Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the Company’s Consolidated Financial Statements and Notes thereto included in Item 8 of this Report. In addition, this MD&A contains certain statements relating to future results that are forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. See “Information Concerning Forward-Looking Statements” on page 3 of this Report.
EXECUTIVE SUMMARY
Overview of Markets and Related Industry Performance
Recreational Vehicle ("RV") Industry
The RV industry is our primary market and comprised 56% of the Company’s consolidated net sales in 2020. Sales from the RV industry increased 8% in 2020 compared to 2019. This increase in sales occurred despite an approximate 6-week operations shutdown in the late first quarter and early second quarter of 2020 in certain of our RV facilities in alignment with production shutdowns by certain OEM customers in response to the COVID-19 pandemic. In the second half of 2020, OEM production improved sharply in response to a strong increase in retail and wholesale demand for RVs, and our sales to RV OEMs also improved.
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According to the Recreation Vehicle Industry Association (“RVIA”), wholesale industry shipments totaled 430,000 units in 2020, an increase of 6% compared to 406,000 units in 2019. RV industry retail unit sales increased 12% in 2020 according to Statistical Surveys, Inc ("SSI"), outpacing wholesale industry unit shipments. As a result, RV industry dealer inventories, which were already at historically low levels entering 2020, declined by more than 80,000 units in 2020, resulting in dealer inventories at their lowest levels in the last decade.
Marine Industry
Sales to the marine industry, which represented approximately 14% of the Company's consolidated net sales in 2020, increased 3% in 2020 compared to 2019. Our marine revenue is generally correlated to marine wholesale powerboat unit shipments, which were impacted by marine OEM COVID-19 production shutdowns late in the first quarter and early in the second quarter of 2020. While marine wholesale powerboat unit shipments began to improve in the second half of 2020, total 2020 marine wholesale powerboat unit shipments decreased an estimated 14% according to the National Marine Manufacturers Association. At the same time, marine retail powerboat shipments increased 15% for 2020, benefiting from increased demand for powerboats, resulting in marine dealer inventory levels that are at their lowest since 2014 as retail sales outpaced marine wholesale unit shipments in 2020.
Manufactured Housing ("MH") Industry
Sales to the MH industry, which represented 17% of the Company’s consolidated sales in 2020, decreased 1% in 2020 compared to 2019. MH sales are correlated to MH industry wholesale unit shipments, which were impacted by temporary MH OEM production shutdowns as a result of COVID-19 in the late first quarter and early second quarter of 2020, slowly recovering in the second half of 2020 as MH OEMs worked through labor and supply constraints. Based on industry data from the Manufactured Housing Institute, MH wholesale industry unit shipments were flat in 2020.
Industrial Market
The industrial market is comprised primarily of the kitchen cabinet industry, high-rise, hospitality, retail and commercial fixtures market, office and household furniture market and regional distributors. Sales to this market represented 13% of our consolidated net sales in 2020, increasing 14% in 2020 compared to 2019. Overall, our revenues in these markets are focused on the residential housing, hospitality, high-rise housing and office, commercial construction and institutional furniture markets. We estimate that a pproximately 60% of our industrial business is directly tied to the residential housing market, with the remaining 40% directly tied to the non-residential and commercial markets.
Combined new housing starts increased 7% in 2020 compared to 2019, with single family housing starts increasing 12% and multifamily residential starts decreasing 3% for the same period. Our industrial products are generally among the last components installed in new unit construction and as such our related sales typically trail new housing starts by four to six months.
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CONSOLIDATED OPERATING RESULTS
The following table sets forth the percentage relationship to net sales of certain items on the Company’s consolidated statements of income for the years ended December 31, 2020, 2019 and 2018.
