LCI Industries (LCII) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q4 2006 Drew Industries earnings presentation. My name is Tony, and I'll be your coordinator today. [OPERATOR INSTRUCTIONS]

I'd now like to turn the call over to Ryan McGrath with Lambert, Edwards. Please proceed, sir.

Good morning, and welcome to Drew Industries fourth quarter and year-end 2006 conference call. I'm Ryan McGrath, with Lambert, Edwards and Associates, Drew's investor relations firm, and I have me today members of the Drew management team, including Leigh Abrams, President and CEO and a director of Drew, David Webster, President and CEO of Kinro and a director of Drew, Jason Lippert, chairman, President and CEO of Lippert Components, and Fred Zinn, Executive VIce President and CFO of Drew. We want to take a few minutes to discuss our quarterly and year-end results. However, before we do so, it is my responsibility to inform you that certain statements made in today's conference call regarding Drew Industries and its operations may be considered forward-looking statements under the security laws. As a result, I must caution you that actual results and events could differ materially than those described in the forward-looking statements. These risk factors are identified in press recent releases and in our Forms 10-Q and 10-K filed with the SEC.

With that I'd like to turn the call over to Leigh Abrams. Leigh?

Thank you, Ryan, and good morning, and welcome to all of you on this call and to all of you listening on the internet. Before I begin my formal comments, I'd like to just congratulate David Webster, who just the other night was honored as being the outstanding member for 2006 of the Manufactured Housing Trade Association AAMA. which is the American Architectural Manufacturers Association. David, congratulations. I'd also like to congratulate Jason, who just assumed the additional title of Chairman of Lippert. His father, Doug, has retired after 30 years or so of running the business, until Jason assumed presidency in '03, and Doug will remain on Drew's board of directors. Now to begin my formal comments.

As anticipated, we reported a very profitable 2006 year. In fact, that was our second best year ever, but we had a very poor fourth quarter. This year was extremely unusual in that our traditional weak first quarter achieved almost the same results as our typical strong second quarter. Further, the 2006 quarter was benefited from a continuation of the business generated by the hurricanes, the Gulf Coast hurricanes of 2005, which benefited in '05, both the RV and manufactured housing industries. And then in addition to that, dealers restocked their inventories from units that FEMA had purchased in '05. The 2000 second quarter had little hurricane-related business, but RV dealers continued to add to their inventories, apparently in the hope that 2006 traditional March to August selling seasons would be as strong in prior years.

However, that did not prove to be the case, and it soon became obvious that the impact of higher interest rates, along with weekly increases in gasoline prices and the threat of an oil cut-off because of the conflicts in the Middle East had scared off many consumers from either buying a RV or trading in their existing RVs. As a consequence, RV dealer began to aggressively cut back on orders in August of '06, in an attempt to bring inventories in line with the current sales trends, whereas our sales through early August in '06 were running more than 20% ahead of last year. For the balance of '06 our sales were significantly lower than in 2005. This resulted in very different comparisons to 2005 because of hurricane-related sales in 2005 and because of the 2006 dealer inventory reductions.

Accordingly, our 2006 results were somewhat weaker than 2005, and our fourth quarter results were very weak. On the positive side, we were nicely profitable in both quarters, and at the same time, managed to significantly reduce our inventories and our debt. Recently though, many of the unfavorable factors that affected us last year have significantly improved. Gas prices are down, interest rates have been stable, and the fear of gas shortages has eased. Just as important, the consumer confidence index, a barometer of future RV sales, has begun 2007 on an upward note, although it was somewhat erratic throughout 2006. We continue to remain optimistic about the long-term growth of the RV industry due to extremely strong demographic trends, with almost 20 million people or 11,000 people per day turning age 50 in the next eight years. This is the primary buying group for RVs, although 25 to 45 year old age bracket has also become the faster growing RV age group, which should lead to even further growth in the future. By 2010, industry experts are predicting the RVs will be owned by 8.5 million households, which is an increase of 8%, which is out pacing the overall U.S. household growth of 6%.

