Description
Filed with the SEC from Sep 27 to Oct 03:
Patrick Industries (PATK)
Tontine Partners decreased its holdings to 4,547,147 shares (43.2%) after it sold 223,980 from May 29 through Sept. 25 at prices ranging from $14.07 to $15.10 each.
BUSINESS OVERVIEW
Strategy
Overview
We believe that we have developed quality working relationships with our customers and suppliers, and have oriented our business to the needs of these customers. These customers include all of the larger RV and MH manufacturers and a number of large to medium-sized industrial customers. Our industrial customers generally are directly linked to the residential housing markets. Our RV and MH customers generally demand the lowest competitive prices, high quality standards, short lead times, and a high degree of flexibility from their suppliers. Our industrial customers generally are less price sensitive than our RV and MH customers, and focused on consistent high quality products, exceptional customer service, and quick response time.
In order to best serve our customer base, we have focused our efforts on driving the execution of our Organizational Strategic Agenda (“OSA”), embedding our ‘Customer First’ performance-oriented culture throughout all levels of the organization, implementing talent development initiatives to ensure we have the resources to meet our customers’ evolving needs, developing a nationwide manufacturing and distribution presence in response to our customers’ needs for flexibility and short lead times, and bringing value added products to our customers through the introduction of new products, line extensions, and strategic acquisitions. Additionally, because of the short lead times, which range from 48 hours to same day order receipt and delivery, we have intensified our focus on reducing our inventory levels with the help of some of our key suppliers with vendor managed inventory programs. These initiatives have been instrumental in improving our operating cash flow and liquidity.
As we explore new markets and industries, we believe that these and other strategic initiatives provide us with a strong foundation for future growth. In 2011, approximately 61% of our sales were to the RV industry, 24% to the MH industry, and 15% to the industrial and other markets. In 2010, approximately 58% of our sales were to the RV industry, 28% to the MH industry, and 14% to the industrial and other markets. The increase in unit shipments in the RV market compared to the softness in the other primary market sectors in which Patrick operates, the introduction of new products to the marketplace, and the impact of the acquisitions completed in 2010 and 2011, have contributed to an increase in our RV market sales concentration in 2011 when compared to prior periods.
Operating Strategies
Key operating strategies identified by management, include the following:
Strategic Acquisitions and Expansion
We supply a broad variety of building materials and component products to the RV, MH and industrial markets. With our nationwide manufacturing and distribution capabilities, we believe that we are well positioned for the introduction of new products to further bring value to our customer base. In order to facilitate this initiative, we are focused on driving growth through the acquisition of companies with a strategic fit as well as additional product lines, facilities, or other assets to complement or expand our existing businesses. From January 2010 through March 2012, we completed six acquisitions, which directly complement our core competencies and product lines, and introduced over 50 new products and line extensions to the marketplace.
In January 2010, we acquired the cabinet door business of Quality Hardwoods Sales (“Quality Hardwoods”), our first acquisition following the acquisition of Adorn Holdings, Inc. (“Adorn”) in May 2007. In August 2010, we added new products and expanded our RV and MH distribution presence through the acquisition of the wiring, electrical and plumbing products distribution business of Blazon International Group (“Blazon”).
In 2011, we completed three acquisitions that expanded our product offerings to our existing customer base in the RV and industrial market sectors. In June 2011, we acquired The Praxis Group (“Praxis”), a manufacturer and distributor of high and low gloss painted countertops, foam products, shower doors, electronics and furniture products. In September 2011, we acquired A.I.A. Countertops, LLC (“AIA”), a fabricator of solid surface, granite, and laminated countertops, backsplashes, tables, signs, and other products, and in December 2011, we acquired Performance Graphics, a designer, producer and installer of exterior graphics for the RV, marine, automotive, racing and enclosed trailer industries.
In March 2012, we completed the acquisition of Décor Manufacturing, LLC (“Décor”), which produces laminated and wrapped products for the Northwestern U.S.-based RV industry. See Note 22 to the Consolidated Financial Statements for further details.