Year Ended December 31,
(thousands) 2020 2019 2018
Net sales 2,486,597 100.0 % 2,337,082 100.0 % 2,263,061 100.0 %
Cost of goods sold 2,027,580 81.5 1,914,211 81.9 1,847,195 81.6
Gross profit 459,017 18.5 422,871 18.1 415,866 18.4
Warehouse and delivery expenses 98,400 4.0 98,055 4.2 74,996 3.3
Selling, general and administrative expenses 146,376 5.9 134,466 5.8 128,242 5.7
Amortization of intangible assets 40,868 1.6 35,908 1.5 34,213 1.5
Operating income 173,373 7.0 154,442 6.6 178,415 7.9
Interest expense, net 43,001 1.7 36,616 1.6 26,436 1.2
Income taxes 33,311 1.3 28,260 1.2 32,147 1.4
Net income 97,061 3.9 89,566 3.8 119,832 5.3
Year Ended December 31, 2020 Compared to 2019
Net Sales. Net sales in 2020 increased approximately $149.5 million, or 6%, to $2.49 billion from $2.34 billion in 2019. The increase was attributable to an 8% increase in sales from the RV industry, a 14% increase in the Company’s sales from the industrial markets and a 3% increase in sales from the marine industry, partially offset by a 1% decrease in sales from the MH industry.
In 2020 and 2019, net sales attributable to acquisitions completed in each of those years was $81.9 million and $8.3 million, respectively.
The Company’s RV content per wholesale unit for 2020 increased 2% to $3,235 from $3,170 in 2019. Marine powerboat content per wholesale unit for 2020 increased 24% to an estimated $2,098 from $1,696 in 2019. MH content per wholesale unit for 2020 decreased 1% to $4,580 in 2020 from $4,616 in 2019.
Cost of Goods Sold. Cost of goods sold increased $113.4 million, or 6%, to $2.03 billion in 2020 from $1.91 billion in 2019. As a percentage of net sales, cost of goods sold decreased during 2020 to 81.5% from 81.9% in 2019.
The decrease in cost of goods sold as a percentage of net sales is attributed to certain fixed overhead components against the overall increase in net sales in 2020, partially offset by an increase in labor as an overall percentage of net sales. In general, the Company's cost of goods sold percentage can be impacted by demand changes in certain market sectors that can result in fluctuating costs of certain raw materials and commodity-based components that are utilized in the production of our products.
Gross Profit. Gross profit increased $36.1 million or 9%, to $459.0 million in 2020 from $422.9 million in 2019. As a percentage of net sales, gross profit increased to 18.5% in 2020 from 18.1% in 2019. The increase in gross profit as a percentage of net sales in 2020 compared to 2019 reflects the impact of the factors discussed above under “Cost of Goods Sold”.
Economic or industry-wide factors affecting the profitability of our RV, MH, marine and industrial businesses include the costs of commodities and the labor used to manufacture our products, the competitive environment and the impact of different gross margin profiles of acquired companies, all of which can cause gross margins to fluctuate from quarter-to-quarter and year-to-year.
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Warehouse and Delivery Expenses. Warehouse and delivery expenses increased $0.3 million, or 0.4%, to $98.4 million in 2020 from $98.1 million in 2019. As a percentage of net sales, warehouse and delivery expenses were 4.0% in 2020 and 4.2% in 2019. The decrease as a percentage of net sales in 2020 compared to 2019 was primarily attributable to the lower proportion of MH industry net sales in 2020 compared to 2019, which have higher warehousing and delivery costs as a percentage of net sales.
Selling, General and Administrative ("SG&A") Expenses. SG&A expenses increased $11.9 million, or 9%, to $146.4 million in 2020 from $134.5 million in 2019. As a percentage of net sales, SG&A expenses were 5.9% in 2020 and 5.8% in 2019. The increase in SG&A expenses as a percentage of net sales in 2020 is primarily due to an expansion of general and administrative resources to support end market demand.
Amortization of Intangible Assets. Amortization of intangible assets increased $5.0 million, or 13.8%, in 2020 compared to 2019. The increase in 2020 compared to 2019 primarily reflects the impact of an increase in intangible assets from businesses acquired in 2019 and 2020.
