or 14.4% of net sales for the second quarter of last year. The gross margin was increasingly challenged this quarter by reduced capacity utilization which dropped to just over 50%. The company’s backlog at quarter end was just under one week at $1.6 million.

We successfully reduced our selling, general and administrative expenses for the quarter by $410,000 to $3.1 million compared to last years second quarter SG&A of $3.6 million. As a percentage of net sales SG&A was 10.5% versus 9.2% last year.

Interest income was lower by $433,000 primarily as a result of generally lower interest rates from the company’s investments with U.S. treasury. The current effective income tax rate for Q2 ’09 is 38% compared to 30% for Q2 ’08. The rate has been largely affected by no longer realizing tax-free interest income on short-term investments as well as the decline in certain state tax credit in fiscal 2009 resulting from reductions in the workforce.

Fiscal 2009 second quarter income from continuing operations was $518,000 or $0.08 per diluted share compared to $1.9 million or $0.29 per diluted share last year. When comparing the balance sheet at September 30, 2008 to March 31, 2008 our cash and cash equivalent balance increased $2.1 million to $75.7 million at September 30.

Trade receivables are down approximately $2.3 million compared to the beginning of the fiscal year resulting mainly from lower sales volume. Inventory is up $1.2 million primarily due to increased raw material prices and slightly higher with end finished goods inventory levels.

PPE is up mainly from the $537,000 purchase of the retail sales launch in New Mexico, which we previously leased. This is the location of an existing company owned retail outlet. Accrued liabilities are lower by $1.8 million, the result of a $1 million drop in customer deposits and a $700,000 reduction in salary, wage and benefit accruals. In addition the balance sheet continues to be debt free; Joe.

Joseph Stegmayer

Thanks Dan. Soon after our last conference call, the President signed into law the Housing and Economic Recovery Act of 2008. Some of the provisions of the act should be quite positive for our industry, specifically that provide for a $7500 tax credit for first time homebuyers and if the buyers tax liabilities less than $7500 the tax payer actually receives a cheque back for the balance of both his/her liability. This program will be effective through June 30, 2009.

Also very important is the FHA loan reform contained in the law. The FHA Title 1 loan limit was raised to $69,700. This is made for the purpose of financing net purchase of a manufactured home only without land purchase. This change has been long awaited because the previous loan number of $48,000 had not been changed for 16 years and was not sufficient for many buyers.

Another plus is that the limit is now indexed for the future inflation, which was not the case previously. That creates an affirmative duty for the GSCs, Fannie Mae and Freddie Mac specifically to serve the manufacturing housing industry. This includes the creation of mortgage products for personal property lending and there will be a director who will be responsible for giving reports monthly to Covers including the progress of the GSC’s on this mandate.

Beside from this legislation, I think there will be greater emphasis on end demand for truly affordable high quality homes in the future. As I’ve said for several years on these calls, the factory constructed industry lost many potential buyers of our homes to the onsite constructions industry. As people were unable to purchase higher priced homes by virtue of the Ill-conceived and poorly administered loan products made available to (inaudible) everyone regardless of their qualifications.

The responsible lending using sound underwriting principles should result in a greater percentage of homebuyers considering and purchasing our products once again. So, there are some positive developments, meanwhile we’re doing the right things to deal with the current environment and our strong financial conditions adds to our capability to successfully navigate to a period of financial and economic problems, which are unprecedented in the modern history of this country. Moreover, our people and the quality and diversity of our homes that we built make us confident that we are positioned to grow this business in the years ahead.

We’ll now be happy to take questions, Cecelia.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Walsh - Avondale Partners.

David Walsh - Avondale Partners

First off have backlogs changed appreciably since the end of the quarter as we’ve gone into October here?

Joe Stegmayer

I will pass that to Dan who have the numbers in front of him.

Dan Urness

Sure, I mean our backlogs have been fairly weak for the last year really. They have gone down since this time last year when they were around $4.5 million.

David Walsh - Avondale Partners

I guess earlier in your comments there’s about $1.6 million and is it a consistent rate today or was that a quarter-end number that you had given?

Dan Urness

That was a quarter end number and that’s not in consistent with toady.

