CAVCO INDUSTRIES, INC. 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements Statements in this Report on Form 10-Q include "forward-looking statements," within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the Private Securities Litigation Reform Act of 1995. Forward-looking statements are often characterized by the use of words such as "believes," "estimates," "expects," "projects," "may," "will," "intends," "plans," or "anticipates," or by discussions of strategy, plans or intentions. Forward-looking statements are typically included, for example, in discussions regarding the manufactured housing and site-built housing industries; our financial performance and operating results; our liquidity and financial resources; the expected effect of certain risks and uncertainties on our business, financial condition and results of operations; economic conditions and consumer confidence; potential acquisitions, strategic investments and other expansions; operational and legal risks; how the Company may be affected by the novel coronavirus COVID-19 pandemic ("COVID-19") or any other pandemic or outbreak; labor shortages and the pricing and availability of raw materials; governmental regulations and legal proceedings; the availability of favorable consumer and wholesale manufactured home financing; market interest rates and Company investments and the ultimate outcome of our commitments and contingencies. Forward-looking statements contained in this Report on Form 10-Q ("Report") speak only as of the date of this report or, in the case of any document incorporated by reference, the date of that document. We do not intend to publicly update or revise any forward-looking statement contained in this Report or in any document incorporated herein by reference to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time, except as required by law. Forward-looking statements involve risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those expressed or implied by such forward-looking statements, many of which are beyond our control. To the extent that our assumptions and expectations differ from actual results, our ability to meet such forward-looking statements, including the ability to generate positive cash flow from operations, may be significantly hindered. Factors that could affect our results and cause them to materially differ from those contained in the forward-looking statements include, without limitation, those discussed in Risk Factors in Part I, Item 1A of our 2021 Annual Report on Form 10-K filed with the Securities and Exchange Commission ("Form 10-K"). Introduction The following should be read in conjunction with Cavco Industries, Inc. and its subsidiaries' (collectively, "we," "us," "our," the "Company" or "Cavco") Consolidated Financial Statements and the related Notes that appear in Item 1 of this Report. References to "Note" or "Notes" pertain to the Notes to our Consolidated Financial Statements. Company Overview Headquartered in Phoenix, Arizona, we design and produce factory-built housing products primarily distributed through a network of independent and Company-owned retailers, planned community operators and residential developers. We are one of the largest producers of manufactured homes in the United States, based on reported wholesale shipments. Our products are marketed under a variety of brand names including Cavco, Fleetwood, Palm Harbor, Nationwide, Fairmont, Friendship, Chariot Eagle, Destiny, Commodore, Colony, Pennwest, R-Anell, Manorwood and MidCountry. We are also one of the leading producers of park model RVs, vacation cabins and factory-built commercial structures. Our finance subsidiary, CountryPlace Acceptance Corp. ("CountryPlace"), is an approved Federal National Mortgage Association and Federal Home Loan Mortgage Corporation ("Freddie Mac") seller/servicer and a Government National Mortgage Association ("Ginnie Mae") mortgage-backed securities issuer that offers conforming mortgages, non-conforming mortgages and home-only loans to purchasers of factory-built homes. Our insurance subsidiary, Standard Casualty Company ("Standard Casualty"), provides property and casualty insurance to owners of manufactured homes. 24 Table of Contents We operate 26 homebuilding production lines located in Millersburg and Woodburn, Oregon; Riverside, California; Nampa, Idaho; Phoenix and Goodyear, Arizona; Austin, Fort Worth, Seguin and Waco, Texas; Montevideo, Minnesota; Dorchester, Wisconsin; Nappanee and Goshen, Indiana; Lafayette, Tennessee; Douglas and Moultrie, Georgia; Shippenville and Emlenton, Pennsylvania; Martinsville and Rocky Mount, Virginia; Cherryville, North Carolina; and Ocala and Plant City, Florida. The majority of the homes produced are sold to, and distributed by, independently owned and controlled retail operations located throughout the United States and Canada. In addition, our homes are sold through 45 Company-owned U.S. retail locations. Included in the above