PATRICK INDUSTRIES INC 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the Company’s Condensed Consolidated Financial Statements and Notes thereto included in Item 1 of this Report. In addition, this MD&A contains certain statements relating to future results which 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 27 of this Report. The Company undertakes no obligation to update these forward-looking statements. OVERVIEW OF MARKETS AND RELATED INDUSTRY PERFORMANCE First Quarter 2021 Financial Overview Recreational Vehicle ("RV") Industry The RV industry is our primary market and comprised 59% and 55% of the Company’s sales in the first quarter ended March 28, 2021 and March 29, 2020, respectively. Sales to the RV industry increased 57% in the first quarter of 2021 compared to the prior year quarter. According to the Recreation Vehicle Industry Association ("RVIA"), wholesale shipments totaled approximately 148,500 units in the first quarter of 2021, an increase of 48% compared to approximately 100,400 units in the first quarter of 2020. The increase in wholesale unit shipments in the first quarter of 2021 is attributed to an increase in RV dealer demand for RV units. This increase in dealer demand is correlated with consumer demand for RV units, which we believe is in part correlated with changes in consumer recreation patterns, which include an increased interest in outdoor recreation. A ccording to our estimates, RV d ealer inventories are trending at historical lows relative to what we understand to be typical inventory levels of RV dealers. We believe that the supply-demand dynamics of historically low dealer inventory levels, combined with strong retail consumer demand, have resulted in positive momentum in our RV end market. We estimate RV retail unit sales increased 30-35% in the first quarter of 2021 compared to the first quarter of 2020. Marine Industry Sales to the marine industry, which represented approximately 16% and 13% of the Company's consolidated net sales in the first quarter of 2021 and 2020, respectively, increased 75% compared to the prior year quarter. Our marine revenue is generally correlated to marine wholesale powerboat unit shipments, and according to National Marine Manufacturers Association ("NMMA") marine wholesale powerboat unit shipments increased an estimated 20 14% for the first quarter 2021 compared to the same period in 2020. At the same time, marine retail powerboat unit sales increased an estimated 30-35% in the first quarter of 2021 compared to the first quarter of 2020, benefiting from increased demand for powerboats, resulting in marine dealer inventory levels that we believe are at their lowest since 2014 as retail sales continue outpacing marine wholesale unit shipments in the first quarter of 2021. Manufactured Housing ("MH") Industry Sales to the MH industry, which represented 14% and 19% of the Company’s sales in the first quarter of 2021 and 2020, respectively, increased 7% in the first quarter of 2021 compared to the first quarter of 2020. Based on industry data from the Manufactured Housing Institute, MH wholesale unit shipments increased 5% in the first quarter of 2021 compared to the prior year quarter. Industrial Market The industrial market is comprised primarily of the kitchen cabinet industry, hospitality market, retail and commercial fixtures market, office and household furniture market and regional distributors. Sales to this market represented 11% and 13% of our sales in the first quarter of 2021 and 2020, respectively, and increased 17% in the first quarter of 2021 compared to the prior year quarter. 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 approximately 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. According to the U.S. Census Bureau, combined new housing starts increased 10% in the first quarter of 2021 compared to the prior year quarter, with single family housing starts increasing 20% and multifamily residential starts decreasing 7% 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. REVIEW OF CONSOLIDATED OPERATING RESULTS First Quarter Ended March 28, 2021 Compared to First Quarter Ended March 29, 2020 The following table sets forth the percentage relationship to net sales of certain items on the Company’s Condensed Consolidated Statements of Income. First Quarter Ended ($ in thousands) March 28, 2021 March 29, 2020 Change Amount % Change Net sales $ 850,483 100.0 % $ 589,232 100.0 % $ 261,251 44.3 % Cost of goods sold 688,951 81.0 479,751 81.4 209,200 43.6 % Gross profit 161,532 19.0 109,481 18.6 52,051 47.5 % Warehouse and delivery expenses 29,913 3.5 24,732 4.2 5,181 20.9 % Selling, general and administrative expenses 51,232 6.0 35,869 6.1 15,363 42.8 % Amortization of intangible assets 11,906 1.4 9,601 1.6 2,305 24.0 % Operating income 68,481 8.1 39,279 6.7 29,202 74.3 % Interest expense, net 11,179 1.3 10,492 1.8 687 6.5 % Income taxes 9,789 1.2 7,600 1.3 