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 Pr ivate Securities Litigation Reform Act of 1995. See “Information 19 Concerning Forward-Looking Statements” on page 34 of this Report. The Company undertakes no obligation to update these forward-looking statements. OVERVIEW OF MARKETS AND RELATED INDUSTRY PERFORMANCE First Quarter 2022 Financial Overview Recreational Vehicle ("RV") Industry The RV industry is our primary market and comprised 61% and 59% of the Company’s sales in the first quarter ended March 27, 2022 and March 28, 2021, respectively. Sales to the RV industry increased 64% in the first quarter of 2022, compared to the prior year period. According to the Recreation Vehicle Industry Association ("RVIA"), wholesale shipments totaled approximately 171,500 units in the first quarter of 2022, an increase of 15% compared to approximately 148,500 units in the first quarter of 2021. The increase in wholesale unit shipments in the first quarter of 2022 is attributed to continued RV dealer demand for RV units. This increase in dealer demand is correlated with continued consumer demand for RV units, as dealers replenish inventories to match consumer demand and prepare for expected continued momentum in the RV industry. We estimate RV retail unit sales decreased 10-15% in the first quarter of 2022 in comparison to the first quarter of 2021 (which was a record quarter in relation to historical first quarter trends). Marine Industry Sales to the marine industry, which represented approximately 16% of the Company's consolidated net sales in both the first quarters of 2022 and 2021, increased 62% in the first quarter of 2022 compared to the prior year quarter. Our marine revenue is generally correlated to marine wholesale powerboat unit shipments which, according to National Marine Manufacturers Association ("NMMA"), remained relatively constant for the first quarter of 2022 compared to the prior year period. Marine retail powerboat unit sales decreased an estimated 9% in the first quarter of 2022 compared to the prior year period, primarily as a result of a lack of retail units available for purchase due to low inventory levels. Estimated wholesale shipments slightly outpaced retail shipments in the first quarter of 2022, and we estimate that marine dealer inventory levels continue to remain low. Manufactured Housing ("MH") Industry Sales to the MH industry, which represented 13% and 14% of the Company’s sales in the first quarter of 2022 and 2021, respectively, increased 44% in the first quarter of 2022 compared to the first quarter of 2021 . Based on industry data from the Manufactured Housing Institute, MH wholesale unit shipments increased 11% in the first quarter of 2022 compared to the prior year period. Industrial Market The industrial market is comprised primarily of the kitchen cabinet and countertop industry, hospitality market, retail and commercial fixtures market, office and household furniture market and regional distributors. Sales to this market represented 10% and 11% of our sales in the first quarter of 2022 and 2021, respectively, and increased 39% in the first quarter of 2022 compared to the prior year quarter. Overall, our revenues in these markets are focused on the residential and multifamily housing, hospitality, high-rise housing and office, commercial construction and institutional furniture markets. We estimate that approximately 65% of our industrial business is directly tied to the residential housing market, with the remaining 35% directly tied to the non-residential and commercial markets. According to the U.S. Census Bureau, combined n ew housing starts increased 10% in the first quarter of 2022 compared to the prior year quarter, with single family housing starts increasing 4% and multifamily housing starts increasing 30% 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. 20 REVIEW OF CONSOLIDATED OPERATING RESULTS First Quarter Ended March 27, 2022 Compared to 2021 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 27, 2022 March 28, 2021 Amount Change % Change Net sales $ 1,342,175 100.0 % $ 850,483 100.0 % $ 491,692 58 % Cost of goods sold 1,046,830 78.0 % 688,951 81.0 % 357,879 52 % Gross profit 295,345 22.0 % 161,532 19.0 % 133,813 83 % Warehouse and delivery expenses 41,169 3.1 % 29,913 3.5 % 11,256 38 % Selling, general and administrative expenses 75,560 5.6 % 51,232 6.0 % 24,328 47 % Amortization of intangible assets 16,861 1.3 % 11,906 1.4 % 4,955 42 % Operating income 161,755 12.1 % 68,481 8.1 % 93,274 136 % Interest expense, net 14,886 1.1 % 11,179 1.3 % 3,707 33 % Income taxes 34,196 2.5 % 9,789 1.2 % 24,407 249 % Net income $ 112,673 8.4 % $ 47,513 5.6 % $ 65,160 137 % Net Sales . Net sales in the first quarter of 2022 increased $491.7 million, or 58%, to $1,342.2 million from $850.5 million in the first