Patrick Industries, Inc. — Q2 2012 Form 10-Q
Reporting period: Quarter ended July 1, 2012; comparisons are with the quarter and six months ended June 26, 2011. Financial amounts below are in U.S. dollars; “million” is abbreviated as “m.”
Business context and reporting period
Patrick manufactures and distributes products primarily for the recreational vehicle (RV), manufactured housing (MH), and industrial markets. For the first six months of 2012, RV, MH, and industrial markets represented approximately 69%, 19%, and 12% of sales, respectively. The filing attributes growth to improving markets, increased market penetration, acquisitions, and higher commodity prices passed through to customers.
Financial performance and liquidity
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net sales | $115.6m | $82.6m | $218.3m | $152.1m |
| Gross profit | $17.8m | $12.0m | $34.3m | $19.9m |
| Gross margin | 15.4% | 14.6% | 15.7% | 13.1% |
| Operating income | $7.6m | $4.5m | $15.1m | $5.3m |
| Net income | $13.3m | $3.7m | $18.3m | $2.5m |
| Diluted EPS | $1.22 | $0.36 | $1.70 | $0.24 |
- Sales increased 39.9% in Q2 and 43.5% in the first half. Q2 growth included approximately $16.2m from acquisitions and $16.8m from other factors, principally RV market penetration and shipments.
- Gross margin improved as higher volume leveraged fixed costs, acquisitions contributed, and operational actions improved labor efficiency, yields, and product profitability. Operating income also benefited from lower warehouse and delivery costs as a percentage of sales.
- Reported net income includes a noncash $6.65m income-tax credit from reversal of a deferred-tax valuation allowance. Management said this increased diluted EPS by $0.61 in Q2 and $0.62 for the six months; therefore reported earnings growth is not solely operating growth.
- Six-month operating cash flow was $14.3m, versus cash used of $1.3m in 2011. Working capital movements included increases of $10.2m in receivables and $5.6m in inventory, partly offset by a $13.5m increase in accounts payable and accrued liabilities.
- Six-month investing cash use was $5.9m, including $2.2m of capital expenditures and $3.7m for the Décor acquisition. Financing cash use was $7.6m, mainly reflecting debt repayments. Cash at July 1 was $1.4m.
- At July 1, total debt carrying value was $25.4m, including $1.0m current maturities; long-term debt less current maturities was $24.4m. Debt included $18.7m drawn on a $50m revolving facility, subordinated notes, and an AIA seller note. Revolver borrowings carried rates of 4.75% under the prime-rate option or 2.74% under the LIBOR option.
- The company reported a $43.2m available borrowing base and compliance with its credit covenants. Actual fixed-charge coverage was 5.8 versus a 1.25 minimum; excess availability plus qualified cash was $25.3m versus a $2.0m minimum.
Material changes versus the prior comparable period
- Both Manufacturing and Distribution grew substantially. First-half outside sales were $168.2m in Manufacturing and $50.1m in Distribution, versus $115.9m and $36.2m, respectively, in 2011. Segment operating income rose to $16.8m and $2.7m, respectively, from $7.7m and $0.8m.
- Interest expense fell to $1.6m for the first half from $2.8m, while stock-warrant revaluation changed from a $7,000 credit to a $1.8m expense. The warrant revaluation is noncash and was affected by the company’s share price and warrant exercises.
- Total assets increased to $112.9m from $85.8m at December 31, 2011, principally alongside acquisitions and increased working capital. Shareholders’ equity rose to $50.4m from $28.8m.
- Patrick acquired Décor in March for approximately $4.3m, funded with $3.7m of credit-facility borrowings and $0.6m of stock. After quarter-end, on July 23, the company acquired Gustafson Lighting for approximately $2.8m, funded under the credit facility.
Outlook, management commentary, and risks
- Management anticipated moderate, relatively steady improvement in its markets through the remainder of 2012, while cautioning that visibility was limited. It projected approximately 8% growth in full-year RV wholesale unit shipments and approximately 7% growth in MH shipments.
- Management estimated gross margins for the rest of 2012 would be consistent with full-year 2011 and the first two quarters of 2012, subject to commodity costs, competition, and other factors. It expected a zero effective tax rate for full-year 2012 and normalized tax rates beginning in 2013.
- Planned 2012 capital expenditures were approximately $6.7m, including ERP-system replacement, manufacturing equipment, and capacity-related investment. This exceeds the stated $4.0m 2012 capital-expenditure covenant limit; management said it expected to amend the credit agreement to accommodate the plan.
- Management cited economic uncertainty, tight consumer credit, fuel prices, residential-housing conditions, seasonality, and changing RV dealer-show schedules as risks. A large MH customer’s vertical integration and distribution changes were already reducing sales in some product lines.
- The company’s revolving debt bears variable interest. A covenant breach could permit acceleration or require refinancing on unfavorable terms. Management said cash, operating cash flow, and borrowing availability were expected to cover foreseeable needs for at least 12 months, excluding acquisitions.
- Tontine Capital and affiliates beneficially owned 44.4% of common stock, creating significant shareholder influence and potential divergence from other shareholders’ interests. Disclosure controls were reported effective; the ERP replacement is expected to change systems and internal processes in phases.
Most important facts for investors to verify
- How much of earnings improvement reflects recurring operating performance versus the $6.65m noncash tax benefit and noncash warrant revaluation?
- Whether the credit agreement was amended to permit the planned $6.7m of 2012 capital expenditures, given the stated $4.0m covenant limit.
- Whether working-capital growth, particularly receivables and inventory, remains manageable as sales expand and how much operating cash flow depends on supplier-payment timing.
- The realized contribution, integration costs, and funding impact of Décor and post-quarter Gustafson, and the extent to which acquisition-led growth is sustainable.
- Compliance with borrowing-base and covenant requirements, remaining liquidity after the Gustafson acquisition, and exposure to variable interest rates and debt maturities.
- Potential effects of Tontine’s concentrated ownership and the identified MH customer’s vertical integration on governance, sales, and market access.