With respect to the manufactured housing industry, the most compelling positive factor is that today's manufactured home is truly a quality home, and is almost certainly the best buy in the housing industry. Unfortunately, relatively few people know of this. The public is just not aware of the strides that industry has made in the last ten or 15 years, in improving the quality and the appearance and the comfort of the house. We are -- we're really hopeful that the industry will take the initiative and commence an effective generic advertising campaign that will both expand the industry's current market base and also help to convince zoning officials to allow manufactured homes to be sited in their communities. I think over time that this will be accomplished. Increasing the buying basis through an informative advertising campaign should also help with the financing problems that the industry is expensing -- experiencing.

Lenders are currently requiring that manufactured housing borrowers that have FICO scores of between 620 and 690 or even higher, and the traditional buyer of manufactured homes just doesn't have credit ratings this high, and thus is now precluded from buying our homes. As a result, a significant portion of potential buyers has been lost, and we believe that only by expanding the base through an effective ad -- public relations campaign will we be able to replace some of these buyers. In addition, as the baby boomers reach retirement age in greater numbers in the next several years, we expect the industry to begin to recover from today's very depressed levels. Even today, many retirees sell their primary residence and use part of the proceeds to purchase a manufactured home in a warm climate and then they use the balance of the proceeds for retirement purposes. However, with the slow down in the market for site-built homes, it apparently has become more difficult for homeowners to sell their site-built homes and buy a manufactured home and this could account for part of the downturn that we're experiencing right now in manufactured housing.

Further, we expect Gulf Coast rebuilding to begin in earnest in 2007. as many insurance claims are now being settled and the federal government is allocating more recovery funds to the hurricane-devastated areas, some of which may be used for manufactured housing. Let me philosophize a little bit. I say although a slow-down in sales is disappointing, our operating management really proved that circumstance is not completely out of their control. They continue to push for sales of new products and to gain market share for existing products whenever possible. In addition, we completed two acquisitions in '06, and one so far in '07. These acquisition were all accretive to earnings and offer us the opportunity to expand our product lines and to become an even more important resource to our customers. As a result of these actions, our sales were not down as much as either the RV or the manufactured housing industries.

Further, over the last several years, we have grown very quickly. In effect, our sales more than doubled in 2006 from our sales in 2003. It's been my experience when a company grows at this rate, it doesn't always have time to fully analyze from a financial aspect every action that is taken in order to meet the demands of its customers. And I believe that this was certainly true for Drew, especially considering how strong our profits had been over that span of time.

Well, if there could ever be a positive thing about an industry slow down, I think we found it. With our sales slower and our profit dow -- profits down, both David and Jason had time to carefully assess their operations and they saw and acted upon opportunities to cut costs by improving the efficiency of many of our production processes and consolidated operations to fewer factories. Now the results of these cost-saving measures are just now beginning to show -- show itself and should continue to do so over the next several years. Our managers have found ways to do more with less, and are convinced that when the industries return to strong growth that they will have the capacity to handle the growth and to continue to offer our customers superior service and quality product at reasonable prices.

I am certain that our managers would have taken these actions under any conditions; however, I firmly believe that our strong -- our very strong incentive programs were certainly an additional motivator. Approximately 20% of subsidiary operating profits are put into bonus pools which are shared among all our managers. Our pay for performance compensation is based upon profit levels, and thus compensation for most of us will be lower in 2006 than in 2005. However, we're trying to take meaningful actions that will improve operations and help assure that our 2007 profit, and thus our profit-based incentive will be higher in 2007 than in either 2006 or 2005.

Although the last several months have been very difficult for all suppliers and manufacturers in both the RV and manufactured housing industries, we believe there is a light at the end the tunnel. At least with respect to the RV industry, we're really hopeful that some of the pent-up demand from potential buyers who postponed purchasing RVs last summer will do so in the current buying season. And finally, as I say as often as possible, I truly believe that our success is attributable directly to our extraordinary operating management team headed David Webster and Jason Lippert. David and Jason are responsible for the continued market share gains and new product successes at both Kinro and Lippert. As always, good management is the key to a successful business and I believe we have the best. Over the last several years, both of our subsidiaries have gained market share, they've introduced a variety of new products, they've made great acquisitions, and most importantly, they've simultaneously kept costs low and quality and customer service high.