quarter of 2021. The net sales increase in the first quarter of 2022 reflects strong demand for our products across all end markets as well as the contribution of acquisitions completed in 2021. The Company's RV market sales increased 64%, marine market sales increased 62%, MH market sales increased 44% and industrial market sales increased 39% when compared to the prior year quarter. Revenue attributable to acquisitions completed in the first three months of 2022 was $8.4 million in the first quarter of 2022 . Revenue attributable to acquisitions completed in the first three months of 2021 was $5.4 million in the first quarter of 2021 . The Company’s RV content per wholesale unit (on a trailing twelve-month basis) for the first quarter of 2022 increased approximately 33% to $4,370 fr om $3,288 for the first quarter of 2021 . Marine powerboat content per wholesale unit (on a trailing twelve-month basis) for the first quarter of 2022 increased approximately 73% to an estimated $4,113 from $2,371 for the first quarter of 2021. MH content per wholesale unit (on a trailing twelve-month b asis) for the first quarter of 2022 increased approximately 19% to $5,501 from $4,611 for the first quarter of 2021 . Cost of Goods Sold. Cost of goods sold increased $357.8 million, or 52%, to $1,046.8 million in the first quarte r of 2022 from $689.0 million in 2021. As a percentage of net sales, cost of goods sold decreased 300 basis points during the first quarter of 2022 to 78.0% from 81.0% in 2021. Cost of goods sold as a percentage of net sales decreased in the first quarter 2022 primarily as a result of (i) continued cost reduction and automation initiatives we deployed throughout 2021 and into 2022 that have begun to have a positive impact on costs, (ii) volume-driven efficiencies as a result of leveraging fixed overhead, (iii) improved labor efficiencies as a result of investment in human capital and improved retention rates, and (iv) synergies and different cost profiles from acquisitions completed in 2021 and 2022. These four factors contributed to a 350 basis point decrease in labor as a percentage of net sales and 120 basis point decrease in overhead as a percentage of net sales, partially offset by a 170 basis point increase in material costs as a percentage of net sales as a result of supply-chain constraints, and an increase in 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 production. 21 Gross Profit. Gross profit increased $133.8 million, or 83%, to $295.3 million in the first quarter of 2022 from $161.5 million in 2021. As a percentage of net sales, gross profit increased 300 basis points to 22.0% in the first quarter of 2022 from 19.0% in the same period in 2021. The increase in gross profit as a percentage of net sales in the first quarter ended March 27, 2022 compared to the same period in 2021 reflects the impact of the factors discussed above under “Cost of Goods Sold”. Warehouse and Delivery Expenses . Warehouse and delivery expenses increased $11.3 million, or 38%, to $41.2 million in the first quarter of 2022 from $29.9 million in the first quarter of 2021. As a percentage of net sales, warehouse and delivery expenses decreased 40 basis points to 3.1% in the first quarter of 2022 compared to 3.5% in the first quarter of 2021. The increase in warehouse and delivery expenses is attributable to the increase in sales. However, the decrease as a percentage of net sales is primarily attributable to leveraging certain fixed warehousing costs and the lower proportion of MH sales in the first quarter of 2022 as compared to 2021, which have higher warehouse and delivery costs as a percentage of net sales. Selling, General and Administrative ("SG&A") Expenses . SG&A expenses increased $24.4 million, or 47%, to $75.6 million in the first quarter of 2022 from $51.2 million in the prior year quarter. As a percentage of net sales, SG&A expenses were 5.6% in the first quarter of 2022 compared to 6.0% in the first quarter of 2021. The increase in SG&A expenses in the first quarter of 2022 compared to 2021 is primarily due to (i) the increase in net sales, and (ii) increases in the breadth and depth of corporate resources, specifically our investments in human capital and other initiatives to support the size and growth of the Company. As a percentage of sales, SG&A expenses decreased 40 basis points for the first quarter of 2022 compared to the first quarter of 2021. This decrease is primarily a result of the fixed nature of certain SG&A expenses. Amortization of Intangible Assets. Amortization of intangible assets increased $5.0 million, or 42%, to $16.9 million in the first quarter of 2022 from $11.9 million in the prior year quarter. The increase in the first quarter of 2022 compared to the prior year period primarily reflects the impact of businesses acquired in 2021 