Strategic Divestitures
In an effort to strategically align our current operations with businesses within our core competencies, reduce overall fixed costs, and reduce our leverage position, we continue to evaluate alternatives for the divestiture of unprofitable, non-core operations. In 2009, we sold certain assets of our American Hardwoods operation and the related operating facility. In addition, we sold certain assets of our aluminum extrusion operation in July 2009. The decision to divest these two operations in 2009 was largely based on projected and potential operating losses under the then current operating models and working capital requirements of these operations that led us to assess the overall fit of these operations within the parameters of our strategic plan at that time. The financial results of these operations are classified as discontinued operations in the consolidated financial statements. See Note 5 to the Consolidated Financial Statements for further details.
Diversification into Other Markets
While we continually seek to improve our position as a leading supplier to the RV and MH industries, we are also seeking to expand our product lines into other industrial, commercial and institutional markets. Many of our products, such as countertops, cabinet doors, laminated panels and mouldings, drawer sides and fronts, slotwall, and shelving, have applications in the kitchen cabinet, household furniture, and architectural markets. We have a dedicated sales force focused on increasing our industrial market penetration and on our diversification into additional commercial and institutional markets.
We believe that diversification into other industrial markets provides opportunities for improved operating margins with complementary products using current manufacturing processes and applications. In addition, we believe that our nationwide manufacturing and distribution capabilities have enabled us to be well-positioned for new product expansion.
Utilization of Manufacturing Capacity
Efficiency Optimization
The decline in volume levels in 2008 and 2009 due to soft industry conditions in all of the major end markets we serve resulted in unused capacity at almost all of our locations. We have the ability to increase volumes in almost all of our existing facilities without adding comparable incremental fixed costs. With the expected continued weak economic conditions in certain parts of the country, we are continually exploring opportunities for further facility consolidation. However, we have remained committed to certain geographic areas, specifically where there is a larger concentration of MH business and where revenue and cash flow contributions are nominal, due to our commitment to our customer base and to position us in the event of a recovery in the manufactured housing industry. Additionally, we are focused on cross-training all of our manufacturing work force in our manufacturing cells within each facility to maximize our efficiencies and increase the flexibility of our labor force.
Plant Consolidations / Closures
Certain manufacturing and distribution operating facilities were either sold or consolidated during 2011 and 2010 in an effort to improve operating efficiencies in the plants through increased capacity utilization, keep the overhead structure at a level consistent with operating needs, and continue the Company’s efforts to reduce its leverage during the depressed economic cycle in 2008, 2009, and part of 2010, and to facilitate the refinancing of our previous credit facility.
A manufacturing and distribution facility in Woodburn, Oregon was sold in February 2010 for $4.2 million and the Company recorded a pretax gain on sale of approximately $0.8 million in its first quarter 2010 operating results. The Company is currently operating in the same facility under a lease agreement with the purchaser for the use of a portion of the square footage previously occupied.
The Company’s manufacturing and distribution facility in Fontana, California was sold in March 2010 for $4.9 million and the Company recorded a pretax gain on sale of approximately $2.0 million in its first quarter 2010 operating results. The Company is currently operating in the same facility under a lease agreement with the purchaser for the use of a portion of the square footage previously occupied.
In April 2010, we closed our manufacturing division in Madisonville, Tennessee and consolidated manufacturing operations into the existing owned Mt. Joy, Pennsylvania manufacturing facility in order to offset a sizable reduction in sales volumes that stemmed from the adoption of a new vertical integration strategy by one of our key manufactured housing customers in Tennessee who began to produce and supply its own interior home components.
In October 2010 after numerous attempts to increase market penetration in the Northwest, we sold the RV and MH business related to our Oregon manufacturing division to Décor in order to realign company assets. We continued to operate a high-pressure laminate manufacturing cell for the industrial market and a distribution center for the RV and MH markets in our existing Woodburn, Oregon location from 2010 through February 2012. In March 2012, we acquired Décor, immediately expanding our presence in the Northwest U.S.-based RV industry. Décor will continue to operate on a stand-alone basis in its existing manufacturing facility in Tualatin, Oregon and we expect to consolidate our Oregon manufacturing operations by the end of the third quarter of 2012.
In 2011, we consolidated the newly acquired countertop manufacturing business of Praxis into one of our existing manufacturing facilities in Elkhart, Indiana that engages in similar activities. In addition, we consolidated the solid surface operations of one of our existing manufacturing facilities located in Elkhart into the larger manufacturing facility acquired with our acquisition of AIA.
