LCI Industries (LCII) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2007 Drew Industries Incorporated earnings conference call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS). As a reminder, this call is being recorded for replay purposes.

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

Thank you. Good morning, everyone. Welcome to Drew Industries 2007 third quarter conference call. I'm Ryan McGrath of Lambert, Edwards and Associates, Drew's Investor Relations firm. I have with me today members of Drew's management team including Leigh Abrams, President, CEO and a Director of Drew; David Webster, President and CEO of Kinro and Director of Drew; Jason Lippert, President and CEO of Lippert Components and a Director of Drew; and Fred Zinn, Executive Vice President and CFO with Drew.

We want to take a few minutes and discuss our quarterly 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 securities laws. As a result, I must caution you there are a number factors, many of which are beyond the Company's control, which could cause actual results and events to differ materially than those described in the forward-looking statements. These risk factors are identified in our press release and in our Forms 10-Q and 10-K filed with the SEC.

With that, I would like to turn the call over to Leigh Abrams. Leigh?

Thank you, Ryan. Good morning and welcome to all of you on this call and to all of those listening on the Internet. We are once again very pleased to report a profitable quarter, even though wholesale shipments to dealers in both the RV and the manufactured housing industry continue to be soft. In fact, our third quarter sales were down 4% from last year's third quarter, but less than the industry declines of approximately 6% to 8%.

Despite the third quarter sales decline, our net income increased 60% from last year's third quarter to $11.1 million or $0.50 per diluted share. Net income for the nine months ended September '07 increased 22% to $1.51 compared to $1.25 for the same period last year. This was accomplished in face of a 10% sales decline for the nine months in 2007.

I should point out, though, that for the first nine months of 2007, we've already exceeded our earnings per share for all of 2006, which was $1.42 per diluted share. As we've always said in the past, we really could not have achieved these results if it were not for our newly introduced products, our continued marketshare gains from existing product lines, as well as a series of small acquisitions that we've been very successful in making over the last several years.

Then in addition to these longer-term strategies, our third quarter net income improvement was also significantly enhanced by our cost-cutting programs which are continuing. Over the last 12 months, we have closed 15 factories and are in the process of closing three additional factories, and consolidating production from those factories into several of our other factories. Our salaried workforce has been reduced by more than 100 employees and overhead is being reduced wherever possible by a series of many small cuts which, together, result in substantial cost savings.

Despite these cuts, we're confident that our capacity for producing product in the future along with our management team are more than capable to handle any improvement in either the RV or the manufactured housing industries when those industries begin to strengthen.

With respect to the RV industry, the bulk of our sales still come from the towable segment; in fact, 90% of our RV sales are from the towable segment. And we are really very pleased with the retail sales for towable RVs, especially travel trailers, which have improved year-over-year for each of the last six months. Despite rising gas prices, though, and the fluctuating stock market and the problems in the real estate and mortgage markets, and you add falling consumer confidence year to date through August '07 -- the last months for which retail data is available -- travel trailer retail sales were up more than 6% but were up an average of about 8% for July and August. So the trend seems to be improving.

However, wholesale shipments for travel trailers for the eight months of 2007 are down 15%. So we're looking at a decrease in wholesale shipments with an increase in retail shipments. However, fifth wheel retail sales through August '07 are down about 5% compared to a wholesale shipment decline of 11%. We have greater product content in fifth wheel RVs but there are many more travel trailers sold than there are fifth wheels. The industry apparently has prepared the way for increased 2008 wholesale shipments during the prime selling season, which begins in March and generally ends in August. Because according to industry analysts, for each of the last 12 consecutive months through August of '07, retail sales of travel trailers and fifth wheel RVs have outpace wholesale shipments, which indicates that dealer inventories of travel trailers and fifth wheels are shrinking.

Travel trailers models, which are lower priced than fifth wheel RVs and lower priced than motorhomes, continue to sell very well at retail, as I pointed out. It appears to me it's as if it's -- almost if owning a travel trailer has become a necessity, just as a car is. The RV lifestyle appears to be a way of life that many people just will not do without. At least I hope that this is the explanation of what is happening with respect to the current upward trend in the travel trailer retail market.