and 2022. Operating Income. Operating income increased $93.3 million, or 136%, to $161.8 million in the first quarter of 2022 from $68.5 million in 2021. As a percentage of net sales, operating income increased 400 basis points to 12.1% in the first quarter of 2022 versus 8.1% in the same period in 2021. The change in operating income and operating margin is primarily attributable to the items discussed above. Interest Expense, Net. Interest expense increased $3.7 million, or 33%, to $14.9 million in the first quarter of 2022 from $11.2 million in the prior year period. The increase in interest expense reflects (i) increased borrowings related to 2021 acquisitions and (ii) the Company's issuance of its 4.75% Senior Notes in April 2021 and 1.75% Convertible Notes in December 2021. Income Taxes. Income tax expense increased $24.4 million in the first quarter of 2022 to $34.2 million from $9.8 million in the prior year period. The increase in income tax expense is due primarily to an increase in pretax income as well as an increase in the effective tax rate. The effective tax rate in the first quarter of 2022 and 2021 was 23.3% and 17.1%, respectively. The 2022 and 2021 rates include the impact of the recognition of excess tax benefits on share-based compensation that was recorded as a reduction to income tax expense in the amount of $4.0 million and $5.7 million, respectively. 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. 22 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. First Quarter Ended March 27, 2022 Compared to 2021 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 14 of the Notes to Condensed Consolidated Financial Statements. First Quarter Ended (thousands) March 27, 2022 March 28, 2021 Amount Change % Change Sales Manufacturing $ 998,585 $ 614,564 $ 384,021 62% Distribution 365,734 251,130 114,604 46% Gross Profit Manufacturing 236,286 120,926 115,360 95% Distribution 75,768 44,150 31,618 72% Operating Income Manufacturing 170,544 78,429 92,115 117% Distribution 45,966 21,175 24,791 117% Manufacturing Sales. Sales increased $384.0 million, or 62%, to $998.6 million in the first quarter of 2022 from $614.6 million in the prior year quarter. This segment accounted for approximately 73% and 71% of the Company’s sales for the first quarter of 2022 and 2021, respectively. The sales increase in the first quarter of 2022 compared to 2021 was attributed to sales increases in all four of the Company's end markets, where sales to the RV end market increased 73%, marine increased 57% , MH increased 50% and industrial increased 43%. Net sales in the first quarter of 2022 and 2021 attributable to acquisitions completed in the first three months of 2022 and 2021 was approximately $8.4 million and $4.8 million, respectively. Gross Profit . Gross profit increased $115.4 million, or 95%, to $236.3 million in the first quarter of 2022 from $120.9 million in the first quarter of 2021. As a percentage of sales, gross profit increased to 23.7% in the first quarter of 2022 from 19.7% in the first quarter of 2021. Gross profit margin increased during the first quarter of 2022 compared to first quarter of 2021 primarily due to a 220 basis point decrease in manufacturing labor as a percentage of sales and a 230 basis point decrease in manufacturing overhead as a percentage of sales, partially offset by a 50 basis point increase in manufacturing material expense as a percentage of sales as a result of supply-chain constraints and increased material costs. 23 Operating Income. Operating income increased $92.1 million, or 117%, to $170.5 million in the first quarter of 2022 from $78.4 million in the prior year quarter. The overall increase in operating income in the first quarter of 2022 primarily reflects the items discussed above. Distribution Sales. Sales increased $114.6 million, or 46%, to $365.7 million in the first quarter of 2022 from $251.1 million in the prior year quarter. This segment accounted for approximately 27% and 29% of the Company’s sales for the first quarter of 2022 and 2021, respectively. The sales increase in the first quarter of 2022 compared to the first quarter of 2021 was attributed to a 46% increase in our RV market sales, a 201% increase in marine market sales, a 38% increase in MH market sales, and a 6% increase in industrial market sales. Net sales in the first quarter of 2021 attributable to acquisitions completed in the first three months of 2021 was approximately $0.6 million. Gross Profit. Gross profit increased $31.6 million, or 72%, to $75.8 million in the first quarter of 2022 from $44.2 million in the first quarter of 2021. As a percentage of sales, gross profit increased to 20.7% in the first quarter of 2022 from 17.6% in the first quarter of 2021. Gross profit margin increased during the first quarter of 2022 compared to