With that, I'll now ask Fred Zinn, our Executive Vice President and our CFO, to review our financial results in more detail.

Thank you. Leigh. The impact on our business of the recent slow-down in the RV industry, along with the continuing decline in manufactured housing and the effect of the 2005 Gulf Coast hurricanes were certainly keys to understanding our results in 2006, and we did discuss those at length in the press release. Now, I'd like to summarize some other factors that affected our results in 2006, paying particular attention to those that will have a continuing impact in 2007.

In September 2006, we closed the Indiana-based specialty trailer operation, which had a pretax loss of $3.3 million in 2006, and there will be no effect on our 2007 earnings from this closed operation. Further, just closing the operation has allowed management to focus more attention on other more productive areas of our business. We also reduced overhead costs and consolidated facilities, and that will cut our costs by more than $4 million in 2007, without impacting our ability to grow or service the needs of our customers. Additional overhead reductions and facility consolidations are being analyzed by management, and we will implement cost reductions in any area that does not interfere with our long-term goals. In the last two years, operating management intensified its efforts to reduce costs by purchasing imported components that are less costly. These efforts have continued, especially with respect to components for some of our newer products, where margins have been lower than in our more-established product lines.

We've also focused on controlling interest expense by reducing debt levels. During 2006, we reduced total debt, net of invested cash, by $21 million, and that was accomplished despite the fact that we completed acquisitions during 2006 with a combined cost of $34 million, and made capital expenditures of more than $22 million. The debt reduction was, in part, due to operating managements' success in reducing inventory levels by $18 million in the second half of 2006. We will continue to closely monitor inventory levels and that should help us reduce interest costs in 2007. Further, though, our return on assets did decline in 2006. The significant reduction in inventories should help improve ROA in 2007. As I mentioned, capital expenditures for 2006 aggregated $22 million and that was less than the $24 million to $27 million that we had projected at the end of the third quarter. We anticipate that capital expenditures will decline further in 2007 to about $15 million to $18 million.

In addition, during the last two years, we partially offset these capital expenditures with nearly $7 million of proceeds on sales of fixed assets. In sale of one facility, we provided short financing to the buyers and we anticipate we'll be collecting an additional $4 million in less than a year, and at that time, we will report $2.8 million gain in the sale of that facility. Several other properties are also currently being marketed. And as we mentioned, additional plan consolidations are being considered. With strong cash flow and improved operating -- asset management, we expect additional substantial reduction in our debt levels and interest costs of 2007, unless we complete significant acquisitions this year. The combined cost reduction efforts, including closing the Indiana specialty trailer operation, reducing overhead costs, consolidating factories, negotiating lower costs for components, and controlling interest expense are expected to have a positive impact on our operating results in 2007.

With respect to revenues, we continue to out perform the industries we serve by gaining market share and completing strategic acquisitions. As a result, in the RV segment, our estimated content per travel trailer and fifth wheel increased 13% in 2006 to about $1,560 per unit, and that's up from $1,380 in 2005. Our estimated content per motor home also increased to about $290 per unit in 2006, from $240 in 2005. In the manufactured housing segment we estimate our content per home increased to more than $1,800 in 2006 from about $1,500 last year. Part of that increase, though, was because homes produced by the industry for FEMA in 2005 were smaller and therefore included less of our product, as opposed to the larger homes produced this year.

We continue to focus on expanding our product lines to increase content per unit, and that's evidenced by the three acquisitions we completed in the last 12 months. The January 2007 acquisition of Trailair/Equa-Flex, as well as the 2006 acquisitions of Happijac and Steelco will not only help increase our content per RV for this coming year, but should be a accretive to our earnings. The content growth makes us an increasingly important partner with our customers, and demonstrates that our customers believe we provide them with quality products and outstanding service. While the level of shipments in the RV and manufactured housing industries will certainly impact Drew's results over the coming quarters, we believe we've made substantial strides in expanding our markets and reducing our cost structure, and that should put us in an improved competitive position in 2007.