With regard to manufactured housing, there really aren't many positive trends except that the year-over-year shipment decline for July and August combined were about an 8% decline, rather than the 27% plus decline that occurred during the industry in the first six months of 2007. However, I should point out 2006 included some hurricane-related business, so the 27% decline was probably somewhat less. Industry experts are hoping that the problems affecting the site-built real estate market, particularly the subprime market, may eventually benefit the manufactured housing industry.

During the last several years, as you know, many traditional buyers of manufactured homes were instead able to buy a site-built home, rather than a manufactured home because mortgage financing, including subprime mortgages, were available to the site-built buyer at exceptionally favorable terms.

I can give you an example. It was generally less costly on a cash flow basis for a homebuyer to purchase a $200,000 site-built house, which required no down payment and had a very low teaser mortgage rate, than it was for this buyer to purchase a manufactured home that cost $80,000 and required an $8,000 down payment and a mortgage ranging from 8% to 10%. This type of financing, though, is no longer available for the traditional buyer. And we once again look for that buyer to return to the manufactured housing industry for their new homes.

We still strongly believe that today's manufactured home cannot be matched for quality and affordability by any other type of housing available in the United States. We've been saying regularly for the last several years we hope the manufactured housing industry follows through on its plan to commence an effective generic advertising campaign that should both expand the industry's current market base and also help to convince selling officials to allow manufactured homes to be cited in the communities.

In fact, to assist the industry in this end, Drew is sponsoring a three minute segment on American Airlines radio to promote manufactured housing. And that segment is being presented by the Manufactured Housing Institute. The segment will be available on all American Airline flights starting in January '08 and is available to the public on Drew's website.

In addition, as the baby boomers reach retirement age in greater numbers during the next several years, we expect these buyers to help drive the manufactured housing industry's recovery. Even today, many of these retirees are selling their primary residence and using part of the proceeds to purchase a manufactured home in a warmer climate and then use the balance of the proceeds for retirement purposes. Unfortunately, with the current slowdown in the real estate market, it has become more difficult for retirees to sell their site-built home and buy a manufactured home.

This is born out, unfortunately, by the 40 plus percent decline in sale of manufactured homes in Florida, California and Arizona during the first eight months of 2007 compared to last year. However, the trend seems to be improving slightly over the last several months. And in the past, these three states are traditionally favored by retirees and usually represents some of the strongest markets for manufactured homes. So we'll really know when the industry is turning when we can see some improvement in those three states.

Despite all of these negatives affecting the manufactured housing industry, we've continued to be profitable in this segment in each quarter throughout the nine-year industry downturn. As for the fourth quarter of 2007 and for 2008, we will continue to examine every factory and every cost to achieve additional savings. We are confident that these cost-cutting measures will continue to help our operating results while industry sales are soft and will significantly benefit us once the RV and manufactured housing industries improve.

And then finally -- as I say as often as possible and certainly on every one of these calls -- Drew's success is attributable directly to our extraordinary operating management team headed by David Webster and Jason Lippert. David and Jason are responsible for the continued marketshare gains, for our new product introductions, and our successful acquisitions. And it is no secret that good management is the key to a successful business. But the real test of a management team is in difficult times and the industries have certainly had those recently.

But despite the decline in both of the industries we serve, Kinro and Lippert have gained marketshare, they've introduced new products, have made great acquisitions, and most importantly, have simultaneously kept cost low and quality and customer service high.

And with that, I'll now ask Fred Zinn, our Executive Vice President and CEO, to review our financial results in somewhat more detail.

Thank you, Leigh. As Leigh said, we are extremely pleased to be reporting a 60% increase in net income this quarter compared to the third quarter of last year, despite a 4% decline in sales resulting from the continued softness in both the RV and manufactured housing industries. We were able to achieve this profit growth largely because of a 340 basis point increase in our operating margin compared to the third quarter of 2006, as we continue to benefit from the production efficiencies, plant consolidations and overhead reductions that we've discussed last quarter. This quarter, staff reductions and plant closures alone saved us nearly $2 million compared to last year. And the other production efficiencies that have been implemented were also very significant. Additional plant consolidations and cost reductions, as Leigh said, are being planned for the coming quarters.