Product Development and New Product Introductions/Discontinua tions
With our versatile manufacturing and distribution capabilities, we are continually striving to increase our market presence in all of the markets that we serve and gain entrance into other potential markets. We remain committed to new product introduction and to new product development initiatives. New product development is a key component of our strategy to grow our revenue base, keep up with changing market conditions, and proactively address customer demand. We have a design team that works exclusively with RV and MH manufacturers to meet their creative design and product needs, which includes creating new styles and utilizing new colors, patterns, and wood types for panels and mouldings, cabinet doors and other products. We plan to continue to devote our time and attention to manufacturing and distribution products that fit within the strategic parameters of our current business model, including appropriate margin and inventory turn levels.
In addition to the new product offerings stemming from acquisitions, we further enhanced our product offerings to our RV, MH and industrial markets customers through the introduction of several new products and the expansion of our existing product lines in 2011. On the manufacturing side, we began to manufacture several new cabinet door styles, upgraded cabinetry, new slide-out trim, and fabricated backsplashes. Our distribution line was expanded to include new faucets modeled after the residential market, RV gas grills, high quality RV mattresses, recliners, a new convertible sofa-bed, additional television lines, new LED lighting products, a close-up poly wrap product for housing, a new vinyl siding product, and a line of wall-mounted stereos.
In 2011, we discontinued certain distribution product lines including our line of adhesives, vapor barriers, paints and house wrap.
Principal Products
Through our manufacturing divisions, we manufacture and fabricate a variety of products, such as decorative vinyl and paper panels, solid surface, granite, laminated and painted countertops, wrapped profile mouldings, stiles and battens, hardwood, foil and membrane pressed cabinet doors, drawer sides and bottoms, interior passage doors, and slotwall and slotwall components. In conjunction with our manufacturing capabilities, we also provide value added processes, including custom fabrication, edge-banding, drilling, boring, and cut-to-size capabilities.
We distribute pre-finished wall and ceiling panels, drywall and drywall finishing products, electronics, wiring, electrical and plumbing products, cement siding, interior passage doors, roofing products, laminate flooring, and other miscellaneous products.
Manufactured laminated panels and hardwood doors contributed 55% and 10%, respectively, of total 2011 manufacturing segment sales. The wiring, electrical and plumbing products division and the electronics division within our Distribution segment contributed 26% and 20%, respectively, of total sales in this segment in 2011.
We have no material patents, licenses, franchises, or concessions and do not conduct significant research and development activities .
Manufacturing Processes and Operations
Our primary manufacturing facilities utilize various materials such as lauan, MDF, gypsum and particleboard, which are bonded by adhesives or a heating process to a number of products, including vinyl, paper, foil and high-pressure laminate. Additionally, we offer high-pressure laminate bonded to substrates, such as particleboard and lauan which has many uses, including countertops and cabinetry. We manufacture and fabricate solid surface, granite, and high-pressure laminate countertops for all of our primary markets, as well as slotwall and slotwall components for the retail store fixture markets. Roll-laminated products are used in the production of wall, cabinet, shelving, counter and fixture products with a wide variety of finishes and textures.
We manufacture three distinct cabinet door product lines in both raised and flat panel designs, as well as square, shaker style, cathedral and arched panels. One product line is manufactured from raw lumber using solid oak, maple, cherry and other hardwood materials, and comes in a variety of finishes and glazes. Another line of doors is made of laminated fiberboard, and a third line uses membrane press technology to produce doors and components with vinyls ranging from 2 mil to 14 mil in thickness. Several outside profiles include square, shaker style, cathedral, and arched raised panel doors and the components include rosettes, hardwood moulding, arched window trim, blocks and windowsills, among others. Our doors are sold mainly to the RV and MH industries. We also market to the cabinet manufacturers and “ready-to-assemble” furniture manufacturers.
Our vinyl printing facility produces a wide variety of decorative vinyls which are 4 mil in thickness and are shipped in rolls ranging from 300-750 yards in length. This facility produces material for both internal use by Patrick and sale to external customers.
Markets
We are engaged in the manufacturing and distribution of building products and material for use primarily by the RV and MH industries, and in other industrial markets. While the ongoing uncertainty surrounding the future course of the economy and fluctuating market conditions have had an impact on business conditions in our three primary markets, we have seen a recovery in the RV and certain other markets.
