Patrick Industries, Inc. — Q2 2018 Form 10-Q
Reporting period: Second quarter and six months ended July 1, 2018; comparisons are with the periods ended June 25, 2017. Patrick manufactures components and distributes building products to recreational vehicle (RV), marine, manufactured housing (MH), and industrial customers.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $604.9 million | $407.1 million | $1,156.7 million | $752.6 million |
| Gross profit / margin | $114.8 million / 19.0% | $71.5 million / 17.6% | $212.5 million / 18.4% | $129.0 million / 17.1% |
| Operating income / margin | $53.1 million / 8.8% | $33.7 million / 8.3% | $94.8 million / 8.2% | $57.6 million / 7.7% |
| Net income | $34.9 million | $21.3 million | $64.9 million | $38.7 million |
| Diluted EPS | $1.42 | $0.85 | $2.62 | $1.60 |
Q2 sales rose 49% and net income 64%; first-half sales rose 54% and net income 68%. The first-half effective tax rate was 22.9%, versus 27.7%; management estimated a full-year 2018 rate of 25%–26%, excluding certain share-based compensation tax benefits and any further impact.
First-half operating cash flow was $91.2 million, compared with $19.7 million. Investing activities used $278.4 million, including $264.4 million for acquisitions and $14.1 million for capital expenditures. Financing activities provided $184.5 million. Cash ended at $0.1 million.
At July 1, total debt was $616.2 million before the $33.1 million unamortized convertible-note discount; balance-sheet debt, net of that discount and other specified items, was $582.5 million. Debt comprised $344.9 million on the revolver, $98.8 million on the term loan, and $172.5 million of convertible notes. Revolver availability, net of cash, was $453.0 million. The company reported compliance with its debt covenants: leverage ratio 2.22 against a 3.00 maximum, and fixed-charge coverage 3.74 against a 1.50 minimum.
Material changes and drivers
- All four markets grew. Company sales increased 41% in RV, 137% in marine, 36% in MH, and 58% in industrial in Q2; first-half increases were 46%, 167%, 39%, and 61%, respectively.
- Acquisitions materially contributed to growth: seven acquisitions involving 11 companies closed in the first half. Acquired businesses contributed $77.6 million of first-half revenue and $8.5 million of operating income. Acquisition cash outlays were $264.4 million.
- Manufacturing generated 78% of first-half sales; its sales rose 44% and segment operating income reached $117.9 million. Distribution sales rose 96% and segment operating income reached $17.5 million. Segment figures precede corporate expenses and amortization.
- Gross margin improved, supported by sales leverage, acquired higher-margin products, and efficiency initiatives. Higher labor costs partly offset those benefits. Net interest expense increased to $10.6 million for the first half from $4.0 million, reflecting acquisition funding and working-capital needs.
Outlook, risks, and unusual items
- Management expected continued growth in its primary markets during the remainder of 2018. Its forecasts included low-to-mid-single-digit full-year RV wholesale shipment growth, low-double-digit MH shipment growth, and 3%–5% marine powerboat retail growth. These are industry expectations, not company earnings guidance.
- Planned 2018 capital expenditures were $25–$30 million, mainly for capacity, geographic expansion, equipment, and product/process development. Management stated that available cash, operating cash flow, and credit availability were expected to cover working capital and capital expenditures for at least 12 months, excluding acquisitions.
- Key exposures include dependence on cyclical and seasonal end markets, especially RV; commodity and labor cost volatility; customer demand and inventory changes; and the ability to pass cost increases through to customers. Management noted tight labor markets and volatile raw-material prices. A 100-basis-point increase in variable rates was estimated to add about $4.4 million of annual interest expense.
- The January 2018 issue of $172.5 million of 1.00% convertible notes matures in 2023. Hedge transactions are intended to reduce potential conversion dilution; warrants could dilute shares if the market price exceeds their approximately $113.93 strike price. The notes’ initial conversion price was approximately $87.89.
- The company repurchased $54.1 million of shares in the first half and reported $56.6 million of repurchases year-to-date through July 27. The filing describes a $50 million repurchase authorization; investors should reconcile the authorization and repurchase amounts. Contingent consideration on certain acquisitions had an estimated fair value of $13.3 million, with aggregate potential payments capped at $19.8 million.
- Adoption of the new revenue-recognition standard had no material impact. No material changes to previously disclosed risk factors were reported; management said disclosure controls were effective.
Important facts for investors to verify
- How much of sales and earnings growth reflects acquisitions versus organic growth, and whether acquired businesses meet expected returns.
- Whether improved gross margins can persist amid labor and commodity costs, and any shifts in customer demand, dealer inventories, or seasonal orders.
- Debt reduction, covenant headroom, variable-rate exposure, and the terms and potential dilution of convertible notes and warrants.
- The cash and earnings impact of contingent acquisition payments, planned capital spending, and the share-repurchase program.
- Actual full-year results against management’s stated market assumptions and tax-rate estimate; the filing cautions that interim results are not necessarily indicative of full-year results.