2,189 28.8 % Net income $ 47,513 5.6 $ 21,187 3.6 $ 26,326 124.3 % Net Sales . Net sales in the first quarter of 2021 increased $261.3 million, or 44%, to $850.5 million from $589.2 million in the first quarter of 2020. Net sales in the first quarter of 2020 reflect COVID-19-related production shutdowns in our end markets in the second half of March 2020. The consolidated net sales increase in the first quarter of 2021 was primarily attributed to sales increases to the RV and marine markets. The Company's RV 21 market sales increased 57%, marine market sales increased 75%, industrial market sales increased 16% and MH market sales increased 7% when compared to the prior year quarter. Net sales in the first quarter of 2021 attributable to acquisitions completed in that quarter were approximately $5.4 million, and net sales in the first quarter of 2020 attributable to acquisitions completed in that quarter were immaterial. The Company’s RV content per wholesale unit (on a trailing twelve-month basis) for the first quarter of 2021 increased approximately 6% to $3,288 from $3,112 for the first quarter of 2020. Marine powerboat content per wholesale unit (on a trailing twelve-month basis) for the first quarter of 2021 increased approximately 44% to an estimated $2,426 from $1,687 for the first quarter of 2020. MH content per wholesale unit (on a trailing twelve-month basis) for the first quarter of 2021 increased approximately 1.5% to $4,611 from $4,543 for the first quarter of 2020. Cost of Goods Sold. Cost of goods sold increased $209.2 million, or 44%, to $689.0 million in the first quarter of 2021 from $479.8 million in 2020. As a percentage of net sales, cost of goods sold decreased 40 basis points during the first quarter of 2021 to 81.0% from 81.4% in 2020. Cost of goods sold as a percentage of net sales decreased primarily as a result of (i) continued cost reduction and automation initiatives we deployed throughout 2020, (ii) volume-driven efficiencies as a result of leveraging fixed overhead and (iii) synergies and different cost profiles from our 2020 acquisitions, partially offset by an increase in labor and certain commodity cost inputs. In general, the Company's cost of goods sold percentage can be impacted from quarter-to-quarter 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 $52.0 million, or 48%, to $161.5 million in the first quarter of 2021 from $109.5 million in 2020. As a percentage of net sales, gross profit increased 40 basis points to 19.0% in the first quarter of 2021 from 18.6% in the same period in 2020. The increase in gross profit as a percentage of net sales in the first quarter of 2021 compared to the same period in 2020 reflects the impact of the factors discussed above under “Cost of Goods Sold”. Warehouse and Delivery Expenses . Warehouse and delivery expenses increased $5.2 million, or 21%, to $29.9 million in the first quarter of 2021 from $24.7 million in the first quarter of 2020. As a percentage of net sales, warehouse and delivery expenses improved 70 basis points to 3.5% in the first quarter of 2021 compared to 4.2% in the first quarter of 2020. This decrease as a percentage of sales is primarily attributable to the lower proportion of MH sales in the first quarter of 2021 as compared to 2020, which have higher warehouse and delivery costs as a percentage of net sales. Selling, General and Administrative ("SG&A") Expenses . SG&A expenses increased $15.4 million, or 43%, to $51.2 million in the first quarter of 2021 from $35.9 million in the prior year quarter. As a percentage of net sales, SG&A expenses were 6.0% in the first quarter of 2021 compared to 6.1% in the first quarter of 2020. The increase in SG&A expenses in the first quarter of 2021 compared to 2020 is primarily due to (i) the increase in net sales and (ii) increases in the breadth and depth of corporate resources to support the size and growth of the Company. Amortization of Intangible Assets. Amortization of intangible assets increased $2.3 million, or 24%, to $11.9 million in the first quarter of 2021 from $9.6 million in the prior year quarter. The increase in the first quarter of 2021 compared to the prior year quarter primarily reflects the impact of businesses acquired in 2020. Operating Income. Operating income increased $29.2 million, or 74%, to $68.5 million in the first quarter of 2021 from $39.3 million in 2020. As a percentage of net sales, operating income increased 140 basis points to 8.1% in the first quarter of 2021 versus 6.7% in the same period in 2020. The change in operating income and operating margin is primarily attributable to the items discussed above. 