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PATK > SEC Filings for PATK > Form 10-Q on 13-Nov-2012All Recent SEC Filings

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Form 10-Q for PATRICK INDUSTRIES INC


13-Nov-2012

Quarterly Report


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 42 of this Report. The Company undertakes no obligation to update these forward-looking statements.

The MD&A is divided into seven major sections:

OVERVIEW OF MARKETS AND RELATED INDUSTRY PERFORMANCE

REVIEW OF CONSOLIDATED OPERATING RESULTS
Third Quarter and Nine Months Ended September 30, 2012 Compared to 2011

REVIEW BY BUSINESS SEGMENT
General
Third Quarter and Nine Months Ended September 30, 2012 Compared to 2011 Unallocated Corporate Expenses

LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
Capital Resources
Summary of Liquidity and Capital Resources

CRITICAL ACCOUNTING POLICIES

OTHER
Seasonality
Inflation

INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS

OVERVIEW OF MARKETS AND RELATED INDUSTRY PERFORMANCE

Summary

The third quarter and nine months ended of 2012 reflected a continuation of growth in the recreational vehicle ("RV") market and signs of a mild recovery in the manufactured housing ("MH") and industrial markets. We are continuing to capture market share through our strategic acquisition and new product initiatives, which resulted in sales levels increasing beyond the general industry results. While there remains general uncertainty related to the strength of the overall economy, jobs growth, the European debt crisis, the impact of the November 2012 Presidential elections, and retail and commercial credit and lending conditions, the industries that we serve have experienced, and are expected to continue to experience moderate and steady through at least the remainder of 2012 and into the first quarter of 2013 in all three of our primary markets with seasonal patterns tracking consistent with the prior year.

For full year 2012, we are currently estimating an approximate 12% increase in RV wholesale unit shipments over the same period in the prior year. Although we expect an increase in production levels in the MH industry in 2012, we believe that wholesale unit shipments in this industry will continue to be well below the levels seen during the period of 2004 through 2007. The National Association of Home Builders (as of November 2, 2012) is forecasting a 24% increase in new housing starts in 2012 compared to 2011 that is consistent with slowly improving overall economic conditions.


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RV Industry

The RV industry, which is our primary market and represented 69% of the Company's nine months 2012 sales, continued to strengthen in the first nine months of 2012, as evidenced by an increase of approximately 11% in wholesale unit shipments in the first nine months of 2012 versus the comparable 2011 period, according to the Recreational Vehicle Industry Association ("RVIA"). In the third quarter of 2012, unit shipment levels increased 19% compared to 2011, reflecting the tenth quarter over quarter increase in shipments in the previous 11 quarters. Industry-wide retail sales and the related production levels of RVs will depend to a significant extent on the course of the economy and consumer confidence. Continued high or increased fuel prices have the potential to negatively impact RV retail unit sales in the short-term. However, we believe that the RV "lifestyle" will continue to drive a solid base shipment level. Additionally, we believe there is a positive correlation between equity market performance, consumer confidence, and RV shipment levels, and therefore, it is our assumption that the RV industry has a positive longer-term outlook as overall economic conditions and consumer confidence improve.

Although some consumers still remain cautious when deciding whether or not to purchase discretionary items, such as RVs, long-term demographic trends favor RV industry growth fueled by the anticipated positive impact that aging baby boomers are estimated to have on the industry as the industry continues its recovery from the recent economic recession. In particular, lifestyle trends continue to spur demand for RVs and RV manufacturers in response are right-sizing their products to provide an optimal mix of size, amenities and price to budget-conscious consumers. According to the RVIA, buyers aged 35-54 are the largest segment of RV owners. In addition, 8.9 million or 8.5% of U.S. households own an RV which equates to a 16% increase since 2001 and a 64% gain since 1980.

Factors that may favorably impact production levels further in this industry include stronger economic growth, increased jobs growth, and easing consumer credit. Wholesale unit shipments of RVs in 2006 totaled 390,500, the highest total in the past 25 years. After five consecutive years of record growth, RV shipments declined 9.5% in 2007 as consumers postponed purchases because of early effects of the U.S. economic downturn. Shipments fell further in 2008 and 2009 by 33% and 30%, respectively, due to the economic recession. A 46% increase in unit shipments in the RV market in 2010 and a 4% increase in 2011 compared to the continued softness during this period in the other primary market sectors in which Patrick operates, and the acquisitions completed in 2011 and thus far in 2012, contributed to an increase in our RV market sales concentration in the third quarter and first nine months of 2012 when compared to the prior year periods.