Operating Income. Operating income increased $19.0 million, or 12%, to $173.4 million in 2020 from $154.4 million in 2019. Operating income in 2020 and 2019 included $10.7 million and $0.9 million, respectively, from the businesses acquired in each year. Operating income as a percentage of net sales was 7.0% in 2020 and 6.6% in 2019. The increase in operating income is primarily attributable to the items discussed above as well as the operating margin profiles of businesses acquired in 2020.
Interest Expense, Net. Interest expense, net, increased $6.4 million, or 17%, to $43.0 million in 2020 from $36.6 million in 2019. The increase in net interest expense reflects increased borrowings related to 2020 acquisitions, partly offset by decreases in the average interest rate on the variable rate portion of the Company's debt, which reflects a lower weighted average LIBOR in 2020 compared to 2019.
Income Taxes. Income tax expense increased $5.0 million, or 18%, to $33.3 million in 2020 from $28.3 million in 2019. For 2020, the effective tax rate was 25.6% compared to 24.0% in 2019. The increase in the effective tax rate in 2020 was mostly attributable to a change in the mix of state taxes and decreased benefits from stock-based compensation.
See our Form 10-K for the year ended December 31, 2019 for a discussion of our consolidated operating results for the year ended December 31, 2019 compared to 2018.
Use of Financial Metrics
Our MD&A includes financial metrics, such as RV, marine and MH content per unit, which we believe are important measures of the Company's business performance. Content per unit metrics are generally calculated using our market sales divided by third-party industry volume metrics. These metrics should not be considered alternatives to U.S. GAAP. Our computations of content per unit may differ from similarly titled measures used by others. These metrics should not be considered in isolation or as substitutes for an analysis of our results as reported under U.S. GAAP. Beginning in the third quarter of 2020, we calculate marine content per unit based on estimated wholesale powerboat unit shipments, which we believe better represents the relationship between our sales and marine OEM production, rather than based on estimated retail powerboat unit sales.
BUSINESS SEGMENTS
The Company's reportable segments, manufacturing and distribution, are based on its method of internal reporting. The Company regularly evaluates the performance of the manufacturing and distribution segments and allocates resources to them based on a variety of indicators including net sales and operating income. The Company does not measure profitability at the end market (RV, marine, MH and industrial) level.
• Manufacturing – This segment includes the following products: laminated products that are utilized to produce furniture, shelving, walls, countertops and cabinet products; cabinet doors; fiberglass bath fixtures
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and tile systems; hardwood furniture; vinyl printing; decorative vinyl and paper laminated panels; solid surface, granite, and quartz countertop fabrication; RV painting; fabricated aluminum products; fiberglass and plastic components; fiberglass bath fixtures and tile systems; softwoods lumber; custom cabinetry; polymer-based flooring; electrical systems components including instrument and dash panels; wrapped vinyl, paper and hardwood profile mouldings; interior passage doors; air handling products; slide-out trim and fascia; thermoformed shower surrounds; specialty bath and closet building products; fiberglass and plastic helm systems and components products; treated, untreated and laminated plywood; wiring and wire harnesses; boat covers, towers, tops and frames; marine hardware; aluminum and plastic fuel tanks; CNC molds and composite parts; slotwall panels and components; and other products.
• Distribution – The Company distributes pre-finished wall and ceiling panels; drywall and drywall finishing products; electronics and audio systems components; appliances; wiring, electrical and plumbing products; fiber reinforced polyester products; cement siding; raw and processed lumber; interior passage doors; roofing products; laminate and ceramic flooring; tile; shower doors; furniture; fireplaces and surrounds; interior and exterior lighting products; and other miscellaneous products in addition to providing transportation and logistics services.
Net sales pertaining to the manufacturing and distribution segments as stated in the table below and in the following discussions include intersegment sales. Gross profit includes the impact of intersegment operating activity.
The table below presents information about the net sales, gross profit, and operating income of the Company’s segments. Reconciliations of the amounts below to consolidated totals are presented in Note 18 to Consolidated Financial Statements.