figures are two recent acquisitions. On July 4, 2021, we purchased an additional 20% ownership in Craftsman Homes, LLC and Craftsman Homes Development, LLC (collectively known as “Craftsman") in addition to our existing 50% ownership, making us controlling owner. Craftsman is a manufactured home retailer with four locations in Nevada selling Company and other manufacturer branded homes. They also provide general construction to setup the customer's property and assist with multi-home developments and multi-family dwellings. The transaction was accounted for as a business combination achieved in stages and the results of operations have been included in the accompanying Consolidated Financial Statements since the date of the acquisition of the additional 20% interest, with a reduction for the earnings attributable to the noncontrolling shareholder. On September 24, 2021, we purchased certain manufactured housing assets and assumed certain liabilities of The Commodore Corporation ("Commodore"), including its six manufacturing facilities and two wholly-owned retail locations. In addition to manufacturing, Commodore also participates in commercial lending operations with its dealers. The transaction was accounted for as a business combination and the results of operations have been included in the accompanying Consolidated Financial Statements since the date of acquisition. Company and Industry Outlook According to data reported by the Manufactured Housing Institute, industry home shipments increased 12.0% in calendar year 2021 compared to the prior year, which was impacted by shutdowns related to COVID-19. We did not experience any significant factory shutdowns in the prior year period, in contrast to certain other industry participants. The industry offers solutions to the affordable housing crisis and these industry shipment numbers do not represent demand; instead, they represent the industry's ability to produce in the current environment. The average price per square foot for a manufactured home is lower than a site-built home. Also, based on the relatively low cost associated with manufactured home ownership, our products have traditionally competed with rental housing's monthly payment affordability. The two largest manufactured housing consumer demographics, young adults and those who are age 55 and older, are both growing. " First-time" and "move-up" buyers of affordable homes are historically among the largest segments of new manufactured home purchasers. Included in this group are lower-income households that are particularly affected by periods of low employment rates and underemployment. Consumer confidence is especially important among manufactured home buyers interested in our products for seasonal or retirement living. We seek out niche market opportunities where our diverse product lines and custom building capabilities provide a competitive advantage. Our green building initiatives involve the creation of an energy efficient envelope and higher utilization of renewable materials. These homes provide environmentally-friendly maintenance requirements, typically lower utility costs and sustainability. We maintain a conservative cost structure in an effort to build added value into our homes and we work diligently to maintain a solid financial position. Our balance sheet strength, including the position in cash and cash equivalents, helps avoid liquidity problems and enables us to act effectively as market opportunities or challenges present themselves. 25 Table of Contents We continue to make certain commercial loan programs available to members of our wholesale distribution chain. Under direct commercial loan arrangements, we provide funds for financed home purchases by distributors, community owners and developers (see Note 7 to the Consolidated Financial Statements). Our involvement in commercial loans helps to increase the availability of manufactured home financing to distributors, community owners and developers and provides additional opportunity for product exposure to potential home buyers. While these initiatives support our ongoing efforts to expand product distribution, they expose us to risks associated with the creditworthiness of this customer base and our inventory financing partners. The lack of an efficient secondary market for manufactured home-only loans and the limited number of institutions providing such loans results in higher borrowing costs for home-only loans and continues to constrain industry growth. We work directly with other industry participants to develop secondary market opportunities for manufactured home-only loan portfolios and expand lending availability in the industry. Additionally, we continue to invest in community-based lending initiatives that provide home-only financing to new residents of certain manufactured home communities. We also develop and invest in home-only lending programs to grow sales of homes through traditional distribution points. We believe