first quarter of 2021 primarily due to a 610 basis point decrease in distribution labor as a percentage of sales partially offset by a 300 basis point increase in distribution material expense as a percentage of sales as a result of supply-chain constraints and increased material costs. Operating Income. Operating income increased $24.8 million, or 117%, to $46.0 million in the first quarter of 2022 from $21.2 million in the prior year quarter. The improvement in operating income in the first quarter of 2022 primarily reflects the items discussed above. LIQUIDITY AND CAPITAL RESOURCES Our liquidity at March 27, 2022 consisted of cash and cash equivalents of $63.8 million and $255.6 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 used in operating activities was $23.0 million in the first quarter of 2022 compared to net cash provided by operating activities of $50.3 million in the first quarter of 2021. The change is primarily attributable to an increase in use of cash for net working capital of $140.3 million, associated primarily with investments in inventory to support customer needs and growth of accounts receivable in line with net sales. This use of cash was partially offset by a source of cash from (i) a $65.2 million increase in net income and (ii) a $7.7 million increase in depreciation and amortization. Investing Activities Net cash used in investing activities increased $98.1 million to $143.1 million in the first quarter of 2022 from $45.0 million in the first quarter of 2021 primarily due to an increase in cash used in business acquisitions of $102.7 million. Financing Activities Net cash provided by financing activities was $107.2 million in the first quarter of 2022 compared to a $43.8 million use of cash in the first quarter of 2021. This change is primarily due to (i) $154.0 million in net revolver borrowings in the first quarter of 2022 compared to $27.0 million in net revolver repayments in the first quarter of 2021 and (ii) a $4.5 million decrease in taxes paid for share-based payment arrangements, partially offset by a $26.5 million increase in stock repurchases and dividends to shareholders. 24 Summary of Liquidity and Capital Resources At March 27, 2022, the Company's existing cash and cash equivalents, cash generated from operations, and available borrowings under its current 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. The ability to access unused borrowing capacity under the Company's current 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 credit facility (the "2021 Credit Agreement"). As of and for the reporting period ended March 27, 2022, the Company was in compliance with its financial covenants as required under the terms of its 2021 Credit Agreement. The required maximum consolidated secured net leverage ratio and the required minimum consolidated fixed charge coverage ratio, as such ratios are defined in the 2021 Credit Agreement, compared to the actual amounts as of March 27, 2022 and for the fiscal period then ended are as follows: Required Actual Consolidated secured net leverage ratio (12-month period) 2.75 0.54 Consolidated fixed charge coverage ratio (12-month period) 1.50 6.73 In addition, as of March 27, 2022, the Company's consolidated total net leverage ratio (12-month period) was 2.24. While this ratio was a covenant under the Company’s credit agreement in existence prior to the 2021 Credit Agreement, it is not a covenant under the 2021 Credit Agreement. However, it is used in the determination of the applicable borrowing margin under the 2021 Credit Agreement. Working capital requirements vary from period to period depending on manufacturing volumes primarily related to the RV, MH, marine and 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. 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, 2021. 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. 25 Russia-Ukraine War In February 2022, Russia invaded Ukraine. As military activity proceeds and sanctions, export controls and other measures are imposed against Russia, Belarus and specific areas of Ukraine, the war is increasingly affecting the global economy and financial markets, as well as exacerbating ongoing economic challenges, including rising inflation and global supply-chain disruption. We will continue to monitor the impacts of the Russia-Ukraine war on macroeconomic conditions and continually assess the effect these matters may have on consumer demand, our suppliers’ ability to deliver products, cybersecurity risks and our liquidity and access to capital. See “Risk Factors — Risks Related to Our Business” below. 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. 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 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, 2021, 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.