Patrick Industries, Inc. — Q2 2014 Form 10-Q
Reporting period: Second quarter and six months ended June 29, 2014. Financial amounts below are in millions unless stated otherwise.
Business context
Patrick manufactures and distributes components and products serving the recreational vehicle (RV), manufactured housing (MH), and industrial markets. RV accounted for about 75% of sales in the first half; MH and industrial markets each represented about 14% and 11%, respectively. The filing attributes growth to improving end markets, market-share gains, and acquisitions.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $187.9 | $159.6 | $358.0 | $301.7 |
| Gross profit | $31.8 | $25.2 | $59.0 | $47.6 |
| Gross margin | 16.9% | 15.8% | 16.5% | 15.8% |
| Operating income | $15.5 | $12.9 | $27.3 | $23.3 |
| Net income | $9.2 | $7.6 | $16.1 | $13.6 |
| Diluted EPS | $0.86 | $0.70 | $1.50 | $1.25 |
- Sales rose 17.7% in Q2 and 18.7% year to date. Management estimated organic growth of approximately 10% in Q2 and 11% for the first half; acquisitions contributed to the remaining increase.
- Gross margin improved, which management attributed to higher sales relative to fixed overhead, acquisition effects, and improved labor efficiency and material yields. Operating margin was 8.3% in Q2 versus 8.1%; for the first half it was 7.6% versus 7.7%.
- Warehouse and delivery costs rose faster than sales, reflecting driver shortages, overtime, contract drivers, and freight-rate pressure. Distribution gross margin also declined year over year, partly due to a greater mix of lower-margin products.
- Manufacturing segment sales increased 13.7% in Q2 and 14.3% for the first half; Distribution sales increased 29.0% and 31.1%, respectively.
Cash flow, debt, and liquidity
- First-half operating cash flow was $16.7, compared with $15.0 in 2013. Receivables increased $17.8 and inventories increased $4.3, absorbing working capital; accounts payable and accrued liabilities provided a $14.7 increase.
- Investing cash outflow was $57.4, including $55.0 for the Precision and Foremost acquisitions and $2.4 of capital expenditures. Financing cash inflow was $44.0, largely reflecting $46.7 of net additional borrowings, partly offset by $3.7 of share repurchases.
- Cash was $3.3 at June 29, 2014. Revolver debt was $101.7, up from $55.0 at December 31, 2013. The credit limit was increased from $80.0 to $125.0; reported unused availability was $22.6, excluding cash.
- Debt covenants were met: 1.40 leverage ratio against a 3.50 maximum, and 11.70 interest coverage against a 2.25 minimum. The facility matures October 24, 2017 and is secured by substantially all company assets.
- Working capital was $76.0, calculated as current assets of $128.6 less current liabilities of $52.6. The company reported that available cash, operating cash flow, and borrowing capacity should cover anticipated working capital and capital expenditures for at least 12 months, excluding acquisitions.
Material changes and unusual items
- Patrick acquired Precision Painting Group for approximately $9.7 and Foremost for approximately $45.4 in June. Their combined purchase price was funded through the credit facility. Their reported contribution to Q2 sales was approximately $1.6; Foremost was acquired on the last business day of the quarter.
- In July, Patrick purchased five operating facilities from the Precision sellers for approximately $6.1. Purchase-price allocations for the June acquisitions remained preliminary and subject to working-capital adjustments.
- Goodwill increased to $29.5 from $16.5 at year-end, primarily from acquisitions; net intangible assets increased to $48.0 from $25.6. Acquired intangibles will increase amortization expense.
- The company repurchased 94,546 shares in the first half for approximately $3.7. About $16.3 remained authorized for repurchases at June 29.
- A $1.1 excess tax benefit from stock-based compensation was recorded in shareholders’ equity. The estimated effective tax rate was 38.5%, versus 39% in the comparable 2013 periods.
Outlook, commentary, and risks
- Management expected year-over-year quarterly revenue growth for the rest of 2014, excluding acquisitions completed in 2013 and 2014. It cited an RVIA forecast of about 9% growth in full-year RV shipments, expected MH shipment growth of about 5%, and an NAHB forecast of about 12% growth in housing starts.
- Management expected full-year gross margin to increase from 2013, subject to commodity pricing, competitive pricing, and other factors outside its control. It planned up to approximately $8.0 of 2014 capital expenditures, including ERP replacement and equipment upgrades.
- Key operating risks include dependence on the RV market, seasonality, commodity-price volatility, competition, freight costs and driver availability, and uncertainty in MH and housing recovery. Management noted limited visibility beyond about six months and that actual results may differ from forecasts.
- Liquidity and growth plans are affected by working-capital needs, acquisitions, capital spending, debt service, and share repurchases. A 100-basis-point increase in variable rates was estimated to add about $1.0 of annual interest cost at the June debt level.
- Tontine Capital beneficially owned 22.9% of shares outstanding as of July 25, 2014, creating potential influence over shareholder matters and possible stock-sale pressure. Management reported disclosure controls were effective and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether the June and July acquisitions deliver expected growth, synergies, margins, and cash returns, and how final purchase accounting changes goodwill and amortization.
- Whether receivables and inventory growth convert into operating cash flow, while debt remains manageable and covenant headroom is maintained.
- Whether RV, MH, and housing forecasts materialize, and whether driver shortages, freight costs, commodity prices, and lower-margin product mix pressure margins.
- Progress and costs of the ERP replacement and planned capital expenditures, alongside the remaining share-repurchase authorization.
- Changes in Tontine Capital’s ownership and any resulting effects on governance or the trading price of the shares.