Results this quarter were also aided by our strong cash flow, which enabled us to reduce interest expense by nearly $1 million compared to the third quarter of 2006. We expect our cash flow to continue to be strong. And I'll talk a little bit more about that in a minute.

Compared to the second quarter of 2007, our consolidated operating profit margin declined to 10.5% of sales from the 11.4% of sales we reported last quarter. That was largely due to the decline in sales from the second quarter as well as a temporary increase in material costs for certain items in inventory at the end of the second quarter, which impacted our cost of goods sold in the third quarter. You may recall we mentioned that in the last conference call.

We continued to gain overall marketshare in our RV segment, and our content per industrywide RV increased to about $1,295 for the 12 months ended September, 2007 compared to the $1,273 we reported last quarter. The current content per RV is 9% higher than we reported a year ago.

In the manufactured housing segment, industry production statistics for September haven't been released yet, but we estimate that our content per home is about $1,805 to $1,820 for the trailing 12 months. That's down slightly from the $1,853 content per home we reported last quarter. That decline is partly due to a reduction in the average size of the homes produced by the manufactured housing industry. That means that less of our product is included in the average home.

On a per floor basis, our content per manufactured home is down only about 1%. As I mentioned, strong cash flow aided by significant inventory reductions and lower capital expenditures continues to improve our bottom line through reduced interest expense. Proceeds on asset sales and stock option exercises also improved cash flow by about $14 million so far this year.

We expect our cash flow to continue to be strong. Part of that will come from our operating results and part will come from continued improvements in asset management. While inventories are down $20 million since last September, management continues to explore ways to reduce our investment inventory even more.

As in prior quarters, finished goods inventories represented less than a two week supply. Further, we are in the process of selling facilities with combined book values of $9 million and estimated market values aggregating more than $10 million, which will provide additional cash flow.

At the end of the third quarter, our debt, net of nearly $41 million of invested cash, was down to just $2 million. We reduced our net debt by about $10 million in Q3 alone, and that's despite spending $11 million on the acquisition of Extreme Engineering.

While our cash balances fluctuate each day, over the last couple of weeks we've generally been in a net cash position. That is, our cash balances have exceeded our total debt. As I mentioned last quarter, stock-based compensation is currently running about $600,000 per quarter. Drew typically grants stock options to employees every other year and we expect to grant employee options at our Board of Directors meeting later this month. As always, the option exercise price will be based upon the closing price of the stock on the day before the Board meeting. Depending on the number of options granted, the stock price on the date of the grant, and the other factors that impact the Black-Scholes valuation of stock options, I expect that our stock-based compensation expense will increase by about $400,000 for quarter in 2008.

Our income tax expense this quarter represented 37.5% of pretax income. That's down from last quarter due to some adjustments we determined when we filed our 2006 state tax returns over the past couple of months. On the other hand, our effective tax rate for the fourth quarter this year is expected to increase to about 38.7%. And that's partly due to the changes in the allocation of our income among the various states in which we do business.

As we've mentioned previously, we're 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.

With that, I'll turn it back to Leigh.

Thank you, Fred. [Michella], if we could take some questions now, please.

(OPERATOR INSTRUCTIONS). Scott Stember, Sidoti.

Could you talk about some of the new products? Where they're running at on our annualized basis versus last year? And is anything new that's popped up into the mix that's worth talking about?

I'm going to ask Fred to give you some overall totals and then I'll ask Jason to talk about it then, David.

Yes, Scott. This last quarter for that list of products which -- I'm not sure which version you're looking at, but we've added a couple in the last couple of quarters, including the ramp doors -- but for the total, we ran at about $120 million annual pace this last quarter, whereas last year I believe we were at about $105 million. So up about 12%, 13%.