MH Industry

The MH industry, which showed signs of a mild recovery in the first nine months of 2012, represented approximately 19% of the Company's nine months 2012 sales. This industry continues to be negatively impacted by slow jobs growth, a lack of retail financing and credit availability, and significant foreclosed residential housing inventories. According to industry sources, wholesale unit shipments, which continue to trend well below historical levels, increased approximately 1% from the third quarter of 2011 and 13% on a year-to-date basis versus the comparable prior year period. We believe that demand in the MH industry has reached the bottom of the cycle and we expect moderate growth assuming the availability of credit and recalibration of quality credit standards. Additionally, manufactured housing provides a cost effective alternative for those individuals and families seeking to establish home ownership or whose credit ratings have been impacted by the economic and jobs environment over the past three years. We also believe manufactured housing to be an attractive option for those who have migrated to temporary housing alternatives. Factors that may favorably impact production levels further in this industry include quality credit standards in the residential housing market, job growth, favorable changes in financing laws, new tax credits for new home buyers and other government incentives, and higher interest rates on traditional residential housing loans. Based on the industry's current annualized run rates, the Company projects wholesale MH unit shipments for the full year 2012 to increase by approximately 6% compared to 2011.


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Industrial Market

The industrial market, which comprises primarily the kitchen cabinet industry, retail and commercial fixture market, household furniture market and regional distributors, is primarily impacted by macroeconomic conditions, and more specifically, conditions in the residential housing market. The industrial market sector, which accounted for approximately 12% of the Company's sales in the first nine months of 2012, saw new housing starts for the third quarter of 2012 and the first nine months of 2012 increase by approximately 28% and 27%, respectively, from the comparable periods in 2011 (as reported by the U.S. Department of Commerce). We estimate approximately 60% of our industrial revenue base is directly tied to the residential housing market, and we believe there is a direct correlation between the demand for our products in this market and new residential housing construction and remodeling activities. Our sales to this market generally lag new residential housing starts by six to twelve months. In order to offset some of the impacts of the weakness in the residential housing market, we have focused on diversification efforts, strategic acquisitions, and bringing new and innovative products to the market, and have targeted certain sales efforts towards market segments that are less directly tied to residential new home construction, including the retail fixture, furniture, and countertop markets. As a result, we have seen a shift in our product mix which has had a positive impact on revenues from the industrial markets.

We remain cautious about further growth in the industrial sector due to restricted credit conditions and current uncertainty related to general economic conditions and the large numbers of repossessed homes in the marketplace. In the long-term, we believe residential housing growth will be based on job growth, the availability of credit, affordable interest rates, and continuing government incentives to stimulate housing demand and reduce surplus inventory due to foreclosures.

2012 Outlook

We believe we are well-positioned to increase revenues in all of the markets that we serve as the overall economic environment improves. While our visibility related to sustained longer term industry strength is limited, as we navigate through the remainder of 2012 in anticipation of moderate, relatively steady improvement in market conditions in all three of the markets we serve, we will continue to review our operations on a regular basis, balance appropriate risks and opportunities, and maximize efficiencies to support the Company's long-term strategic growth goals. Our team remains focused on strategic acquisitions, capturing market share and increasing our per unit content, keeping costs aligned with revenue, maximizing operating efficiencies, talent management, and the execution of our organizational strategic agenda. We will continue to size our operating platform according to the revenue base. Key focus areas for the balance of 2012 include strategic revenue growth, improved net income, earnings per share and earnings before interest, taxes, depreciation and amortization ("EBITDA"), working capital management and liquidity maximization. Additional focus areas include:

ˇ sales into additional commercial/institutional markets to diversify revenue base;

ˇ further improvement of operating efficiencies in all manufacturing operations and corporate functions;

ˇ acquisition of businesses/product lines that meet established criteria;

ˇ aggressive management of inventory quantities and pricing, and the addition of select key commodity suppliers; and

ˇ ongoing development of existing product lines and the addition of new product lines.