that growing our investment and participation in home-only lending may provide additional sales growth opportunities for our financial services segment, as well as provide a means that could lead to increased home sales for our factory-built housing operations. While home production continues to experience hiring challenges, unpredictable factory employee absenteeism and building material supply disruptions, our factory utilization for the third fiscal quarter of 2022 was back to pre-pandemic levels of approximately 80%, up from a rate of 75% the past four quarters. This is the result of an increase in production headcount and less production hours per module. Housing demand remains strong, as qualified individuals continue pursuing affordable home-ownership. Home order rates have moderated from the extreme highs we saw the past few quarters, but still remain above pre-COVID rates, which we considered to be strong. Our backlogs at January 1, 2022 were $1.1 billion, consistent with second fiscal quarter of 2022 and up $633 million, or 134.1%, compared to $472 million at December 26, 2020. The year over year increase includes $277 million attributable to Commodore. Backlogs exclude home orders that have been paused or canceled at the request of the customer. Key housing building materials include wood and wood products, gypsum wallboard, steel, windows, appliances, insulation and other petroleum-based produ cts. Pricing and availability of certain raw materials have recently been volatile due to a number of factors in th e current environment. We continue to monitor and react to inflation in these materials by maintaining a focus on our product pricing in response to higher materials costs, but such increases may lag behind the escalation of such costs. Availability of these products has not caused a production halt in the current period, but we have experienced periodic shutdowns in other periods and shortages of primary building materials have caused production inefficiencies as we have needed to change processes in response to the delay in materials. While it is difficult to predict the future of housing demand, employee availability, supply chain and Company performance and operations, maintaining an appropriately sized and well-trained workforce is key to increasing production to meet increased demand, and we face challenges in overcoming labor-related difficulties in the current environment to increase home production. We continually review the wage rates of our production employees, and have established other monetary incentive and benefit programs, with a goal of providing competitive compensation. We also provide leadership training to new managers and other employees in supervisory roles to enhance communication and improve the oversight and motivation of other employees, more extensively use online recruiting tools, update our recruitment brochures and improve the appearance and appeal of our manufacturing facilities to improve the recruitment and retention of qualified production employees and reduce annualized turnover rates. Regardless, we believe our ability to recruit the workforce we need to meet the overall need for affordable housing continues to improve. 26 Table of Contents In the financial services segment, we continue to assist customers in need by servicing existing loans and insurance policies and complying with state and federal regulations regarding loan forbearance, home foreclosures and policy cancellations. Certain loans serviced for investors expose us to cash flow deficits if customers do not make contractual monthly payments of principal and interest in a timely manner. For certain loans serviced for Ginnie Mae and Freddie Mac, and home-only loans serviced for certain other investors, we must remit scheduled monthly principal and/or interest payments and principal curtailments regardless of whether monthly mortgage payments are collected from borrowers. Ginnie Mae permits cash obligations on loans in forbearance from COVID-19 to be offset by other incoming cash flows from loans such as loan pre-payments. Although monthly collections of principal and interest from borrowers have exceeded scheduled principal and interest payments owed to investors, mandatory extended forbearance under the Coronavirus Aid, Relief and Economic Security Act and certain other regulations related to COVID-19 could negatively impact cash obligations in the future. Results of Operations Net Revenue Three Months Ended ($ in thousands, except revenue per home sold) January 1, 2022 December 26, 2020 Change Factory-built housing $ 413,590 $ 270,822 $ 142,768 52.7 % Financial services 18,124 17,950 174 1.0 % $ 431,714 $ 288,772 $ 142,942 49.5 % Factory-built homes sold by Company-owned retail sales centers 658 768 (110) (14.3) % to independent retailers, builders, communities and developers 3,766 2,835 931 32.8 % 4,424 3,603 821 22.8 % Net factory-built housing revenue per home sold $ 93,488 $ 75,166 $ 