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 34 of this Report. The Company undertakes no obligation to update these forward-looking statements. 18 OVERVIEW OF MARKETS AND RELATED INDUSTRY PERFORMANCE First Quarter 2023 Financial Overview Recreational Vehicle ("RV") Industry The RV industry is our primary market and comprised 41% and 61% of the Company’s consolidated net sales in the first quarter ended April 2, 2023 and March 27, 2022, respectively. Net sales to the RV industry decreased 55% in the first quarter of 2023 compared to the prior year period. According to the Recreation Vehicle Industry Association ("RVIA"), RV wholesale shipments decreased 54% in the first quarter of 2023 to approximately 78,600 units from approximately 171,900 units in the first quarter of 2022. While we estimate RV industry retail unit sales for the first quarter of 2023 decreased approximately 8% compared to the first quarter of 2022, industry retail sales still exceeded wholesale shipments in the first quarter of 2023 as RV OEMs reduced production to maintain a more balanced inventory channel in alignment with lower retail demand primarily related to macroeconomic conditions. Marine Industry Net sales to the marine industry, which represented approximately 31% and 16% of the Company's consolidated net sales in the first quarter ended April 2, 2023 and March 27, 2022, respectively, increased 25% in the first quarter of 2023 compared to the prior year period. The increase in net sales beyond industry volumes is driven primarily by acquisitions completed in 2022, product mix, and market share gains. Our marine revenue is generally correlated to marine industry wholesale powerboat unit shipments, which, according to Company estimates based on data published by the National Marine Manufacturers Association ("NMMA"), increased 14% for the first quarter of 2023 compared to the prior year period. We estimate that marine industry retail powerboat unit sales decreased an estimated 19% in the first quarter of 2023 compared to the prior year period primarily due to the current macroeconomic environment faced by the end consumer. Estimated wholesale shipments were higher than estimated retail unit sales as dealer inventories increased from recent historically low levels. Manufactured Housing ("MH") Industry Net sales to the MH industry, which represented 15% and 13% of the Company’s consolidated net sales in the first quarter of 2023 and 2022, respectively, decreased 23% in the first quarter of 2023 compared to the prior year period. Based on industry data from the Manufactured Housing Institute, MH industry wholesale unit shipments decreased 29% in the first quarter of 2023 compared to the prior year period primarily driven by persistent inflation and elevated interest rates that caused OEMs to adjust production based on anticipated lower consumer demand. 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. Net sales to this market represented 13% and 10% of our consolidated net sales in the first quarter of 2023 and 2022, respectively, and decreased 3% in the first quarter of 2023 compared to the prior year period. Overall, our revenues in these markets are focused on residential and multifamily housing, hospitality, high-rise housing and office, commercial construction and institutional furniture markets. We estimate that, in general, approximately 70-80% of our industrial business is directly tied to the residential housing market, with the remaining 20-30% directly tied to the non-residential and commercial markets. According to the U.S. Census Bureau, combined new housing starts decreased 18% in the first quarter of 2023 compared to the prior year quarter, due to industry headwinds from elevated interest rates, persistent inflation and decreased housing affordability, particularly in the single-family market. Single-family housing starts decreased 29% compared to the prior year period, while multifamily housing starts increased 5% 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. 