In conjunction with our organizational strategic agenda, we will continue to make targeted capital investments to support new business and leverage our operating platform, and we will work to more fully integrate sales efforts to strengthen and broaden customer relationships and meet customer demands with high quality service that exceeds our customers' expectations. In the first nine months of 2012, capital expenditures were approximately $5.3 million. The capital plan for full year 2012 includes spending related to the replacement of our current management information systems, new manufacturing equipment to support our 2012 strategic and acquisition initiatives, the acquisition of a building in the Midwest to increase capacity to support the growth in one of our manufacturing divisions, and the replacement of or enhancements to existing production line equipment at several of our manufacturing operations. In September 2012, our 2011 Credit Agreement (as defined herein) was amended to increase the limitation on annual capital expenditures to $6.7 million in order to accommodate the forecasted increase in our capital expenditure needs as described above for the full year 2012.


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REVIEW OF CONSOLIDATED OPERATING RESULTS

Third Quarter and Nine Months Ended September 30, 2012 Compared to 2011

The following table sets forth the percentage relationship to net sales of
certain items on the Company's condensed consolidated statements of operations.

                                        Third Quarter Ended              Nine Months Ended
                                     Sept. 30,         Sept. 25,      Sept. 30,        Sep.25,
                                          2012              2011           2012           2011
Net sales                                100.0 %           100.0 %        100.0 %        100.0 %
Cost of goods sold                        85.0              83.0           84.6           85.6
Gross profit                              15.0              17.0           15.4           14.4
Warehouse and delivery expenses            3.6               4.6            3.5            4.4
Selling, general and
administrative expenses                    4.8               5.4            4.9            5.3
Amortization of intangible assets          0.3               0.2            0.3            0.2
Gain on sale of fixed assets and
acquisition of business                   (0.2 )               -           (0.1 )         (0.1 )
Operating income                           6.5               6.8            6.8            4.6
Stock warrants revaluation                (0.1 )            (0.1 )          0.5              -
Interest expense, net                      0.8               1.0            0.7            1.6
Income tax credit                            -                 -           (2.0 )            -
Net income                                 5.8               5.9            7.6            3.0

Net Sales. Net sales in the third quarter of 2012 increased $35.5 million or 45.9%, to $112.9 million from $77.4 million in the comparable prior year period. The sales increase in the quarter reflected a 66% increase in the Company's revenue from the RV industry and a 13% increase in revenue from the MH industry. Approximately $18.7 million of the revenue improvement was attributable to acquisitions completed in 2011 and 2012: The Praxis Group ("Praxis") in June 2011; A.I.A. Countertops, LLC ("AIA") in September 2011; Performance Graphics in December 2011; Décor Mfg., LLC ("Décor") in March 2012; Gustafson Lighting ("Gustafson") in July 2012; and Creative Wood Designs, Inc. ("Creative Wood") in September 2012. The remaining $16.8 million increase is primarily attributable to increased RV market penetration and a 19% increase in quarterly wholesale unit shipments in the RV industry. The RV industry represented approximately 68% of the Company's sales in the third quarter of 2012.

For the nine months ended September 30, 2012, net sales increased $101.7 million or 44.3%, to $331.2 million from $229.5 million in the prior year period, primarily reflecting improving conditions in the RV industry, increased raw material commodity prices which were passed through to customers, the acquisitions mentioned above (which in aggregate contributed $46.5 million of the sales increase), and improved retail fixture and residential furniture sales in the industrial market. The RV industry, which represented approximately 69% of the Company's sales in the nine months of 2012, saw wholesale unit shipments increase by approximately 11% in the first nine months of 2012 compared to 2011.

The MH industry, which represented 20% of the Company's third quarter 2012 sales, experienced a 1% increase in wholesale unit shipments compared to the prior year period. Partially offsetting the sales increase is the impact of the vertical integration efforts of one of our larger customers in the MH market that is producing in-house one of the product lines for certain of its facilities that we had previously been supplying. In addition, that same customer has set up distribution centers which provide certain product lines to several of its own manufacturing facilities that we had previously been supplying. For the first nine months of 2012, the MH industry represented approximately 19% of the Company's sales. On a year-to-date basis, MH unit shipments increased approximately 13% from 2011.

The industrial market sector accounted for approximately 12% of the Company's third quarter and nine months 2012 sales. We estimate that approximately 60% of our industrial revenue base is linked to the residential housing market, which experienced an increase in new housing starts of approximately 28% and 27% for the third quarter and first nine months of 2012, respectively, compared to the prior year periods (as reported by the U.S. Department of Commerce). As discussed above, as a result of our efforts to diversify into industrial market segments less directly tied to residential new home construction, we have seen an increase in our revenue from the institutional fixture, furniture and countertop markets, among others. Sales to the industrial market sector, which is primarily tied to the residential housing and commercial and retail fixture markets, increased 14% in the first nine months of 2012 from the prior year period.