David Walsh - Avondale Partners

And just a follow-up on that, any changes with regards to capacity utilizations still trending at that just over 50% rate?

Dan Urness

Well that’s comedown from since the last quarter and the quarter before that and we are working to keep that from reducing any further.

David Walsh - Avondale Partners

And third question, just as you look back over the quarter, I just wondered if you could give any color on what sales trends look like on a month-to-month basis, if you saw any changes or is that fairly level as you went through a period?

Joe Stegmayer

I think David it has gotten somewhat tighter with respect to income orders. It was as Dan indicated, it’s been very tough all along, but I think while it’s hard to measure there probably has been even a little further decline since the public knowledge of the financial crisis over the last month or two.

David Walsh - Avondale Partners

What are seeing with regards to raw materials? Have those prices started to trend back down or are you still seeing inflation there?

Joe Stegmayer

A mixed bag; on raw materials we are seeing and we still believe that we’re seeing some increases. In fact, we just received two more increases on some major products we buy just in the last couple of weeks. However, we have seen a stabilization, at some point a decline in some other raw materials. I think the more distinct point would be that what it’s going to look like in the months ahead because commodity prices are obviously falling.

Some of the reasons we’ve been given for the increase in raw materials by our vendors has been the petroleum price increases, the increased cost of adhesives, the increased cost of paints and increased the cost so many products we use petroleum; even carpets and floor coverings and so as these priced decline it will be able to see some relief on those products.

David Walsh - Avondale Partners

Sure, and would we see a lag effect then if those prices were to come down. Would you see those starts to get reflected fairly quickly or what do your inventories look like from a raw materials perspective and how long would it take to work through those?

Joseph Stegmayer

I think it would to come down fairly quickly. We turn our raw material inventories quite rapidly. So it’s not so much of a problem and we do have a surcharge generally on the homes we sell. That surcharge will be adjusted as some of these commodities and purchase prices come down. I would say that there should not be much of a lag really in realizing lower prices.

David Walsh - Avondale Partners

And then just lastly here, your company’s cash balance has continued to increase, which is a good thing, but just wondered if you could give any color on what your plans are with regards to those cash balances?

Joseph Stegmayer

Well, I would say short term we’d like to find some very safe and liquid investment alternatives. We’ve been very conservative, unfortunately moved our investments into U.S. Treasuries before this debacle. In fact probably some nine months ago. So the money that we have invested is very safe; it’s all in the U.S. Treasuries and it’s very liquid; obviously though the yield on is minims at this point. So I guess at short term we’d like to see if we can find some other instruments that will offer safety with somewhat higher yields and we are looking into that as we speak.

Longer range, I think probably more to your question, we continue to look for opportunities to strategically position our company for again greater growth when times change and so we’ll continue to look for opportunities to expand either from an acquisition standpoint or from a Greenfield or de novo operation and we’re going to stay pretty much in the areas we know, factory construction and there will probably be more opportunities in this field in the months ahead. So we’re keeping our ear to the ground with respect to those opportunities.

Operator

Your next question comes from James Mccanless - FTN Midwest.

James Mccanless - FTN Midwest

I wanted to ask first how many retail stores do you have open now?

Dan Urness

We currently have six.

James Mccanless - FTN Midwest

Joe, with what you were talking about with Title 1 hopefully getting more active and more lenders getting involved there, does it make any sense to expand out your retail distribution?

Joseph Stegmayer

Possibly James, but I would say that we have a very strong distribution network of independent dealers. We’ve been in our markets for so long, over 40 years and I think over the years we continue to upgrade and obviously with the downturn we’ve seen in the last couple of years with strong survive and we’re unfortunate to have a very strong distributors.

I don’t think we did tend to get into retail internally in a large way. We will certainly consider certain pockets of opportunity perhaps if it presented in themselves and we found something that make sense, but I think our overall strategic intent is to continue to work through independent distributors, retailers and community developers and land lease community operators.

James Mccanless - FTN Midwest

And then just taking with Title 1 for a second, in terms of the different pieces of the puzzle whether it’s the local banks or Jenny May etc. where do you see is the potential stopping point for that right now. I know that Jenny May had committed earlier this year to buying about $1 billion worth of that papers. That commitments still in place and what are we seeing on the local finance level.