In 2010 and 2011, sales to the RV industry improved as evidenced by higher production levels and wholesale unit shipments versus the prior year periods. We believe that ongoing credit concerns, slow job growth, swings in consumer confidence levels, and continued lower levels of discretionary spending will all continue to contribute to further volatility in the markets we serve in 2012 before a sustained recovery takes hold. Recreational vehicle purchases are generally consumer discretionary income purchases, and therefore, any situation which causes concerns related to discretionary income can have a negative impact on these markets.
The MH industry continues to be negatively impacted by financing concerns and a lack of available financing sources, and the current credit situation in the residential housing market puts additional pressure on consumers, who are generally using financial institutions and conventional financing as a source for these purchases. Approximately 57% of our industrial revenue base in 2011 was associated with the U.S. residential housing market, and therefore, there is a direct correlation between the demand for our products in this market and new residential housing production.
In order to offset some of the impacts of the residential housing market declines, we have focused on diversification and have targeted certain sales efforts towards market segments that are less directly tied to new home construction demand, 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 short-term growth in the industrial sector due to restricted credit conditions and current uncertainty related to general economic conditions and the large number 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.
Recreational Vehicles
The recreational vehicle industry has been characterized by cycles of growth and contraction in consumer demand, reflecting prevailing general economic conditions which affect disposable income for leisure time activities. We believe that fluctuations in interest rates, consumer confidence, the level of disposable income, and equity securities market trends have an impact on RV sales. Over the past three years, however, we have noticed a level of resilience in the RV marketplace where RV buyers appear to have prioritized the purchase of a unit over other items in an effort to pursue their desired “lifestyle”. While concerns about the availability and price of gasoline can have an impact on RV demand, market trends also indicate that the average RV owner travels less distance but with similar frequency than during periods of lower gas prices and greater availability.
Demographic and ownership trends continue to point to favorable market growth in the long-term, as the number of “baby-boomers” reaching retirement is steadily increasing, products such as sports-utility RVs and “toy haulers” with a rear section to store and transport motorcycles, snowmobiles, ATVs and other leisure products are attractive to younger buyers, and RV manufacturers are also providing an array of product choices, including producing lightweight towables and smaller, fuel efficient motorhomes. Green technologies, such as lightweight composite materials, solar panels, and energy-efficient components are appearing on an increasing number of RVs. In addition, federal economic credit and stimulus packages that contain provisions to stimulate RV lending and provide favorable tax treatment for new RV purchases may help promote sales and aid in the RV industry’s continued economic recovery.
Recreational vehicle classifications are based upon standards established by the Recreational Vehicle Industry Association (“RVIA”). The principal types of recreational vehicles include conventional travel trailers, folding camping trailers, fifth wheel trailers, motor homes, and conversion vehicles. These recreational vehicles are distinct from mobile homes, which are manufactured houses designed for permanent and semi-permanent residential dwelling.
Conventional travel trailers and folding camping trailers are non-motorized vehicles designed to be towed by passenger automobiles, sport utility vehicles, crossover vehicles, pick-up trucks or vans. They provide comfortable, self-contained living facilities for short periods of time. Conventional travel trailers and folding camping trailers are towed by means of a frame hitch attached to the towing vehicle. Fifth wheel trailers, designed to be towed by heavy-duty pick-up trucks, are constructed with a raised forward section that is attached to the bed area of the pick-up truck. This allows for a bi-level floor plan and more living space than a conventional travel trailer.
A motor home is a self-powered vehicle built on a motor vehicle chassis. The interior typically includes a driver’s area, kitchen, bathroom, shower, dining, and sleeping areas. Motor homes are self-contained with their own lighting, heating, cooking, refrigeration, sewage holding, and water storage facilities. Although they are not designed for permanent or semi-permanent living, motor homes do provide comfortable living facilities for short periods of time.
Sales of recreational vehicle products have been cyclical. Shortages of motor vehicle fuels and significant increases in fuel prices have had a material adverse effect on the market for recreational vehicles in the past, and could adversely affect demand in the future. The RV industry is also affected by the availability and terms of financing to dealers and retail purchasers. Substantial increases in interest rates and decreases in the general availability of credit have had a negative impact upon the industry in the past and may do so in the future. Recession and lack of consumer confidence generally result in a decrease in the sale of leisure time products such as recreational vehicles.