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Cost of Goods Sold. Cost of goods sold increased $31.8 million or 49.5%, to $96.0 million in third quarter 2012 from $64.2 million in 2011. For the first nine months of 2012, cost of goods sold increased $83.6 million or 42.6%, to $280.1 million from $196.5 million in the prior year period. As a percentage of net sales, cost of goods sold increased during the quarter to 85.0% from 83.0% in 2011. For the first nine months of 2012, cost of goods sold as a percentage of net sales decreased to 84.6 % from 85.6% in the prior year period.

General fluctuations in the costs of commodities used in the manufacture of our products negatively impacted cost of goods sold as a percentage of net sales in the third quarter of 2012 compared to 2011. Cost of goods sold as a percentage of net sales was positively impacted during the first nine months of 2012 by:
(i) increased revenues relative to our overall fixed overhead cost, (ii) the impact of acquisitions completed during 2011 and 2012, (iii) increased distribution segment revenues and gross profit compared to the third quarter and nine months periods in 2011, (iv) and actions to reduce or eliminate negative margins on certain products.

In addition, higher energy costs and increased demand in certain market sectors have resulted in fluctuating costs of certain raw materials that we utilize and distribute. The Company continues to explore alternative sources of raw materials and components, both domestically and from overseas.

Gross Profit. Gross profit increased $3.7 million or 28.1%, to $16.9 million in third quarter 2012 from $13.2 million in third quarter 2011. For the nine months periods, gross profit increased $18.1 million or 54.7%, to $51.2 million in 2012 from $33.1 million in 2011. As a percentage of net sales, gross profit decreased to 15.0% in third quarter 2012 from 17.0% in the same period in 2011 and increased to 15.4% in the first nine months of 2012 from 14.4% in the prior year period.

The decline in gross profit as a percentage of net sales for the third quarter of 2012 primarily reflects the impact of fluctuations in the costs of commodities used in our manufacturing operations compared to the prior year as mentioned above. The improvement in gross profit dollars and percentage of net sales in the nine month 2012 period compared to 2011 reflected the positive impact of the factors discussed above under "Cost of Goods Sold" including the positive contribution to gross profit of the acquisitions noted above. We believe these acquisitions will provide positive contribution to our operating profitability going forward.

Economic or industry-wide factors affecting the profitability of our RV, MH, and industrial businesses include the costs of commodities used to manufacture our products and the competitive environment which can cause gross margins to fluctuate from quarter to quarter and year to year. We currently estimate gross profit margins for the fourth quarter of 2012 to be in a range consistent with gross profit margins for the full year 2011 and the first three quarters of 2012 subject to the above and other factors.

Warehouse and Delivery Expenses. Warehouse and delivery expenses increased $0.6 million or 15.5%, to $4.1 million in third quarter 2012 from $3.5 million in third quarter 2011. For the nine months, warehouse and delivery expenses increased $1.6 million or 15.6%, to $11.7 million in 2012 from $10.1 million in 2011. The expense increase in both the third quarter and the first nine months of 2012 was primarily attributable to increased sales volumes.

As a percentage of net sales, warehouse and delivery expenses were 3.6% and 4.6% in third quarter 2012 and 2011, respectively, and 3.5% and 4.4% for the comparable nine months periods. The decrease as a percentage of net sales for both the third quarter and first nine months of 2012 reflected the better utilization of our truckload delivery capacities as a result of higher sales volumes, and the impact of increased distribution sales volume compared to its associated fixed costs.


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Selling, General and Administrative (SG&A) Expenses. SG&A expenses increased $1.2 million or 27.7%, to $5.4 million in third quarter 2012 from $4.2 million in third quarter 2011. For the nine months, SG&A expenses increased $4.1 million or 33.7%, to $16.3 million in 2012 from $12.2 million in 2011. Additional headcount associated with recent acquisitions and an increase in accrued incentive compensation related to higher levels of operating profits contributed to a net increase in selling and administrative wages, incentives and payroll taxes in both the third quarter and first nine months of 2012 compared to the prior year periods. As a percentage of net sales, SG&A expenses were 4.8% and 5.4% in third quarter 2012 and 2011, respectively, and were 4.9% in the first nine months of 2012 compared to 5.3% in 2011.