Year Ended December 31,
(thousands) 2020 2019 2018
Sales
Manufacturing $ 1,765,818 $ 1,673,486 $ 1,779,048
Distribution 762,472 699,159 521,235
Gross Profit
Manufacturing 324,938 307,362 337,451
Distribution 133,291 110,957 81,016
Operating Income
Manufacturing 190,518 174,913 215,246
Distribution 54,376 38,953 31,491
Year Ended December 31, 2020 Compared to 2019
Manufacturing
Net Sales. Sales increased $92.3 million, or 6%, to $1.77 billion from $1.67 billion in 2019. This segment accounted for approximately 70% of the Company’s consolidated net sales in 2020 and 2019. The sales increase reflected increased net sales across all of our end markets.
In 2020 and 2019, net sales attributable to acquisitions completed in each of those periods was $52.5 million and $8.3 million, respectively.
Gross Profit. Gross profit increased $17.5 million, or 6%, to $324.9 million in 2020 from $307.4 million in 2019. As a percentage of net sales, gross profit was 18.4% in 2020 and 2019.
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Operating Income. Operating income increased $15.6 million, or 9%, to $190.5 million in 2020 from $174.9 million in 2019. Operating income attributable to acquisitions completed in 2020 and 2019 was $7.0 million and $0.9 million, respectively. The increase in operating income primarily reflects the increase in gross profit mentioned above.
Distribution
Net Sales. Sales increased $63.3 million, or 9%, to $762.5 million in 2020 from $699.2 million in 2019. This segment accounted for approximately 30% of the Company’s consolidated net sales for 2020 and 2019. The increase in net sales in 2020 is primarily attributed to an increase in RV, industrial and marine end market net sales, partially offset by a decrease in net sales to the MH market. Revenue attributable to acquisitions completed in 2020 was $29.4 million.
Gross Profit. Gross profit increased $22.3 million, or 20%, to $133.3 million in 2020 from $111.0 million in 2019. As a percentage of net sales, gross profit was 17.5% in 2020 compared to 15.9% in 2019. The increase in gross profit as a percentage of net sales for 2020 reflected the contribution of increased net sales in our higher margin transportation business and the positive impact of leveraging fixed costs on higher sales volumes in our other distribution businesses.
Operating Income. Operating income in 2020 increased $15.4 million, or 40%, to $54.4 million from $39.0 million in 2019. The businesses acquired in 2020 contributed approximately $3.7 million to operating income in the Distribution segment in 2020. The overall improvement in operating income in 2020 primarily reflects the items discussed above.
Unallocated Corporate Expenses
As presented in Note 18 to the Consolidated Financial Statements, unallocated corporate expenses in 2020 increased $7.2 million, or 30%, to $30.7 million from $23.5 million in 2019. The increase in 2020 was mostly attributed to an increase in professional fees, administrative wages and incentive compensation.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of liquidity are cash flow from operations, which includes selling its products and collecting receivables, available cash reserves and borrowing capacity available under the 2019 Credit Facility (as defined below). Principal uses of cash are to support working capital demands, meet debt service requirements and support the Company's capital allocation strategy, which includes acquisitions, capital expenditures, dividends and repurchases of the Company’s common stock, among others.
Cash Flows
Year Ended December 31, 2020 Compared to 2019
Operating Activities
Cash flows from operating activities are one of the Company's primary sources of liquidity, representing the net income the Company earned in the reported periods, adjusted for non-cash items and changes in operating assets and liabilities.
Net cash provided by operating activities decreased $32.2 million to $160.2 million in 2020 from $192.4 million in 2019 primarily due to: (i) an increase in cash used by inventories of $54.2 million, which is primarily due to an increase in inventories purchased at year end to support a strong increase in end market demand for our products and (ii) an increase in cash used by trade and other receivables of $35.0 million, primarily due to an increase in year end sales as well as the timing of collection of trade receivables. Partially offsetting the above increase in the use of operating cash flows were: (i) an increase in cash from prepaid expenses, accounts payable, accrued liabilities and
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other of $30.1 million; (ii) an increase in depreciation and amortization of $10.5 million; (iii) an increase in other operating items of $8.8 million and (iv) an increase in net income of $7.5 million.