19 REVIEW OF CONSOLIDATED OPERATING RESULTS First Quarter Ended April 2, 2023 Compared to 2022 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) April 2, 2023 March 27, 2022 Amount Change % Change Net sales $ 900,100 100.0 % $ 1,342,175 100.0 % $ (442,075) (33) % Cost of goods sold 705,856 78.4 % 1,046,830 78.0 % (340,974) (33) % Gross profit 194,244 21.6 % 295,345 22.0 % (101,101) (34) % Warehouse and delivery expenses 35,845 4.0 % 41,169 3.1 % (5,324) (13) % Selling, general and administrative expenses 82,401 9.2 % 75,560 5.6 % 6,841 9 % Amortization of intangible assets 19,764 2.2 % 16,861 1.3 % 2,903 17 % Operating income 56,234 6.2 % 161,755 12.1 % (105,521) (65) % Interest expense, net 18,484 2.1 % 14,886 1.1 % 3,598 24 % Income taxes 7,577 0.8 % 34,196 2.5 % (26,619) (78) % Net income $ 30,173 3.4 % $ 112,673 8.4 % $ (82,500) (73) % Net Sales . Net sales in the first quarter of 2023 decreased $442.1 million, or 33%, to $900.1 million from $1,342.2 million in the first quarter of 2022. The net sales decrease in the first quarter of 2023 reflects growth in our marine end market, market share gains, and the contribution of acquisitions completed in 2022 that partially offset a $454 million decline in RV revenues in the quarter resulting from the continued reduction of production by our RV OEM customers and a $40 million decline in manufactured housing net sales due to industry headwinds from elevated financing rates and persistent inflation. The Company's RV market sales decreased 55%, marine market sales increased 25%, MH market sales decreased 23% and industrial market sales decreased 3% 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 . There were no acquisitions completed in the first three months of 2023. The Company’s RV content per wholesale unit (on a trailing twelve-month basis) for the first quarter of 2023 increased approximately 22% to $5,349 fr om $4,367 for the first quarter of 2022 . Marine powerboat content per wholesale unit (on a trailing twelve-month basis) for the first quarter of 2023 increased approximately 27% to an estimated $5,266 from $4,144 for the first quarter of 2022. MH content per wholesale unit (on a trailing twelve-month b asis) for the first quarter of 2023 increased approximately 16% to $6,366 from $5,487 for the first quarter of 2022 . These increases in content per wholesale unit reflect market share gains, contributions from businesses acquired in 2022, and favorable pricing. Cost of Goods Sold. Cost of goods sold decreased $340.9 million, or 33%, to $705.9 million in the first quarte r of 2023 from $1,046.8 million in 2022. As a percentage of net sales, cost of goods sold increased 40 basis points during the first quarter of 2023 to 78.4% from 78.0% in the prior year period. Cost of goods sold as a percentage of net sales increased in the first quarter of 2023 primarily as a result of reduced industry volume mentioned above that provided less favorable fixed cost absorption when compared to the prior period. This industry volume-driven impact was partially offset by (i) continued cost reduction and automation initiatives we deployed throughout 2022 and into 2023 that had a positive impact on material costs, (ii) improved labor efficiencies as a result of investment in human capital and improved retention rates, and (iii) synergies and different cost profiles from acquisitions completed in 2022. For the first quarter of 2023, these factors contributed to a 320 basis point increase in overhead as a percentage of net sales, partially offset by a 20 basis point decrease in labor as a percentage of net sales and a 260 basis point decrease in material costs as a percentage of net sales. 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. 20 Gross Profit. Gross profit decreased $101.1 million, or 34%, to $194.2 million in the first quarter of 2023 from $295.3 million in the prior year period. As a percentage of net sales, gross profit decreased 40 basis points to 21.6% in the first quarter of 2023 from 22.0% in the same period in the prior year period. The decrease in gross profit as a percentage of net sales in the first quarter of 2023 compared to the same period in 2022 reflects the impact of the factors discussed above under “Cost of Goods Sold”. Warehouse and Delivery Expenses . Warehouse and delivery expenses decreased $5.4 million, or 13%, to $35.8 million in the first quarter of 2023 from $41.2 million in the first quarter of 2022. As a percentage of net sales, warehouse and delivery expenses increased 90 basis points to 4.0% in the first quarter of 2023 compared to 3.1% in the first quarter of 2022. The decrease in warehouse and delivery expenses in the first quarter of 2023 compared to the same period in 2022 is attributable to the decrease in sales. The increase as a percentage of net sales in the first quarter of 2023 as compared to the same 2022 period is primarily attributable to elevated fuel prices, increased insurance rates, and the fixed-cost nature of some warehouse and delivery expenses. Selling, General and Administrative ("SG&A") Expenses . SG&A expenses increased $6.8 million, or 9%, to $82.4 million in the first quarter of 2023 from $75.6 million in the prior year quarter. As a percentage of net sales, SG&A expenses were 9.2% in the first quarter of 2023 compared to 5.6% in the first quarter of 2022. The increase in SG&A expenses in the first