The period beginning in 2000 and continuing through 2007 resulted in seven out of eight years with industry-wide wholesale shipment levels of RVs over 300,000 units primarily due to the favorable demographic trend of the aging “baby-boomer” population, improved consumer confidence, lower interest rates, and a fear of flying after the September 11, 2001 terrorist attacks. In 2008, shipment levels declined approximately 33% to 237,000 units, reflecting tight credit conditions, declining consumer confidence, reduced disposable income levels, and the generally depressed economic environment. In 2009, shipment levels declined an additional 30% to 165,700 units reflecting low consumer confidence and the continuance of unfavorable market conditions experienced by the industry in 2008. However, production levels in the RV industry were stronger than expected in the latter half of 2009 based on a higher demand for RVs by retail dealers. In 2010, the RV industry continued to strengthen as shipment levels increased 46% from 2009 reaching 242,300 units. Shipment levels increased 4% in 2011 to 252,300 units compared to 2010. Despite these increases, wholesale unit shipments of RVs in 2011 were still 25% lower than the average shipment levels during the period 2000-2007 and 33% lower than the three year period from 2005-2007.
In 2011, the Original Equipment Manufacturers (“OEMs”) moved more toward less costly raw material products, driven in part by the significant price increases on commodity products during 2011. The RVIA expects the recovery to strengthen as credit availability, job security and consumer confidence improve. The RVIA is currently forecasting a 5% increase in 2012 wholesale unit shipments compared to the 2011 level.
The Company estimates that approximately 90% of its revenues related to the RV industry are derived from the towables sector of the market, which is consistent with the overall RV production mix. The towable units are lighter and less expensive than standard gas or diesel powered motorized units, representing a more attractive solution for the cost-conscious buyer. From 2010 to 2011, motorized unit shipments declined approximately 2% and towable unit shipments rose approximately 5%. We believe that we are well positioned with respect to our product mix within the RV industry to take advantage of any improved market conditions.
CEO BACKGROUND
Paul E. Hassler , age 64, has been our Chairman of the Board since May 2008. Mr. Hassler was Chief Executive Officer of the Company from April 2004 to January 2009 (retired) and President from April 2004 to May 2008. Mr. Hassler held the position of Vice President Operations and Distribution - West of the Company from December 2003 through the first quarter of 2004; Executive Director of West Coast Operations from 1994 to 2003; and General Manager of California Operations from 1986 to 1994. Mr. Hassler has over 38 years of recreational vehicle, manufactured housing and industrial experience in various capacities and has demonstrated leadership as Non-Executive Chairman of the Board. He has served as a director of the Company since 2005.
Terrence D. Brennan , age 73, was the President and Chief Executive Officer of NBD Bank, Elkhart, Indiana from 1973 to 1997 (retired). Mr. Brennan has extensive knowledge of the banking industry and its operations, experience in corporate management and leadership, and strategic planning. He possesses accounting and financial acumen, and has been determined to be an “audit committee financial expert” under the Securities and Exchange Commission (“SEC”) rules and regulations by our Board. Mr. Brennan currently serves as the Chairman of the Company’s Corporate Governance and Nominations Committee, and as a member of the Company’s Compensation Committee and Audit Committee. He has served as a director of the Company since 1999.
Joseph M. Cerulli , age 52, has been employed by Tontine Associates, LLC, an affiliate of Tontine Capital Partners, LP, Tontine Capital Overseas Master Fund, LP, and Tontine Capital Overseas Master Fund II, LP (collectively, “Tontine”), since January 2007. Prior to that, Mr. Cerulli was an independent financial consultant from 2002 to 2006. Mr. Cerulli was a director of Neenah Enterprises, Inc., one of the largest independent foundry companies in the U.S., from February 2009 to July 2010. As an employee of Tontine, the majority shareholder of the Company’s common stock as of the March 28, 2012 record date, Mr. Cerulli possesses particular knowledge of our Company and the industries in which we operate and possesses accounting and financial acumen and extensive knowledge with respect to financial and investment matters. Mr. Cerulli currently serves as a member of the Company’s Corporate Governance and Nominations Committee and the Compensation Committee. He has served as a director of the Company since 2008.