Investing Activities
Net cash used in investing activities increased $258.7 million to $337.9 million in 2020 from $79.2 million in 2019 primarily due to (i) an increase in cash used in business acquisitions of $250.0 million; an increase in capital expenditures of $4.4 million and (iii) a decrease in cash provided by proceeds from sale of property, plant and equipment and other investing activities of $4.1 million.
Financing Activities
Net cash flows provided by financing activities increased $63.7 million to $83.0 million in 2020 from $19.3 million in 2019 primarily due to: (i) an increase in net borrowings of $135.0 million in 2020 compared to an increase in net borrowings of $43.9 million in 2019, due primarily to our use of the 2019 Revolver (as defined herein) to fund 2020 business acquisitions and (ii) a decrease in payments of deferred financing, debt issuance, contingent consideration and other of $9.9 million. These increases in cash from financing activities were partially offset by increases in cash paid for dividends and stock repurchases under our buyback program of $37.1 million.
See our Form 10-K for the year ended December 31, 2019 for a discussion of cash flows for the year ended December 31, 2019 compared to 2018.
Summary of Liquidity and Capital Resources
The Company believes that existing cash and cash equivalents, cash generated from operations, and available borrowings under its 2019 Credit Facility will be sufficient to meet anticipated cash needs for working capital and capital expenditures for at least the next 12 months, exclusive of any acquisitions, based on its current cash flow budgets and forecast of short-term and long-term liquidity needs.
The ability to access unused borrowing capacity under the 2019 Credit Facility as a source of liquidity is dependent on maintaining compliance with the financial covenants as specified under the terms of the credit agreement that established the 2019 Credit Facility (the "2019 Credit Agreement"). In 2020, the Company was in compliance with its financial debt covenants as required under the terms of the 2019 Credit Agreement. The required maximum consolidated total leverage ratio and the required minimum consolidated fixed charge coverage ratio compared to the actual amounts as of December 31, 2020 and for the fiscal year then ended are as follows:
Required Actual
Consolidated total leverage ratio (12-month period) 4.50 2.44
Consolidated fixed charge coverage ratio (12-month period) 1.50 4.81
Working capital requirements vary from period to period depending on manufacturing volumes primarily related to the RV, MH and marine industries as well as the industrial markets we serve, the timing of deliveries, and the payment cycles of customers. In the event that operating cash flow is inadequate and one or more of the Company's capital resources were to become unavailable, the Company would seek to revise its operating strategies accordingly. The Company will continue to assess its liquidity position and potential sources of supplemental liquidity in view of operating performance, current economic and capital market conditions, and other relevant circumstances.
Borrowings under the revolving credit loan (the "2019 Revolver") and the term loan (the "2019 Term Loan" and, together with the 2019 Revolver, the "2019 Credit Facility") established under the 2019 Credit Agreement, which are subject to variable rates of interest, are subject to a maximum total borrowing limit of $650.0 million (effective September 17, 2019). See Note 8 of the Notes to the Consolidated Financial Statements for further information. See Note 9 of the Notes to Consolidated Financial Statements for information on interest rate swaps used to partially hedge variable interest rates under the 2019 Revolver and 2019 Term Loan. The unused availability under the 2019 Credit Facility as of December 31, 2020 was $314.6 million.
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Off-Balance Sheet Arrangements
None.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The SEC has defined a company’s critical accounting policies as those that are most important to the portrayal of its financial condition and results of operations, and which require the Company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Although management believes that its estimates and assumptions are reasonable, they are based upon information available when they are made. Actual results may differ materially from these estimates under different assumptions or conditions. Other material accounting policies are described in Notes 1, 3 and 15 of the Notes to Consolidated Financial Statements. The Company has identified the following critical accounting policies and estimates:
Goodwill and Other Intangible Assets. The Company’s acquisitions include purchased goodwill and other intangible assets. Goodwill represents the excess of cost over the fair value of the net assets acquired. Other intangible assets acquired are classified as customer relationships, non-compete agreements, patents and trademarks.