And you're also facing the fact that the industry is down.

That's exactly right.

Jason, you want to add anything about your new products?

I think ramp doors for the towable toy haulers and motorhome toy haulers is still a big target for us right now. But we're still working on specialty axles for specialty trailers like cargo trailers and horse trailers, equestrian trailers and things like that. But those are two of our bigger areas, I'd say.

David, you want to add anything? Hello, David? We may have lost David. But Kinro is also working on additional products. And that's a focus of the Company is to continue working on --

Leigh?

Yes, David.

I had it on mute.

Oh, I'm sorry. Okay.

We're doing the large parts on fronts and backs and rears of travel trailers, you know, still working on that. And I look for it to be a big part of our -- this next year.

All right, thank you. Scott?

What about axles for trailers and the slide-out mechanisms for the motorized market? Any additional traction there?

Jason?

Yes, I mean, we're still -- I mean the push for axles on towable RVs is always there. And we have a pretty substantial part of the market after just entering it a few years ago. As far as the motorhome products, the slide-outs and leveling systems, we're making great traction there. I'd say we're increasing on that product 15% to 20% a year and are approaching about 50% of that market at this point. So we're making good traction on the motorhome side of things with slide-outs and leveling systems.

And of course there on the motorhome side we're facing reductions in the industry production.

Okay, and Fred, can you maybe talk about any issues with costs of goods sold going into the fourth quarter with regards to working through inventory?

Yes, I think our inventories were in pretty good shape at the end of the third quarter. We do deal with a lot of different raw materials; some were up, some were down. Of course, those that are more dependent on energy costs, on oil prices, we'll see some rises in. But I think generally we're in pretty good shape.

Okay. That's all I have for now.

All right, we'll take the next caller, please.

David Wells, Avondale Partners.

Two quick questions for you. First off, just wondering if you can give some additional color on the temporarily high cost of items in inventory? Do you expect that going forward or do you expect that cost pressure to ease?

Well, David, we mentioned that last quarter. At the end of the second quarter, we had a spike up in some of our raw material costs and that flowthrough cost of sales this quarter. As I mentioned, it looks that we're in better shape. The raw materials are still volatile. We'd don't see 1% and 2% changes; we see 3% and 5% changes. But generally I would say we're in pretty good shape. I don't see a bubble coming through cost of sales in the fourth quarter.

All right, great, thank you. And then finally, just wondering if you could give a little color on where capacity utilization stands currently?

Again, we don't really focus on that because -- I say the same thing every call -- when hurricane situation came about, both of our companies were able to go to two and three shifts a day, six and seven days a week. So if we had to, we could always increase our current eight hour shift to a 10 or a 12-hour shift. We could always go to the six-day shift and if need be, we could always go to a second shift. So, capacity is just not an issue.

All right, great. Thank you.

Send my best, by the way, to Kathryn. Kathryn is on maternity leave.

Will do. Thank you.

John Diffendal, BB&T Capital Markets.

A couple of things. Just -- you've given in the past sort of a cost-cutting run rate. Can you update us on what that number is on a sort of annual basis?

Yes, Fred will do that.

Yes. This quarter we had $2 million, I think I may have mentioned, I mean cost savings. And that's just the cost-cutting. That doesn't include the other efficiencies. For the year, we're looking at about $6 million, but $2 million, our run rate is obviously more than $6 million.

Okay. So it's almost like $8 million going forward?

Yes, you would think so. Although the winter months and -- the fall and winter months, we're not going to see the same [on the same front].

You mentioned 100 salaried people. Looking back 12 months, what would be the total workforce reduction? On a base --

Well, if you give me one second, I can actually -- but I think our --

Seasonally, you always reduce employees, hourly employees, at this point in any way. We generally don't include those in these kind of cuts. These are --

But if you look back, our total production workforce compared to the September 30 of last year -- and it's just that one point in time -- it's down 500 -- or a little bit more, just about 500 from 3,750 last year to 3,274 this year; so down 478. And in terms of other staff, engineering, transportation, administration and such, it's down [161 overall]. In terms of the productivity, our sales per average employee is up 13% from the third quarter of 2006.