18,322 24.4 % Nine Months Ended ($ in thousands, except revenue per home sold) January 1, 2022 December 26, 2020 Change Factory-built housing $ 1,067,967 $ 749,879 $ 318,088 42.4 % Financial services 53,712 51,670 2,042 4.0 % $ 1,121,679 $ 801,549 $ 320,130 39.9 % Factory-built homes sold by Company-owned retail sales centers 2,091 2,283 (192) (8.4) % to independent retailers, builders, communities and developers 9,630 8,096 1,534 18.9 % 11,721 10,379 1,342 12.9 % Net factory-built housing revenue per home sold $ 91,116 $ 72,250 $ 18,866 26.1 % In the factory-built housing segment, the increase in Net revenues was primarily due to an increase in the average sales price and the number of units sold. The higher home prices were driven by product price increases and a shift toward more multi-module homes. Home sales volume increased from the addition of Commodore and higher factory capacity utilization, partially offset by lower retail sales. 27 Table of Contents Net factory-built housing revenue per home sold is a volatile metric dependent upon several factors. A primary factor is the price disparity between sales of homes to independent distributors, builders, communities and developers and sales of homes to consumers by Company-owned retail stores. Wholesale sales prices are primarily comprised of the home and the cost to ship the home from a homebuilding facility to the home-site. Retail home prices include these items and retail markup, as well as items that are largely subject to home buyer discretion, including, but not limited to, installation, utility connections, site improvements, landscaping and additional services. Our h omes are constructed in one or more floor sections ("modules") which are then installed on the customer's site. Changes in the number of modules per home, the selection of different home types/models and optional home upgrades create changes in product mix, also causing fluctuations in this metric. The table below presents the mix of modules and homes sold for the three and nine months ended January 1, 2022 and December 26, 2020: Three Months Ended January 1, 2022 December 26, 2020 Change Modules Homes Modules Homes Modules Homes U.S. Housing and Urban Development ("HUD") code homes 6,166 3,583 5,427 3,186 13.6 % 12.5 % Modular homes 1,270 632 533 255 138.3 % 147.8 % Park model RVs 209 209 162 162 29.0 % 29.0 % 7,645 4,424 6,122 3,603 24.9 % 22.8 % Nine Months Ended January 1, 2022 December 26, 2020 Change Modules Homes Modules Homes Modules Homes HUD code homes 17,366 10,013 15,338 9,030 13.2 % 10.9 % Modular homes 2,257 1,112 1,483 693 52.2 % 60.5 % Park model RVs 596 596 656 656 (9.1) % (9.1) % 20,219 11,721 17,477 10,379 15.7 % 12.9 % Financial services segment revenue increased primarily due to higher volume in home loan sales and more insurance policies in force in the current year compared to the prior year, partially offset by lower interest income earned on the acquired consumer loan portfolios that continue to amortize and lower unrealized gains on marketable equity securities in the insurance subsidiary's portfolio. For the three and nine months ended January 1, 2022, we recognized unrealized gains on marketable equity securities of $0.5 million and $0.4 million, respectively. For the three and nine months ended December 26, 2020, we recognized unrealized gains of $1.0 million and $2.7 million, respectively. 28 Table of Contents Gross Profit Three Months Ended ($ in thousands) January 1, 2022 December 26, 2020 Change Factory-built housing $ 104,119 $ 47,031 $ 57,088 121.4 % Financial services 11,089 12,207 (1,118) (9.2) % $ 115,208 $ 59,238 $ 55,970 94.5 % Gross profit as % of Net revenue Consolidated 26.7 % 20.5 % N/A 6.2 % Factory-built housing 25.2 % 17.4 % N/A 7.8 % Financial services 61.2 % 68.0 % N/A (6.8) % Nine Months Ended ($ in thousands) January 1, 2022 December 26, 2020 Change Factory-built housing $ 252,691 $ 140,178 $ 112,513 80.3 % Financial services 26,458 27,924 (1,466) (5.2) % $ 279,149 $ 168,102 $ 111,047 66.1 % Gross profit as % of Net revenue Consolidated 24.9 % 21.0 % N/A 3.9 % Factory-built housing 23.7 % 18.7 % N/A 5.0 % Financial services 49.3 % 54.0 % N/A (4.7) % Factory-built housing gross profit increased for the three and nine months ended January 1, 2022 primarily due to higher average sales prices and increased home sales volume, partially offset by higher material costs per unit and purchase accounting related items at Commodore. We continue to monitor and react to inflation in building material prices by maintaining a focus on our product pricing; however, product price increases may lag behind the escalation of building material costs. While lower lumber product market price benefits are being realized in cost of sales for the three and nine months ended January 1, 2022, we have seen most other product prices increase, offsetting those lumber declines. In addition to lumber price benefits, Gross profit as a percentage of Net revenue also increased from a shift toward more multi-module homes and from streamlining our HUD code product offering across our network. For the three and nine months ended January 1, 2022, Financial services gross profit decreased primarily due to higher weather related claims and lower unrealized gains on marketable equity securities compared to the prior year period. 