Business context and reporting period
Patrick Industries, Inc. filed this unaudited Form 10-Q for the quarter ended September 30, 2012. The company manufactures and distributes components and products primarily for recreational vehicles (RV), manufactured housing (MH), and industrial markets. Unless otherwise noted, amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions.
Financial performance and position
| Metric | Third quarter 2012 | Third quarter 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $112.9 million | $77.4 million | $331.2 million | $229.5 million |
| Gross profit | $16.9 million | $13.2 million | $51.2 million | $33.1 million |
| Gross margin | 15.0% | 17.0% | 15.4% | 14.4% |
| Operating income | $7.3 million | $5.2 million | $22.4 million | $10.5 million |
| Net income | $6.6 million | $4.5 million | $24.9 million | $7.0 million |
| Diluted earnings per share | $0.60 | $0.44 | $2.32 | $0.68 |
- Cash flow: Nine-month operating cash flow was $14.6 million, compared with $9.5 million. Investing used $14.5 million, including $9.2 million for acquisitions and $5.3 million of capital expenditures. Financing provided $0.2 million. Cash at September 30 was $0.9 million. Operating cash flow less capital expenditures was approximately $9.3 million.
- Balance sheet and debt: At September 30, total assets were $131.8 million, current assets $76.6 million, total liabilities $74.1 million, and shareholders’ equity $57.7 million. Total debt was $33.1 million, including $26.6 million drawn on the revolving facility; the reported current maturity was $1.0 million. The filing reported $44.3 million of borrowing-base availability and $18.3 million of excess availability plus qualified cash under the then-current facility.
- Margins and earnings quality: Third-quarter gross margin fell two percentage points year over year, which management attributed mainly to commodity-cost fluctuations. Nine-month net income included a noncash $6.7 million tax benefit from reversing a deferred-tax valuation allowance; management said this increased nine-month diluted EPS by $0.62. Nine-month results also included a $1.7 million noncash expense from warrant revaluation.
Material changes versus the prior comparable period
- Sales grew 45.9% in the quarter and 44.3% year to date. Management attributed the increases to acquisitions, stronger RV demand and market penetration, passed-through commodity price increases, and improved industrial-market sales. The 2012 acquisitions contributed approximately $9.4 million of third-quarter and $17.6 million of nine-month revenue.
- Despite higher gross profit dollars, third-quarter gross margin declined from 17.0% to 15.0%; the nine-month margin improved from 14.4% to 15.4%. Operating income increased in both periods.
- Nine-month interest expense declined to $2.5 million from $3.6 million, partly because 2011 included financing-cost and interest-rate-swap write-offs.
- Working capital expanded with higher activity: receivables and inventories increased substantially, while accounts payable and accrued liabilities also rose. The cash flow statement reflects these changes.
- Acquisitions during 2012 included Décor, Gustafson Lighting, and Creative Wood. Gustafson generated an approximately $0.2 million bargain-purchase gain. The company also issued 100,000 shares as partial consideration for Décor.
Outlook, commentary, and risks
- Management expected moderate, relatively steady improvement in its markets through the remainder of 2012 and into the first quarter of 2013, while cautioning that longer-term visibility was limited. It estimated full-year 2012 RV wholesale shipments would rise approximately 12% and MH shipments approximately 6%; it cited an industry forecast of 24% growth in housing starts.
- Management estimated fourth-quarter gross margins would be in a range consistent with full-year 2011 and the first three quarters of 2012, subject to commodity prices and other factors. It expected the remaining deferred-tax valuation allowance to be utilized in fourth-quarter 2012 and normalized income-tax rates to apply beginning in first-quarter 2013.
- On October 24, 2012, after quarter-end, Patrick replaced its $50 million facility with an $80 million secured revolving facility maturing in 2017, with an option to request up to $20 million more subject to lender approval. It used the new facility to repay the prior revolver and remaining subordinated notes, and expected a noncash charge of approximately $0.7 million to write off unamortized debt discounts.
- On October 26, 2012, the company acquired Middlebury Hardwood Products for approximately $20.3 million, funded by borrowings. Following that acquisition, the company reported approximately $58.3 million outstanding under the new revolver. Purchase accounting was incomplete when the 10-Q was issued.
- The company said cash, operating cash flow, and borrowing capacity were expected to cover known and foreseeable liquidity needs for at least 12 months, excluding acquisitions. Risks include variable-rate debt, covenant compliance and refinancing exposure, commodity costs, economic and consumer-credit uncertainty, seasonal demand, and a major MH customer’s vertical integration. Tontine Capital and affiliates held approximately 40.7% of common shares based on filings cited by the company, creating significant shareholder influence and concentration risk.
- The company was in compliance with its 2011 facility covenants at September 30. It warned that failure to comply with the new facility’s covenants could lead to unfavorable refinancing or accelerated debt, and that asset proceeds in a forced liquidation might not repay debt in full.
- Management was implementing an ERP system replacement in phases over an expected 18–24 months beginning in fourth-quarter 2012; the project could change processes and internal controls. Disclosure controls were reported effective, with no other material internal-control changes identified during the quarter.
Important facts for investors to verify
- How much of revenue and profit growth reflects organic volume and market-share gains versus acquisitions and commodity-price pass-throughs.
- Whether gross margins recover from the third-quarter decline and how commodity costs, product mix, and customer pricing affect profitability.
- Cash conversion and working-capital needs, particularly receivables and inventory growth, alongside planned capital spending and acquisition funding.
- Post-quarter debt, borrowing availability, interest costs, and compliance with the new facility’s leverage and interest-coverage covenants after the Middlebury acquisition.
- The final purchase accounting and subsequent operating contribution for Middlebury, as well as integration and returns from the 2012 acquisitions.
- The sustainability of reported earnings excluding the $6.7 million tax valuation-allowance benefit, warrant revaluation, and acquisition-related gains or charges.