quarter of 2023 compared to 2022 is primarily due to continued investments to increase the breadth and depth of corporate resources, specifically human capital, technology and other initiatives to support the size and growth of the Company. As a percentage of sales, SG&A expenses increased 360 basis points for the first quarter of 2023 compared to the first quarter of 2022. This increase primarily reflects these continued investments, the decrease in net sales and the fixed-cost nature of certain SG&A expenses. In addition, certain acquisitions completed in 2022 have higher sales and marketing expenses as a percentage of sales than our other businesses. Additionally, SG&A in the first quarter of 2022 includes a $5.5 million pre-tax gain on sale of property. Amortization of Intangible Assets. Amortization of intangible assets increased $2.9 million, or 17%, to $19.8 million in the first quarter of 2023 from $16.9 million in the prior year quarter. The increase in the first quarter of 2023 compared to the prior year period primarily reflects the impact of businesses acquired in 2022. Operating Income. Operating income decreased $105.6 million, or 65%, to $56.2 million in the first quarter of 2023 from $161.8 million in 2022. As a percentage of net sales, operating income decreased 590 basis points to 6.2% in the first quarter of 2023 versus 12.1% in the same period in 2022. The change in operating income and operating margin is primarily attributable to the items discussed above. Interest Expense, Net. Interest expense increased $3.6 million, or 24%, to $18.5 million in the first quarter of 2023 from $14.9 million in the prior year period. This increase primarily reflects the increase in interest rates on our variable rate debt, as well as repayment of our 1.00% Convertible Senior Notes due 2023 at maturity through borrowings under our revolving credit facility, which has a comparatively higher interest rate. Income Taxes. Income tax expense decreased $26.6 million in the first quarter of 2023 to $7.6 million from $34.2 million in the prior year period. The decrease in income tax expense is driven primarily by the decrease in income before income taxes. Additionally, the first quarter of 2023 and 2022 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 $2.3 million and $4.0 million, respectively. 21 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 Company estimates of industry unit volume, which are derived from third-party industry data. 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. First Quarter Ended April 2, 2023 Compared to 2022 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 12 of the Notes to Condensed Consolidated Financial Statements. First Quarter Ended (thousands) April 2, 2023 March 27, 2022 Amount Change % Change Sales Manufacturing $ 708,815 $ 998,585 $ (289,770) (29)% Distribution 210,159 365,734 (155,575) (43)% Gross Profit Manufacturing 155,084 236,286 (81,202) (34)% Distribution 44,077 75,768 (31,691) (42)% Operating Income Manufacturing 87,165 170,544 (83,379) (49)% Distribution 18,307 45,966 (27,659) (60)% Manufacturing Sales. Sales decreased $289.8 million, or 29%, to $708.8 million in the first quarter of 2023 from $998.6 million in the prior year quarter. This segment accounted for approximately 77% and 73% of the Company’s sales for the first quarter of 2023 and 2022, respectively. The sales decrease in the first quarter of 2023 compared to 2022 was attributed to sales decreases in the Company's RV, MH and industrial markets due to reduced industry wholesale unit shipments in the RV and MH industries and previous slowing of housing starts, partially offset by growth in our marine market sales resulting from market share gains and acquisitions completed in 2022. The Company's RV end-market sales decreased 56%, the marine end-market sales increased 26% , the MH end-market sales decreased 24% and industrial end-market sales decreased 2%. Net sales in the first quarter of 2022 attributable to acquisitions completed in the first three months of 2022 was approximately $8.4 million. There were no acquisitions completed in the first three months of 2023. 