29 Table of Contents Selling, General and Administrative Expenses Three Months Ended ($ in thousands) January 1, 2022 December 26, 2020 Change Factory-built housing $ 55,735 $ 30,575 $ 25,160 82.3 % Financial services 4,587 4,839 (252) (5.2) % $ 60,322 $ 35,414 $ 24,908 70.3 % Selling, general and administrative expenses as % of Net revenue 14.0 % 12.3 % N/A 1.7 % Nine Months Ended ($ in thousands) January 1, 2022 December 26, 2020 Change Factory-built housing $ 131,579 $ 92,037 $ 39,542 43.0 % Financial services 14,947 14,153 794 5.6 % $ 146,526 $ 106,190 $ 40,336 38.0 % Selling, general and administrative expenses as % of Net revenue 13.1 % 13.2 % N/A (0.1) % For the three months ended January 1, 2022, Selling, general and administrative expenses related to factory-built housing increased between periods primarily from the addition of Commodore, higher salary and incentive-based compensation expense and expenses incurred in engaging third-party consultants in relation to pursuing the availability of the non-recurring energy efficient home net tax credits. The nine month period also includes $2.4 million in deal costs related to the Commodore acquisition and $1.2 million in expenses related to the SEC inquiry. This was partially offset by a reduction in the amortization of the additional Director and Officer insurance premium, added in the third quarter of fiscal year 2019, which was $4.2 million for the nine months ended December 26, 2020, with no expense in the current year. In Financial services, Selling, general and administrative expenses increased primarily from greater recognition of deferred origination costs on higher loan sales. 30 Table of Contents Other Components of Net Income Three Months Ended ($ in thousands) January 1, 2022 December 26, 2020 Change Interest expense $ 209 $ 177 $ 32 18.1 % Other income, net 4,258 2,243 2,015 89.8 % Income tax (benefit) expense (20,680) 6,189 (26,869) (434.1) % Effective tax rate (35.1) % 23.9 % N/A (59.0) % Nine Months Ended ($ in thousands) January 1, 2022 December 26, 2020 Change Interest expense $ 576 $ 567 $ 9 1.6 % Other income, net 11,387 5,821 5,566 95.6 % Income tax (benefit) expense (910) 15,742 (16,652) (105.8) % Effective tax rate (0.6) % 23.4 % N/A (24.0) % Interest expense consists primarily of debt service on the financings of manufactured home-only loans and interest related to finance leases. Other income, net primarily consists of realized and unrealized gains and losses on corporate investments, interest income related to commercial loan receivable balances (which increased with the addition of Commodore), interest income earned on cash balances and gains and losses from the sale of property, plant and equipment. During the year, we also recognized a non-cash gain of $3.3 million on the remeasurement of the assets and liabilities of Craftsman. See Note 22 to the Consolidated Financial Statements for further information . The effective income tax rate was a benefit for the three and nine months ended January 1, 2022. This is due to $34.4 million of estimated non-recurring net tax credits related to the sale of energy efficient homes between fiscal year 2018 and fiscal third quarter 2022 available under the Internal Revenue Code §45L. This credit was initially established under the Federal Energy Policy Act of 2005 and most recently extended in the Consolidated Appropriations Act, 2021. It allows for eligible manufacturer to claim a tax credit for each qualifying newly constructed and sold residence. Excluding these credits, the effective income tax rate was consistent between periods. Liquidity and Capital Resources We believe that cash and cash equivalents at January 1, 2022, together with cash flow from operations, will be sufficient to fund our operations and provide for growth for the next 12 months and into the foreseeable future. We maintain cash in U.S. Treasury and other money market funds, some of which are in excess of federally insured limits. We expect to continue to evaluate potential acquisitions of, or strategic investments in, businesses that are complementary to the Company, as well as other expansion opportunities. Such transactions may require the use of cash and have other impacts on our liquidity and capital resources. Because of our sufficient cash position, we have not historically sought external sources of liquidity, with the exception of certain credit facilities for the home-only lending programs. Regardless, depending on our operating results and strategic opportunities, we may seek additional or alternative sources of financing in the future. There can be no assurance that such financing would be available on satisfactory terms, if at all. If this financing were not available, it could be necessary for us to reevaluate our long-term operating plans to make more efficient use of our existing capital resources at such time. The exact nature of any changes to our plans that would be considered depends on various factors, such as conditions in the factory-built housing industry and general economic conditions outside of our control. 