22 Interest Expense, Net. Interest expense increased $0.7 million, or 7%, to $11.2 million in the first quarter of 2021 from $10.5 million in the prior year. The increase in interest expense reflects increased borrowings related to 2020 acquisitions, partially offset by a decrease in variable interest rates on the unhedged portions of the Company's term loan and revolving credit facility. Income Taxes. Income tax expense increased $2.2 million, or 29%, to $9.8 million from $7.6 million in the prior year period. The increase in income tax expense is due primarily to an increase in pretax income partially offset by a decrease in the effective tax rate in the first quarter of 2021 compared to the prior year quarter. The effective tax rate in the first quarter of 2021 and 2020 was 17.1% and 26.4%, respectively. The effective tax rate for the first quarter of 2021 includes the impact of the recognition of excess tax benefits on share-based compensation that was recorded as a reduction to income tax expense upon realization in the amount of $5.7 million, with no corresponding amount for the same period in 2020. 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 measures of industry volume. 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. REVIEW BY BUSINESS SEGMENT 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 sales and operating income. The Company does not measure profitability at the customer market (RV, marine, MH and industrial) level. 23 First Quarter Ended March 28, 2021 Compared to 2020 General In the discussion that follows, sales attributable to the Company’s reportable segments include intersegment sales and gross profit includes the impact of intersegment operating activity. The table below presents information about the sales, gross profit and operating income of the Company’s reportable segments. A reconciliation of consolidated operating income is presented in Note 15 of the Notes to Condensed Consolidated Financial Statements. First Quarter Ended (thousands) March 28, 2021 March 29, 2020 Amount Change % Change Sales Manufacturing $ 614,564 $ 426,839 $ 187,725 44% Distribution 251,130 171,266 79,864 47% Gross Profit Manufacturing 120,926 78,947 41,979 53% Distribution 44,150 29,196 14,954 51% Operating Income Manufacturing 78,429 45,704 32,725 72% Distribution 21,175 9,968 11,207 112% Manufacturing Sales. Sales increased $187.8 million, or 44%, to $614.6 million in the first quarter of 2021 from $426.8 million in the prior year quarter. This segment accounted for approximately 71% of the Company’s consolidated net sales for the first quarter of 2021 and 2020. The sales increase in the first quarter of 2021 compared to 2020 was attributed to sales increases in all four of the Company' end markets: RV increased 45%, marine increased 75%, MH increased 24% and industrial increased 15%. Net sales in the first quarter of 2021 attributable to acquisitions completed in that quarter were approximately $4.8 million, and net sales in the first quarter of 2020 attributable to acquisitions completed in that quarter were immaterial. Gross Profit . Gross profit increased $42.0 million, or 53%, to $120.9 million in the first quarter of 2021 from $78.9 million in the first quarter of 2020. As a percentage of sales, gross profit increased to 19.7% in the first quarter of 2021 from 18.5% in the first quarter of 2020. Gross profit margin increased during the first quarter of 2021 compared to the prior year quarter primarily due to a 180 basis point improvement in manufacturing overhead and expenses as a percent of sales as certain of these costs are fixed in nature and a 60 basis point improvement in direct labor, partially offset by a 120 basis point increase in materials as a percent of sales, for a net 120 basis point improvement in the first quarter of 2021 as compared to 2020. Operating Income. Operating income increased $32.7 million, or 72%, to $78.4 million in the first quarter of 2020 from $45.7 million in the prior year quarter. The overall increase in operating income in the first quarter of 2021 primarily reflects the items discussed above. 24 Distribution Sales. Sales increased $79.8 million, or 47%, to $251.1 million in the first quarter of 2021 from $171.3 million in the prior year quarter. This segment accounted for approximately 29% of the Company’s consolidated net sales for the first quarter of 2021 and 2020. The sales increase in the first quarter of 2021 compared to 2020 was attributed to an 84% increase in our RV market sales, a 71% increase in marine market sales and a 31% increase in industrial market sales, partially offset by a 4% decrease in MH market sales. Net sales in the first quarter of 2021 attributable to acquisitions completed in that quarter were approximately $0.6 million, with no corresponding amount of net sales in the first quarter of 2020 attributable to acquisitions completed in that quarter. Gross Profit. Gross profit increased $15.0 million, or 51%, to $44.2 million in the first quarter of 2021 from $29.2 million in the first quarter of 2020. As a percentage of sales, gross profit increased to 17.6% in the first quarter of 2021 from 17.0% in the first quarter of 2020. The increase in gross profit