22 Gross Profit . Gross profit decreased $81.2 million, or 34%, to $155.1 million in the first quarter of 2023 from $236.3 million in the first quarter of 2022. As a percentage of sales, gross profit decreased to 21.9% in the first quarter of 2023 from 23.7% in the first quarter of 2022. Gross profit as a percentage of sales decreased during the first quarter of 2023 compared to first quarter of 2022 due to a 420 basis point increase in manufacturing overhead as a percentage of sales and a 100 basis point increase in manufacturing labor as a percentage of sales, partially offset by a 340 basis point decrease in manufacturing material expense as a percentage of sales. Operating Income. Operating income decreased $83.3 million, or 49%, to $87.2 million in the first quarter of 2023 from $170.5 million in the prior year quarter. The overall decrease in operating income in the first quarter of 2023 primarily reflects the items discussed above. Distribution Sales. Sales decreased $155.5 million, or 43%, to $210.2 million in the first quarter of 2023 from $365.7 million in the prior year quarter. This segment accounted for approximately 23% and 27% of the Company’s sales for the first quarter of 2023 and 2022, respectively. The sales decrease in the first quarter of 2023 compared to the first quarter of 2022 was attributed to a 54% decrease in our RV market sales and a 22% decrease in MH market sales as a result of reduced industry wholesale unit shipments in the respective industries, as well as a 9% decrease in industrial sales, partially offset by a 10% increase in marine market sales. None of the net sales in the first quarter of 2023 or 2022 were attributable to acquisitions completed in the first three months of 2023 or 2022. Gross Profit. Gross profit decreased $31.7 million, or 42%, to $44.1 million in the first quarter of 2023 from $75.8 million in the first quarter of 2022. As a percentage of sales, gross profit increased to 21.0% in the first quarter of 2023 from 20.7% in the first quarter of 2022. Gross profit as a percentage of sales increased during the first quarter of 2023 compared to first quarter of 2022 primarily due to a 260 basis point decrease in distribution labor as a percentage of sales primarily attributable to a decrease in utilization of outsourced labor, partially offset by a 230 basis point increase in distribution material expense as a percentage of sales as a result of increased material costs. Operating Income. Operating income decreased $27.7 million, or 60%, to $18.3 million in the first quarter of 2023 from $46.0 million in the prior year quarter. The decrease in operating income in the first quarter of 2023 primarily reflects the items discussed above. LIQUIDITY AND CAPITAL RESOURCES Our liquidity at April 2, 2023 consisted of cash and cash equivalents of $30.8 million and $457.9 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 $1.0 million in the f i rst quarter of 2023 compared to net cash used in operating activities of $23.0 million in the f i rst quarter of 2022. The change in operating cash flows is primarily attributable to a $93.7 million reduction in cash used for working capital, substantially offset by an $82.5 million reduction in net income. Investing Activities Net cash used in investing activities decreased $119.5 million to $23.6 million in the f i rst quarter of 2023 from $143.1 million in the f i rst quarter of 2022 primarily due to a decrease in cash used in business acquisitions of $131.1 million. 23 Financing Activities Net cash provided by financing activities was $32.5 million in the f i rst quarter of 2023 compared to $107.2 million in the f i rst quarter of 2022. In the first quarter of 2023, borrowings under our revolving credit facility, net of revolver and term loan repayments and the repayment of our 1.00% Convertible Senior Notes due 2023 at maturity, were $55.3 million, compared to borrowings under our revolving credit facility, net of revolver repayments, of $154.0 million in the first quarter of 2022. In addition, there was a $21.1 million decrease in stock repurchases in the first quarter of 2023 compared to the prior year quarter. Summary of Liquidity and Capital Resources At April 2, 2023, 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 senior 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 governing the credit facility (the "2021 Credit Agreement"). As of and for the reporting period ended April 2, 2023, 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 April 2, 2023 and for the fiscal period then ended are as follows: Required Actual Consolidated secured net leverage ratio (12-month period) 2.75 0.74 Consolidated fixed charge coverage ratio (12-month period) 1.50 3.86 In addition, as of April 2, 2023, the Company's consolidated total net leverage ratio (12-month period) was 2.34, which is used to determine 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, 2022. 24 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 15 of the Notes to Condensed Consolidated Financial Statements for further discussion of events occurring after April 2, 2023 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 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, 2022, 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.