That's good. Okay. And give us a little help -- we're getting ready to go into the weaker quarters here obviously seasonally. I mean you've come through the last two quarters in the RV side with, I would probably guess your number one and number two margins, [14.8] and [13.8]. How do you -- I mean given -- trying to weigh the sort of -- what's sort of fall off we might expect as things tend to slow down in the next couple of quarters. Anything you can give us to help us there?

Yes, I can give you a little bit of information. I think we've talked about it before on these calls that as a sanity check, I look at a 20% incremental margin. If our sales are up or down $10 million, I would expect 20% of that approximately to fall to the operating profit line. It does vary widely by product line, but on average, that's about where we are.

So it really depends on how well the industry does over these next couple of months. We reported in the press release that our sales in October were just about the same as last year; just up a little bit from last year. We'll have to wait and see what happens in November and December, but again, it's depending on what happens with our sales, I would expect operating profit to fall or increase by 20%.

I think the fact that inventories at dealers are certainly better than they were last year. I can't say that they were as low as they should be, but they're certainly better than last year. You then take into effect that wholesale shipments, which have been down like 15% throughout the year, are starting to do better. Now, towables are only down in wholesale shipments 1.4% in September and fifth wheels were flat. So, you could start to look at some positive shipment numbers as inventories stay in good shape and if retail sales continue, it will be very interesting to see what September retail is.

We were very concerned about July and August retail. And sure enough, both months were up very strong in retail -- in travel trailers, that is. We'll wait and see what happens in September now. But if September retail continues strong then our optimism may grow a little bit.

Yeah, optimism --

I don't know. David and Jason, do you want to add to that at all?

No, not on this side.

Fred, you mentioned the inventory overhang or the increased inventory going into this quarter cost. Any way to get a number on that? What it might have cost you in the quarter?

I don't have an exact number because every day our raw material prices change. But I would say on the order of $0.5 million to $1 million.

Okay. Anything else in terms of -- any swings that are particularly notable? You mentioned that you had some gains on property sales that offset each other. Anything else that jumped out?

No, not really. I mean I have a list of 47 things that go up and down -- Workers' Compensation was good this quarter; warranty was up a little bit. But taking all of us together there was no huge item and nothing else really I would mention.

And just one last thing from me. You mentioned the tax rate in Q4. What's your guess at this point on tax rate for next year?

I'd probably peg it at around the same. I think I said 38.7 for the fourth quarter; I'd probably guess around the same for -- or maybe slightly less for 2008.

Steve Zammit, Prides Capital.

Congrats on the strong margin performance in the difficult operating environment.

Two questions. First, just from a CapEx perspective, I noticed it's about $10 million to $12 million for this year. I was wondering, looking ahead to 2008, is that in the ballpark of what one should expect? Or do you think there may be other CapEx opportunities?

I would think that's pretty much where it will be unless business really improves and some steps we've been holding off [on]. But if we get an improvement in the industries next year, we may increase CapEx a little bit. But that's pretty much where it should be.

Okay, great. And my second question is just given the performance you've had, even in this tough environment and the cash flow you're generating, I was wondering if you had any additional thoughts in terms of ways to deploy that cash. Whether there are acquisition opportunities out there or whether there are alternatives dividends or stock buybacks that you guys would be looking at?

Our number one, two, and three choices to use cash is acquisitions. And we'll explore that. And it's only if we've reached the point we say there's just no more out there, which I don't believe to be the truth, then we'd consider alternatives. But for the foreseeable future, acquisitions will be our use of cash.

Anything particularly exciting or eminent?

Just a merger with IBM, that's all.

All right. Thanks, guys.

Nothing that we can talk about, obviously.

(OPERATOR INSTRUCTIONS). Gentlemen, there are no questions in this queue at this time.

Well, once again, we thank you all for listening in and you're always welcome to call either Fred and myself. And we will look forward to talking with you in February with our year-end results. Have a good day, everyone.

Thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. And have a good day.