margin in the first quarter of 2021 compared to the first quarter of 2020 is primarily attributed to the higher profitability of a 2020 acquisition compared to the rest of the Distribution segment. Operating Income. Operating income increased $11.2 million, or 112%, to $21.2 million in the first quarter of 2021 from $10.0 million in the prior year quarter. The improvement in operating income in the first quarter of 2021 primarily reflects the items discussed above. LIQUIDITY AND CAPITAL RESOURCES Our liquidity at March 28, 2021 consisted of cash and cash equivalents of $6.2 million as well as $296.8 million of availability under our credit facility. Cash Flows 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 increased $37.1 million to $50.3 million in the first quarter of 2021 from $13.2 million in the first quarter of 2020. The increase is primarily attributable to (i) a $26.3 million increase in net income, (ii) a $5.3 million increase in depreciation and amortization and (iii) $4.6 million less deployed into working capital as compared to the same quarter in the prior year. Investing Activities Net cash used in investing activities increased $13.2 million to $45.0 million in the first quarter 2021 from $31.8 million in the first quarter of 2020 primarily due to an increase in cash used in business acquisitions of $4.6 million and an increase in capital expenditures and other investing activities of $8.6 million. Financing Activities Net cash flows used by financing activities increased $17.6 million to $43.8 million in the first quarter of 2021 from $26.2 million in the first quarter of 2020 primarily due to $27.0 million in net repayments on the Company's credit facility and an $11.7 million increase in tax payments for share-based payment arrangements. Partially offsetting these increases in use of cash were (i) a $15.6 million decrease in stock repurchases in the current quarter compared to the prior year quarter, (ii) $4.2 million in proceeds from the exercise of stock options with no corresponding amount in the prior year quarter and (iii) $2.1 million in payments of contingent consideration and deferred financing costs in the prior year quarter with no corresponding amount in the current year quarter. 25 Summary of Liquidity and Capital Resources At March 28, 2021, the Company's existing cash and cash equivalents, cash generated from operations, and available borrowings under its credit facility are expected to 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. See Note 17 of the Notes to Condensed Consolidated Financial Statements for a description of changes to our debt arrangements subsequent to March 28, 2021. At March 28, 2021, the Company's senior credit facility consisted of a $550 million senior secured revolver and a $100 million senior secured term loan. The maturity date for borrowings under the credit agreement that established the credit facility was September 17, 2024. Borrowings under the senior credit facility were secured by substantially all personal property assets of the Company and any domestic subsidiary guarantors. Pursuant to the credit agreement: • The term loan is due in consecutive quarterly installments in the following amounts: (i) through and including June 30, 2021, $1,250,000 and (ii) beginning September 30, 2021, and each quarter thereafter, $2,500,000, with the remaining balance due at maturity; • The interest rates for borrowings under the revolver and the term loan are the Prime Rate or LIBOR plus a margin, which ranges from 0.00% to 0.75% for Prime Rate loans and from 1.00% to 1.75% for LIBOR loans depending on the Company’s consolidated total leverage ratio. The Company is required to pay fees on unused but committed portions of the revolver, which range from 0.15% to 0.225%. At March 28, 2021, the Company had $296.8 million of unused borrowing availability under its senior credit facility. The ability to access unused borrowing capacity under the 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. As of and for the March 28, 2021 reporting date, the Company was in compliance with its financial covenants as required under the terms of its credit agreement. The required maximum consolidated total leverage ratio and the required minimum consolidated fixed charge coverage ratio, as such ratios are defined in the credit agreement, compared to the actual amounts as of March 28, 2021 and for the fiscal period then ended are as follows: Required Actual Consolidated total leverage ratio (12-month period) 4.00 2.30 Consolidated fixed charge coverage ratio (12-month period) 1.50 5.84 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. On April 20, 2021, we completed the issuance of $350 million aggregate principal amount of senior notes due 2029 in a private placement exempt from registration under the Securities Act of 1933. The notes, which were priced at par, carry an interest rate of 4.75%. Following the