31 Table of Contents State insurance regulations restrict the amount of dividends that can be paid to stockholders of insurance companies. As a result, the assets owned by our insurance subsidiary are generally not available to satisfy the claims of Cavco or its legal subsidiaries. We believe that stockholders' equity at the insurance subsidiary remains sufficient and do not believe that the ability to pay ordinary dividends to Cavco will be restricted per state regulations. The following is a summary of the Company's cash flows for the nine months ended January 1, 2022 and December 26, 2020, respectively: Nine Months Ended (in thousands) January 1, 2022 December 26, 2020 $ Change Cash, cash equivalents and restricted cash at beginning of the fiscal year $ 339,307 $ 255,607 $ 83,700 Net cash provided by operating activities 125,967 91,566 34,401 Net cash used in investing activities (147,842) (5,098) (142,744) Net cash used in financing activities (34,290) (1,451) (32,839) Cash, cash equivalents and restricted cash at end of the period $ 283,142 $ 340,624 $ (57,482) Net cash provided by operating activities increased primarily from higher net income and proceeds from consumer loan sales, which were $142.4 million this year compared to $122.6 million in the previous year. This increase was partially offset by the refunds related to the estimated net tax credits under the Internal Revenue Code §45L which had not been received as of January 1, 2022, rising costs of our raw materials and higher purchases of such materials and payments on Accounts p ayable and Accrued expenses and other current liabilities. Consumer loan originations decreased $1.2 million to $122.9 million for the nine months ended January 1, 2022 from $124.1 million for the nine months ended December 26, 2020. We enter into commercial loan arrangements with distributors, communities and developers under which we provide funds for financing homes. In addition, we enter into commercial loan arrangements with certain distributors of our products under which we provide funds for wholesale purchases. We have also invested in community-based lending initiatives that provide home-only financing to new residents of certain manufactured home communities. For additional information regarding our commercial loans receivable, see Note 7 to the Consolidated Financial Statements. Further, we invest in and develop home-only loan pools and lending programs to attract third party financier interest in order to grow sales of new homes through traditional distribution points. Cash receipts, net of amounts loaned, increased cash by $8.1 million while the prior period net activity provided an additional $6.4 million in cash. Net cash used in investing activities consists of buying and selling debt and marketable equity securities in our Financial Services segment, p urchases of property, plant and equipment and funding strategic growth acquisitions. Greater cash was used in the current period for the purchase of Craftsman and Commodore. Net cash used in financing activities for the current period was primarily for the repurchase of common stock and the payments of the secured term loans, which have been paid in full as of January 1, 2022. Contractual Commitments and Contingencies. There were no material changes to the contractual obligations as set forth in our Annual Report on Form 10-K. Critical Accounting Policies Except as described in Note 1 t o the Consolidated Financial Statements , there have been no other significant changes to our critical accounting policies during the nine months ended January 1, 2022, as compared to those disclosed in Part II, Item 7 of our Form 10-K, under the heading "Critical Accounting Policies," which provides a discussion of the critical accounting policies that management believes affect its more significant judgments and estimates used in the preparation of the Company's Consolidated Financial Statements. 32 Table of Contents Other Matters Related Party Transactions. See Note 21 to the Consolidated Financial Statements for a discussion of our related party transactions. Off Balance Sheet Arrangements See Note 16 to the Consolidated Financial Statements for a discussion of our off-balance sheet commitments, which discussion is incorporated herein by reference. Item 3. Quantitative and Qualitative Disclosures About Market Risk There have been no material changes from the quantitative and qualitative disclosures about market risk previously disclosed in the Form 10-K.