Champion Homes, Inc. quarterly report, Q1 FY2019

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Skyline Champion Corporation (Champion Homes) — Q1 FY2019 Form 10-Q

Business context and period. The filing is by Skyline Champion Corporation, formerly Skyline Corporation, for the three months ended June 30, 2018. The company manufactures factory-built housing in the U.S. and Canada and also operates retail and transportation businesses. On June 1, 2018, Champion Holdings contributed its operating subsidiaries to Skyline in exchange for shares. The transaction was accounted for as a reverse acquisition, with Champion Holdings as the accounting acquirer. Accordingly, reported Q1 results include Champion Holdings through June 1 and Skyline only for June 1–30; the year-ago comparison is Champion Holdings alone. Pro forma comparisons combine both businesses and are not forecasts.

Financial performance and position

  • Revenue: Reported net sales were $322.3 million, up 32.0% from $244.1 million. On a pro forma basis, sales were $368.1 million versus $303.6 million, up 21.2%. U.S. manufacturing and retail sales grew 37.8% reported, including $22.1 million from Skyline for the post-transaction month; U.S. homes sold rose 20.0% and average selling price rose 14.7%. Canadian sales increased 22.1%.
  • Profit and margins: Gross profit was $55.2 million versus $36.0 million; gross margin expanded to 17.1% from 14.8%. Operating income was $10.1 million versus $9.2 million, with operating margin of 3.1% versus 3.8%. The company recorded a net loss of $0.9 million, or $0.02 per share, compared with net income of $5.3 million, or $0.11 per share. The loss included $6.4 million of Exchange-related legal, accounting and advisory costs; SG&A also included $8.1 million of equity-based compensation and $1.2 million of integration costs. Adjusted EBITDA, a non-GAAP measure, was $22.7 million versus $10.9 million; pro forma Adjusted EBITDA was $26.9 million versus $13.8 million.
  • Cash flow: Operating activities provided $4.3 million, compared with cash used of $1.9 million. Investing activities provided $7.7 million, including $9.7 million of cash assumed in the transaction; capital expenditures were $2.0 million. Financing activities used $67.5 million, primarily reflecting a $65.3 million pre-Exchange distribution to Champion Holdings members. Cash and cash equivalents ended at $80.9 million, down $32.8 million from March 31; cash, cash equivalents and restricted cash decreased $55.7 million on the cash-flow statement basis.
  • Debt and liquidity: Total debt was $59.3 million, including $46.9 million drawn on a new $100 million revolving facility and $12.4 million of industrial revenue bonds; floor-plan borrowings were a further $29.5 million. The revolver matures June 2023, and the company reported $30.5 million of unused capacity after the letter-of-credit subfacility. Management said cash, operating cash flow, available revolver capacity and capital-market access should meet needs for the next year. The company was in compliance with credit covenants at quarter-end.
  • Balance sheet: Total assets were $649.4 million, including $178.0 million of goodwill and $44.4 million of net amortizable intangibles recognized primarily in the Exchange. Total equity was $379.6 million. These amounts reflect the preliminary purchase-price allocation, which could change materially as valuations are finalized.

Changes, outlook and material matters

  • Management attributed higher sales to added capacity and retail locations, improved plant output, higher prices and product mix, and the Exchange. U.S. HUD market share was 13.9% versus 13.3%; industry HUD shipments increased 9.2%. Unfilled U.S. and Canadian manufacturing orders were $222 million, compared with $101 million a year earlier; orders can be cancelled and are not necessarily indicative of future sales.
  • Management reported that pricing, operational improvements and product rationalization helped offset rising material and labor costs. The filing provides no formal earnings or revenue guidance. Management’s liquidity statement is not a forecast of operating performance.
  • Reported tax expense was $3.4 million, producing a 133.0% effective tax rate, primarily because Exchange-related costs did not qualify for tax benefits. The company had not completed its accounting for the Tax Cuts and Jobs Act.
  • Contingencies include estimated gross repurchase obligations of approximately $178.5 million before considering resale value, $40.6 million of surety bonds, $22.6 million of letters of credit and $1.0 million of retailer loan guarantees. The company reported a $0.7 million reserve for estimated repurchase losses. Management did not expect ordinary-course legal proceedings to have a material adverse effect.
  • Controls: Management concluded disclosure controls were ineffective at June 30 because an unremediated material weakness concerned accuracy and valuation of raw-material inventories. Champion Holdings’ internal controls, representing about 51.5% of consolidated assets, were excluded from this quarter’s controls evaluation. Remediation was ongoing.
  • Other risks: The filing highlights housing demand and seasonality, customer financing availability and interest rates, material and labor cost/availability, retailer relationships and repurchase exposure, acquisition integration, warranty and product claims, foreign exchange, and the company’s controlled-company status. On August 7, the Principal Shareholders completed a public offering; this made performance-vesting restricted shares probable of vesting and accelerated vesting of remaining time-based restricted shares.

Investor verification priorities

  1. Separate the reported quarter’s partial inclusion of Skyline from Champion Holdings’ results; assess the assumptions and limitations in the pro forma comparison.
  2. Track final Exchange purchase accounting, especially goodwill, identifiable intangibles, deferred taxes and future amortization/depreciation.
  3. Evaluate whether reported margin gains and higher Adjusted EBITDA persist after transaction costs, equity compensation, integration costs and other adjustments.
  4. Monitor cash generation, revolver availability, debt and floor-plan financing, and the $65.3 million distribution’s effect on liquidity.
  5. Assess potential losses under repurchase agreements and other guarantees, and whether the $0.7 million repurchase reserve remains adequate.
  6. Verify remediation and independent assessment of the inventory-control material weakness, including controls over the acquired business.