Amortization of Intangible Assets. In the aggregate, amortization of intangible assets increased $147,000 and $454,000 in the third quarter and first nine months of 2012, respectively, compared to the prior year periods, reflecting the impact of businesses acquired since June 2011.

In conjunction with the acquisition of the manufacturing and distribution business of Praxis in late June 2011, the Company recognized $0.4 million in certain finite-lived intangible assets which are being amortized over periods ranging from 2 to 5 years. As a result, amortization expense increased $47,000 in the first nine months of 2012 compared to the prior year period.

In conjunction with the acquisition of AIA in September 2011, the Company recognized $3.1 million in certain finite-lived intangible assets. These intangible assets are being amortized over periods ranging from 3 to 10 years. As a result, amortization expense increased $95,000 in the third quarter of 2012 and $285,000 in the first nine months of 2012 compared to the prior year periods.

In conjunction with the acquisition of Performance Graphics in December 2011, the Company recognized $0.3 million in certain finite-lived intangible assets. These intangible assets are being amortized over periods ranging from 3 to 10 years. As a result, amortization expense increased $11,000 in the third quarter of 2012 and $33,000 in the first nine months of 2012 compared to the prior year periods.

In conjunction with the acquisition of Décor in March 2012, the Company recognized $1.0 million in certain finite-lived intangible assets. These intangible assets are being amortized over periods ranging from 5 to 10 years beginning in the first quarter of 2012. As a result, amortization expense increased $35,000 in the third quarter of 2012 and $83,000 in the first nine months of 2012, respectively, compared to the prior year periods.

In conjunction with the acquisition of Gustafson in July 2012, the Company recognized $0.3 million in certain finite-lived intangible assets. These intangible assets are being amortized over periods ranging from 1 to 10 years beginning in August of 2012. As a result, amortization expense increased $6,000 in both the third quarter and first nine months of 2012 compared to the prior year periods.

In conjunction with the acquisition of Creative Wood in September 2012, the Company recognized $0.8 million in certain finite-lived intangible assets. These intangible assets will be amortized over periods ranging from 3 to 10 years beginning in the fourth quarter of 2012.

Gain on Sale of Fixed Assets and Acquisition of Business. In conjunction with the acquisition of Gustafson in July 2012, the fair value of the identifiable assets acquired and liabilities assumed of $3.0 million exceeded the fair value of the purchase price of the business of $2.8 million. As a result, the Company recognized a gain of $0.2 million associated with the acquisition. The gain is included in this line item for the third quarter and nine months ended September 30, 2012 in the condensed consolidated statements of operations, as well as a gain on the sale of fixed assets for the third quarter and nine months of 2012 of $11,000 and $14,000, respectively.

In conjunction with the acquisition of Praxis in June 2011, the fair value of the identifiable assets acquired and liabilities assumed of $0.7 million exceeded the fair value of the purchase price of the business of $0.5 million. As a result, the Company recognized a gain of $0.2 million associated with the acquisition. The gain is included in this line item for the nine months ended September 25, 2011 in the condensed consolidated statements of operations, as well as a gain on the sale of fixed assets for the third quarter and nine months of 2011 of $11,000 and $80,000, respectively. See Note 5 to the Condensed Consolidated Financial Statements for further details.


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Operating Income. Operating income increased $2.1 million to $7.3 million in third quarter 2012 from $5.2 million in the prior year. For the nine months, operating income was $22.4 million in 2012 compared to $10.5 million in 2011. The change in operating income is primarily attributable to the items discussed above.

Stock Warrants Revaluation. The stock warrants revaluation credit of $0.1 million in the third quarter of both 2012 and 2011 represents non-cash charges or credits related to mark-to-market accounting for common stock warrants issued to the Company's former senior lenders in conjunction with the December 2008 amendment to the 2007 Credit Agreement (as defined herein) (the "2008 Warrants"). For the nine months, the stock revaluation expense was $1.7 million in 2012 compared to a credit of $0.1 million in 2011.

In the first quarter of 2012, three members of the Company's former bank lending group exercised their 2008 Warrants to purchase 179,531 shares in the aggregate of the Company's common stock. In connection with the cashless exercises, . . .

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