Joseph Stegmayer

Yes, I believe the commitments still on place. I think the FHA Title 1 program doesn’t really kick-in until the end of the calendar year. I think when it becomes the new numbers actually become effective, so we haven’t seen much impact yet in that program. First I think as tough as conditions are and with the lack of knowledge of some of these programs that hasn’t spread around I think we’re yet to see much benefit from the loan reforms and the down payment assistance program during the tax credit. I shouldn’t really call it down payment assistance, but basically that’s how people to get cash back in their pockets or reduce their tax liability in a very short orders, so it can help in that regard. So I think we will start to see more benefit from these programs into the new calendar year. I don’t think we really seen any benefit so far.

James Mccanless - FTN Midwest

And then my last question; repurchase liability, are you seeing anything moving on that, the trend going up, the trend going down?

Joseph Stegmayer

Our repurchase liability’s declining slightly of course as unfortunately our business declined. With respect to actual repurchases, our experience has been very, very modest and we watch that very carefully of course. We kind of work with our retailer and the floor plan lenders to mitigate any problems in that regard. So, that’s something we review continuously and at this point we won’t have any cause to be in line about that, but it is something we watch carefully.

Operator

(Operator Instructions) Your next question comes from David Cohen - Midwood Capital.

David Cohen - Midwood Capital

You mentioned floor plan lenders, have you seen any changes in terms of the availability of that capital for your dealers? Are there any analogies like there are sort of taking place with the automotive where certain lenders are backing away from floor plan financing?

Joseph Stegmayer

David, two things; one is that interest rates are moving up somewhat I believe with the floor plan lenders to the retailers and two, although we’re told that there is no change in the availability of financing for existing accounts, I think they are being very cautious about opening up new accounts with dealers. So, if a new dealer comes to them and asks for line of credit, I think they are going to be fairly conservative about that and so far they have not heard one story about them cutting off any existing dealer.

David Cohen - Midwood Capital

So far what percentage of any of your dealer base has closed up shop? They have gotten that bad where folks have actually closed up shop.

Joseph Stegmayer

The percentage will be miniscule. We’ve count on one hand the number of dealers that we deal with, that has closed, so it has not been a factor. Although, I’ll say it’s certainly a concern going forward because the dealers have had a tough time for a while, but the better operators are used to managing their costs in these tough times, many of them have been through these cycles before, although this one obviously is very touch.

A lot of the distribution is entrepreneurial or family run and they can cut their overheads very quick and adjust accordingly. One thing sometime they get a little bit trapped with their inventories. Obviously it might increase relative to their sales because their sales are decline so much, but the good thing on that note is that inventories are generally quite low among all the retailers. So even for example for retailer has five or six homes, their sales drop, they would rather be at four to five homes and so they have to try to reduce, but the reductions are not from high levels as we’ve seen in past cycles. So, I think that’s a positive if there is one in that part of the decline.

Operator

Your next question comes from Michael Ware - Praesidium Investment Management.

Michael Ware - Praesidium Investment Management

Just a question on pricing; you guys obviously saw the ASPs come down a little bit in this quarter. I’m wondering if you can comment generally on the competitor environment and how your competitors are reacting on the pricing side, whether you’re seeing pricing competition pick up as volumes weaken here?

Joseph Stegmayer

Michael, we have a selling price coming down for really two primarily reasons: one is the competitive environment you’ve mentioned and yes, we certainly are seeing some competitive pressure from a pricing standpoint. There is some operators in the manufacturing side who will resort to pretty desperate measures try to keep of plant running even in the minimal schedule and so we are seeing some price competition in that standpoint.

The other major factor would be a reduction in size of the homes and the amenities in the homes, that’s probably what’s driving this, in other words the product mix issue and that’s I think driving the average selling price more than the pricing issue is. Although, the pricing does have an impact, but frankly people buying lower priced homes as somewhat smaller in size, less options in the homes and that is affecting both average selling price in our margins.

Michael Ware - Praesidium Investment Management

Okay. So there hasn’t been any discernable change in terms of the competitive pricing environment; people are pricing more aggressively as we’ve seen things weaken here?