I'll take just a minute to cover some others areas that will also impact 2007 results. Depreciation and amortization expense aggregated $15.7 million in 2006, and we anticipate between $17 million and $18 million of depreciation and amortization in 2007. Our effective tax rate was 38.8% for 2006. In 2007 the federal tax credit on domestic manufacturing activities will double, up to 2% of manufacturing-related pre tax income. But on the other hand, based on the allocation of our income among the various states and the tax rates in those states, I expect higher state taxes to offset much of the savings that we will be getting from federal income taxes. And I believe our anticipated effective rate for 2007 is just about the same as it was in 2006. As is typical, we in the process of tax audits in several jurisdictions and each quarter we review our tax positions based upon the available information, and we update our tax reserves accordingly. I'd also note that our stock option expense increased by $1.2 million in 2006,to $2.3 million. That increase was primarily due to employee option grants in November of 2005. We typically grant employee options every other year, so there was no grant to employees in 2006, and we anticipate that stock option expense will remain at about the $2.3 million level in 2007.

Now I'll turn it back to Leigh.

Thank you, Fred. Tony, if you could ask for questions, please?

[OPERATOR INSTRUCTIONS] Your first question comes from Scott Stember with Sidoti.

Hi, Scott.

Good morning. With all the moves that you've made to trim capacity and some of the plant closures, could you maybe just quantify between the third and fourth quarters exactly how many facilities were closed? And maybe talk about where your capacity utilization is where we stand now?

Well, let me take the second part of the question first. Capacity utilization is a very tough question to answer. Is it one shift, two shifts, three shifts? Last year when the hurricanes came, our plants were able to go to six and seven days a week, and two and three shifts a day, so what is real capacity? And we have a number of plants around the country so if we don't have capacity in one particular location, we can bring in if need be and pay some extra freight from another location. So capacity is really not a question that we're concerned with. As far as closing plants, I'll ask Fred to do that, and then I can ask David and Jason to jump in as well.

Sure. At the end of last year or during the latter part of last year, we closed the facilities. I would estimate, really just ballpark, that it was considerably -- between 5% on 10% of our capacity, something on that order. We're probably operating at around the same capacity levels as we were in prior years because, obviously, the industries are down a bit, and we did reduce our capacity by those plant closures.

But again, we closed those plants and moved the business into other --

Right, we didn't lose business, we just consolidated with other factories.

David or Jason, you wants to add anything to that?

Not especially.

Not really.

Okay. Next question, please?

Yes, maybe touch on raw material costs and what you're seeing with the slow down in business whether those prices are abating?

Raw material we just found out that steel is going back up again, we got increases in February and another increase in March, so it's very difficult to give any positive trend on raw materials, other than saying that they're bouncing around. Up and down, a little down one month, a little up one month, but steel seems to have picked up it's upward trend again.

And the same is true in aluminum, aluminum was off a little bit. When it went back up, ABS, which we make the bathtubs and other bath products out of also, has increased a couple of times this past year, and as recently as this fall. So it's. as Leigh said, given the volatility that is difficult to manage and it's continued to be volatile.

Okay, and just circling back to a comment in the press release about sales in January being down 15%, is it pretty much the same trends between the two businesses?

They were -- yes, one was slightly stronger than the other, but the trends were the same.

And last question, just talk about some of the new products? I don't know if this is a really good quarter to talk about the run rates on a yearly basis, which is a figure that you guys normally give, and also, you mentioned in the press that the thermoformer, you were able to sign up a customer, maybe talk about that a little bit?

I'll start with Jason [inaudible] new products. I'll let David -- and then follow up with David on the thermoformer. So, Jason, you want to start on new products?