Goodwill and indefinite-lived intangible assets, representing acquired trademarks, are not amortized but are subject to an annual (or under certain circumstances more frequent) impairment test in the fourth quarter based on their estimated fair value. We test more frequently, if there are indicators of impairment, or whenever such circumstances suggest that the carrying value of goodwill or trademarks may not be recoverable. These indicators include a sustained material decline in our share price and market capitalization, a decline in expected future cash flows, or a material adverse change in the business climate. A material adverse change in the business climate could result in a material loss of market share or the inability to achieve previously projected revenue growth.
Impairment reviews of goodwill are performed at the reporting unit level. The Company’s reporting units are defined as one level below our operating segments, Manufacturing and Distribution, which are the same as our reportable segments. In evaluating goodwill for impairment, either a qualitative or quantitative assessment is performed. If the qualitative assessment indicates it is more likely than not that the fair value of the reporting unit is less than its carrying value, the Company performs a quantitative assessment. When estimating reporting unit fair value with the quantitative assessment, the Company uses a combination of market and income-based methodologies. The market approach includes a comparison of multiples of earnings before interest, taxes, depreciation and amortization for the reporting units to similar businesses or guideline companies whose securities are actively traded in public markets. When calculating the present value of future cash flows under the income approach, the Company takes into consideration multiple variables, including forecasted sales volumes and operating income, current industry and economic conditions, and historical results. The income approach fair value estimate also includes estimates of long-term growth rates and discount rates that are commensurate with the risks and uncertainty inherent in the respective reporting units and internally-developed forecasts.
Impairment reviews of indefinite-lived intangible assets (trademarks) consist of a comparison of the fair value of the trademark to its carrying value. Fair value is measured using a relief-from-royalty approach, a form of discounted cash flow method. Estimated royalty rates applied to projected revenues are based on comparable industry studies and consideration of operating margins. Discount rates are derived in a manner similar to what is done in testing goodwill for impairment.
Based on the results of the Company's analyses, the estimated fair value of each of the Company's reporting units and trademarks was determined to exceed the carrying value for each of the years ended December 31, 2020, 2019 and 2018 and so no impairments were recognized. Further, based on the results of the impairment analyses, none of
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the Company’s reporting units or trademarks were at risk of failing the impairment assessments discussed above that would have a material effect on the Company’s Consolidated Financial Statements for any period presented.
See Note 7 of the Notes to Consolidated Financial Statements for information regarding immaterial impairments recorded in 2020 unrelated to the annual goodwill and trademark tests.
Finite-lived intangible assets that meet certain criteria continue to be amortized over their useful lives and are also subject to an impairment test based on estimated undiscounted cash flows when impairment indicators exist.
Business Combinations. From time to time, we may enter into business combinations. We recognize the identifiable assets acquired and the liabilities assumed at their fair values as of the date of acquisition. We measure goodwill as the excess of consideration transferred, which we also measure at fair value, over the net of the acquisition date fair values of the identifiable assets acquired and liabilities assumed. The acquisition method of accounting requires us to make significant estimates and assumptions regarding the fair values of the elements of a business combination as of the date of acquisition, including the fair values of property, plant and equipment, identifiable intangible assets, contingent consideration and other financial assets and liabilities. Significant estimates and assumptions include subjective and/or complex judgments regarding items such as discount rates, customer attrition rates, royalty rates, economic lives and other factors, including estimated future cash flows that we expect to generate from the acquired assets.
The acquisition method of accounting also requires us to refine these estimates over a measurement period not to exceed one year to reflect new information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date. If we are required to adjust provisional amounts that we have recorded for the fair values of assets and liabilities in connection with acquisitions, these adjustments could have a material impact on our financial condition and results of operations. No changes in fiscal 2020 to provisional fair value estimates of assets and liabilities assumed in acquisitions were material. If the subsequent actual results and updated projections of the underlying business activity change compared with the assumptions and projections used to develop the acquisition date fair value estimates, we could record future impairment charges. In addition, we estimate the economic lives of certain acquired assets and these lives are used to calculate depreciation and amortization expense. If our estimates of the economic lives change, depreciation or amortization expenses could be increased or decreased, or the acquired assets could be impaired.