Joseph Stegmayer

Well as I said, we do see some of that; it kind of goes in spurts. Once in a while, our manufacturer come out some special and they will offer a home maybe for a limited time, trying to spur some sales and at a certain price where they will offer certain options at no additional charge until we see some of that and we have to do battle with some of that, but oftentimes those products are downscaled in terms of specifications and quality and the products and development in putting it together, the componentry and so we will also sell on the basis of the quality and the advantages of our product.

So, we don’t necessarily match those prices, we try to be reasonably competitive, but we’re not going to get down to the point where we don’t make a margin on our product and I think, in some cases that can and does happen, but also happens for a fairly short time period because the manufacturers, specially in this environment can afford to do that for very long.

Michael Ware - Praesidium Investment Management

Right, well just one other question; with foreclosures increasing are you seeing site-built homes becoming more of a factor in your market in terms of increasing the competition?

Joseph Stegmayer

Right the foreclosed barn home in this I guess just the fact there’s so many homes in the market, it does have an impact just depending on the areas. There is some areas where it really has no impact, more rural areas and planned-communities, it doesn’t have as much of an impact, but certainly where our homes were located or which could be located near the long track built subdivisions that are discounting home heavily, it may have an impact.

Although, again our price points are still even at discounted pricing and as far as the on-site constructed homes, our price points are still generally lower than those price points. So a buyer can still look to our product at a much lower price point as they could a a discounted site-built home.

Operator

(Operator Instructions) Your final question comes from David Cohen - Midwood Capital.

David Cohen - Midwood Capital

Just looking for some clarification with regard to the FHA Title 1 program; within that is that a loan guarantee or is that something that is originated by the FHA? In other words, does a private lender need to be involved in underwriting the loan; how does that program work?

Joseph Stegmayer

Yes, the loans are generally written by mortgage originators as well as the banks or mortgage brokers, but they are FHA loans, so they can sell them immediately to FHA. So they don’t have a funding issue, that’s the good part of the FHA program, they can sell them immediately and have the FHA insurance. So the availability of those funds is a bit positive. With respect to the $7,500, that’s a tax credit that a homebuyer get and they obviously file for that tax credit. So the originator loan can help them with the paperwork, but they’re not really a conduit for providing that $7,500 back to them.

As I mentioned, the good part is if an individual and some of our buyers might not have capital holding and so forth during the course. They might not have that $7,500 tax liability and so the good part of this program is that they can eliminate whatever tax liability they do have, let’s a $2000 and $5500 balance were actually get in cash as refund.

David Cohen - Midwood Capital

And beside the FHA, I guess who else is the major player in terms of capital financing these loans today?

Joseph Stegmayer

Well, I think we have some lenders that are holding these loans in portfolio such as U.S. bank, which lends to this industry. Our understanding is that they keep these loans on their balance sheet. Wells Fargo has been traditionally a provider of loans to our industry and continues to do so. So, I couldn’t tell you exactly what some of institutions are doing with the loans, I suspect some of them are keeping their own balance sheet, some of them have vehicle to sell them, which I imagine is increasingly difficult.

David Cohen - Midwood Capital

But you haven’t heard anything about this type of paper becoming less; these private source of capital backing away from this type of paper?

Joseph Stegmayer

No, not specifically, no more that we’ve heard about that in the macro sense for all lending; we haven’t heard anything. Keep in mind that these loans now that we’ve been generating in manufactured housing are pretty good because the underwriting standards have been so tough for sometime now.

We do not participate in the wild underwriting if you will, but the on-sight construction industry did it, so we don’t really have the kind of problem with our loans. Most of the loans in our industry have been fairly good credits. They have been reeling down payments on the homes and they have been fairly and I would say meticulous in many cases underwritten. So, I don’t think the performance of our product is going to mirror at all the performance of conventional mortgages.

Operator

And with that, we have no further questions in queue. This will conclude today’s conference ladies and gentlemen. We appreciate your participation. You may disconnect at anytime. Have a great day.

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Source: Cavco Industries Incorporated F2Q09 (Qtr End 30/09/08) Earnings Call Transcript
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