Yes, our big focus right now has continued to be axle products, just because it's an extremely large market, so there's a lot of different -- lot of different individual segments that make up that market that we're going after, from specialty trailers to cargo trailers and other types of trailers outside the RV industry. So we're continuing to tap that market, which is several hundred million dollars strong. That's where our focus is.

Yes. David, you want to talk a little bit about the thermoformer?

We've been working on the large thermoformer after getting the equipment in -- in the house, and we've got a lot of things going for us in the large thermoformer. And yes, we did pick up a customer for the rear complete unit [inaudible] panel, travel trailer, motor homes. So we are looking forward to more products, not just in the RV side of it, but in the farm and ranch products and automobile products also. As I've stated before, it's a great product and we're looking forward to great things out of it.

As we've been saying in the past, this is an area where it could be zero or it could be a very big item, and we're happy to see the first sale and we think this has great potential for the future.

Without giving too much away, can you just comment on the size of the customer?

No, at this point, we -- I did say the order is small and we look for growth in the future. It'll take time to build, but it's a great product and we're optimistic long term.

Great, thanks a lot, guys.

Okay.

Your next question comes from the line of Kathryn Thompson with Avondale Partners. Please proceed.

Hi, Kathryn.

Hi, how's it going?

Good.

Great balance sheet control in a tough quarter. Want to focus first on SG&A, it's a little bit higher than we were expected, in fact a little over 100 basis points up year over year. What were the components for that increase and should we see a similar trend going into the first half of '07?

Yes, SG&A is a little hard to track as a percentage, or a little hard to measure only as a percentage of sales, because, of course, there are fixed components. Our G&A costs are in those numbers and they're largely fixed. I think G&A did -- SG&A did track what we expected in the fourth quarter, but most of the cuts that you'll see that we talked about, the $4 million in cost savings, will be coming out of the G&A area, I don't know if it's 75%, but more than 50% of those costs savings will come out of the G&A area, so we shouldn't see a continuation of that line unless, of course,depending on sales. If sales increase, we'll see SG&A go down as a percentage of sales.

We expect to see part of those savings in our first quarter.

Yes, so start towards the latter part of the first quarter and continue throughout the rest of the year, for this year, the impact should be about $4 million.

Okay. But you will see a little bit of an impact in Q1 and much that will head in the last three quarters?

Yes, more than a little bit, but not as much as in the other quarters. Probably half of what you'd expect in the rest of those quarters.

Okay. As far as your -- it's the second sequential quarter where you've had some capacity cuts and work force reductions. I believe in the previous quarter, you said the cuts in Q3 impacted -- would impact Q4 by $0.01 to $0.02 or maybe $0.03. Is that still the case?

Yes, we did see cuts. Fourth quarter would have been much worse if we hadn't made the cuts.

Okay. And what do you think -- what do you expect the impact of your current cuts will be into Q1?

Well, if we save $4 million, it's $1 million a quarter. You get $0.5 million in the first quarter after taxes, it's a $0.015, give or take.

Okay. All right. So very similar --

It would be, give or take, maybe a little more than $0.03 in each of the ensuing quarters, but that's what we've done so far. We're continuing to look at plant consolidations and further overhead cuts, so you may see that rise. What we've done so far, though, it will be in that range of $0.03 a quarter.

Okay. All right. Also, I know you had comments about RV sales or just your overall sales rather in January. How were sales sequentially in RV and manufactured housing from December to January? More specifically, my understanding is that manufactured housing not a lot has changed between December to January, but on the RV side, your seeing a little bit better trend. Nothing huge, but a little bit better trend. Are you seeing that in your business?

I can just tell you, and then we'll ask Jason and David to comment, that manufactured housing sales are very poor. RV sales were stronger than they were in December, and maybe even a little stronger than we thought they would be. Jason, you want to comment on it?

With respect to?

The strength of RV sales and the --

Presently?

Yes.

Just sequentially from December to January.

January compared to December.

Well, there's really no comparison ever, just because December's always a seasonally slow, but from January --

-- your expectations.

January's sales and even coming into February were much stronger than we expected, so -- and we're feeling pretty good about things right now.