completion of the offering, the Company amended and restated the credit agreement governing its existing $650 million senior secured credit facility to establish a new $700 million senior secured credit facility consisting of a $550 million revolving credit facility and a $150 million term loan facility. The maturity date for borrowings under the new senior secured credit facility was extended to April 2026. The new senior secured credit facility replaced the Company’s previously existing credit facility that 26 was due to mature in September 2024. In addition to being used to repay a portion of existing borrowings, the net proceeds resulting from these transactions were used for general corporate purposes, including in connection with the acquisitions completed subsequent to the end of the first quarter, and will support the Company's strategic objectives and other general business needs. CRITICAL ACCOUNTING POLICIES There have been no material changes to our critical accounting policies which are summarized in the MD&A in our Annual Report on Form 10-K for the year ended December 31, 2020. OTHER Seasonality Manufacturing operations in the RV, marine and MH industries historically have been seasonal and at their highest levels when the weather is moderate. Accordingly, the Company’s sales and profits had generally been the highest in the second quarter and lowest in the fourth quarter. Seasonal industry trends in the past several years have included the impact related to the addition of major RV manufacturer open houses for dealers in the August/September timeframe as well as marine open houses in the January/February timeframe, resulting in dealers delaying certain restocking purchases until new product lines are introduced at these shows. In addition, current and future seasonal industry trends may be different than in prior years due to the impact of national and regional economic conditions and consumer confidence on retail sales of RVs and other products for which the Company sells its components, timing of dealer orders, fluctuations in dealer inventories, the impact of the COVID-19 pandemic on consumer buying patterns, and from time to time, the impact of severe weather conditions on the timing of industry-wide wholesale shipments. Subsequent Events We evaluated all subsequent events and transactions that occurred after the balance sheet date through the date of issuance of the Form 10-Q that required recognition or disclosure in the condensed consolidated financial statements. See Note 17 of the Notes to Condensed Consolidated Financial Statements for further discussion of events occurring after March 28, 2021 until the filing date of this Form 10-Q. INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS The Company makes forward-looking statements with respect to financial condition, results of operations, business strategies, operating efficiencies or synergies, competitive position, growth opportunities for existing products, plans and objectives of management, markets for the common stock of Patrick Industries, Inc. and other matters from time to time and desires to take advantage of the “safe harbor” which is afforded such statements under the Private Securities Litigation Reform Act of 1995 when they are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statements. The statements contained in the foregoing “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, as well as other statements contained in this quarterly report and statements contained in future filings with the Securities and Exchange Commission (“SEC”), publicly disseminated press releases, quarterly earnings conference calls, and statements which may be made from time to time in the future by management of the Company in presentations to shareholders, prospective investors, and others interested in the business and financial affairs of the Company, which are not historical facts, are forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those set forth in the forward-looking statements. Any projections of financial performance or statements concerning expectations as to future developments should not be construed in any manner as a guarantee that such results or developments will, in fact, occur. There can be no assurance that any forward-looking statement will be realized or that actual results will not be significantly different from that set forth in such forward-looking statement. The Company does not undertake to publicly update or revise any forward-looking statements. Information about certain risks that could affect our 27 business and cause actual results to differ from those expressed or implied in the forward-looking statements are contained in the section entitled “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, and in the Company's Forms 10-Q for subsequent quarterly periods, which are filed with the SEC and are available on the SEC’s website at www.sec.gov.