Again, manufactured housing sales are just nothing, they're just going away. David, you want to add to that?

[inaudible]

David, you'll have to get closer to the phone. We can't hear you.

I'm right on top of it. [LAUGHTER] Manufactured housing sales are down, but they're not completely gone. We're still look -- seeing it, and I think the RV industry is -- January is a lot better than the December, but as Jason said, December is not a -- not anything that you can compare it to because it's always down. Now the weather that we are having now could have a small effect on it, but I think it's going to be a good year.

Okay. That's all --

But this is what -- [inaudible] this is what makes the comparison so difficult. For two years in a row, December was a lot stronger than people anticipated because you had hurricanes in two years in a row, but December's usually a bad month.

Absolutely, and really, the main angle of the question was in terms of your own expectations.

Stronger than we thought.

Yes, okay. Great, thank you very much.

But again, we can't -- as we said in the press release, we just won't know until the consumer responds.

Yes. Thank you.

Your next question comes from the line of Juan Gomez from BB&T Capital Markets. Please proceed.

Yes, thank you for taking my call. Just a little bit after the quarter ended, I guess, have you seen any change in the inventory on the towable side for the dealers?

I'll ask Jason and David, do you have any comments on dealer inventories?

For RV I've heard of a lot of mixed comments, but nothing that would indicate that inventories are excessively high. I think the tone that I've heard the last couple months is that inventories are moderate and nothing more or less than what's typical this time of year. There's a lot of retail activity going on right now with the shows and things like that, so that usually kind of jump starts the year. Haven't heard anything negative.

Nothing yet, so the trend is just stable or the same I guess? Nothing getting worse?

No, the only negatives I've heard are there's been a few dealers that have gone belly up, but nothing that --I don't know how normal that is. I just heard comments that a few dealers have had problems so --

Okay.

David, you want to add anything?

No. I think there's still inventory out there, but I don't think it's any higher than it was. I think units are moving, and there's money out there, so I think we'll see a good year.

All right. Just another quick question, on the acquisition front should we expect the same versus '06, I guess '07 looking for other smallish acquisitions or anything bigger?

We're always looking for all kind of acquisitions, large and small. I think we like to take advantage of opportunities when they're there, and we can never project an acquisition until it's closed. We are always looking for acquisitions, but they have to fit our criteria, has to meet our price ranges, and we're very, very patient, very, very disciplined on that. And then we can't obviously talk about anything until we announce it.

All right. That's all then, thank you very much.

Thank you.

[OPERATOR INSTRUCTIONS] Your next question comes from Arnold Brief with Goldman -- Goldsmith & Harris. Please proceed.

Actually, I pressed the #2 to withdraw the question, because it had to do with inventories and you just answered that.

Always nice to hear from you, Arnold.

Maybe I'll ask something else.

Okay.

Do you see the trend in sales on the RV side, if you -- I'm sure they're running behind last year at the same time, but do you see any trend in -- as you look through August through February, any seasonally adjusted trend up at this point?

It's much too early. December is slow. Manufacturers were not pushing units in the last part of the year, they are allowing dealers for bring inventories down. January started out stronger than we anticipated, where a lot of the manufacturers have been worked fours -- three and four days a week. They went to five days a week in January, so business was better. There are, as Jason said, a lot of RV shows at this time of year, so there's a lot of activity. But the real buying season doesn't start until the end of March, early April, and that's what we're going to have wait and see how the consumers respond. It's -- if the situation stays as it is now, we are fairly optimistic that there was some pent-up demand from last year, and this should show up into this season, particularly with gas prices stable and interest rates stable. So we're personally optimistic about the rest of the year, but we just won't know until we see how the consumer responds.

Thank you.

Okay, there are no questions in queue.

All right. Just give one more opportunity, and if there's none, we will say good-bye. Again, everyone, thank you for listening, and we hope we can report better results in the coming quarters, so thanks again. Have a good new year.

Thanks for your attention during the conference. This concludes your presentation, you may now disconnect. Good day.