Todd M. Cleveland , age 44, has been serving as President and Chief Executive Officer of the Company since February 2009. Mr. Cleveland assumed the position of President and Chief Operating Officer of the Company in May 2008. Prior to that, he served as Executive Vice President of Operations and Sales and Chief Operating Officer of the Company from August 2007 to May 2008. Mr. Cleveland also spent 17 years with Adorn Holdings, Inc. (“Adorn”) serving as President and Chief Executive Officer from 2004 to 2007; President and Chief Operating Officer from 1998 to 2004; and Vice President of Operations and Chief Operating Officer from 1994 to 1998. Mr. Cleveland has over 21 years of recreational vehicle, manufactured housing and industrial experience in various operating capacities. He also has extensive knowledge of our Company and the industries to which we sell our products, and experience with management development and leadership, acquisitions, strategic planning, manufacturing, and sales of our products. He has served as a director of the Company since 2008.
John A. Forbes, age 52, has been serving as the President of Utilimaster Corporation, a subsidiary of Spartan Motors, Inc. since July 2010. Prior to that, he was the CFO of Utilimaster from May 2009 to July 2010, the CFO of Nautic Global Group LLC from 2007 to 2009, and the CFO of Adorn LLC from 2003 to 2007. Mr. Forbes has over 29 years of experience in serving various manufacturing industries having held senior financial leadership roles including Trimas Corporation/Masco Tech, Inc., both with Fulton Performance Products and Reese Products . Mr. Forbes also has extensive experience with operations management, acquisitions, strategic planning, risk management, and banking relations. He possesses financial acumen and has been determined to be an “audit committee financial expert” under the SEC’s rules and regulations by our Board. Mr. Forbes currently serves as a member of the Company’s Audit Committee, Corporate Governance and Nominations Committee and the Compensation Committee. He has served as a director of the Company since 2011.
Keith V. Kankel , age 69, was the Interim President and Chief Executive Officer of the Company from 2003 to 2004 (retired). In addition, he was Vice President of Finance of the Company from 1987 through July 2002, and Secretary-Treasurer of the Company from 1974 through July 2002. Mr. Kankel has accounting and financial acumen, with particular knowledge of financial reporting, and has been determined to be an “audit committee financial expert” under the SEC’s rules and regulations by our Board. His long-time service on the Board has provided critical knowledge of our operations and corporate history. Mr. Kankel currently serves as the Chairman of the Company’s Audit Committee and as a member of the Company’s Corporate Governance and Nominations Committee and the Compensation Committee. He has served as a director of the Company since 1977.
Andy L. Nemeth , age 43, has been the Company’s Executive Vice President of Finance, Secretary-Treasurer, and Chief Financial Officer since May 2004. Mr. Nemeth was Vice President-Finance, Chief Financial Officer, and Secretary-Treasurer from 2003 to 2004, and Secretary-Treasurer from 2002 to 2003. Mr. Nemeth was a Division Controller from 1996 to 2002 and prior to that, he spent five years in public accounting. Mr. Nemeth has over 20 years of recreational vehicle, manufactured housing, and industrial experience in various financial capacities. Mr. Nemeth also has particular knowledge of our Company and the industries to which we sell our products, extensive experience with corporate management, acquisitions, strategic planning and banking relations, and has financial and accounting acumen. He has served as a director of the Company since 2006.
Larry D. Renbarger , age 73, was the Chief Executive Officer of Shelter Components, a manufacturer and supplier of products to the manufactured housing and recreational vehicle industries, from 1984 to 1998 (retired). Mr. Renbarger is a director of Thermolite, Inc., a window manufacturer, and of Universal Precision Instruments, Inc., an orthopedic supplier. He has particular knowledge of our Company and the industries to which we sell our products, experience in corporate management and leadership, and strategic planning. He also has a public accounting background and has been determined to be an “audit committee financial expert” under the SEC’s rules and regulations by our Board. Mr. Renbarger currently serves as a member of the Company’s Corporate Governance and Nominations Committee and Audit Committee. He has served as a director of the Company since 2002.
Walter E. Wells , age 73, was the President and Chief Executive Officer of Schult Homes Corporation, a leading builder of manufactured and modular housing, from 1970 to 1998 (retired). Mr. Wells is a director and a member of the compensation committee of Woodland Foundation, which specializes in various types of rehabilitation counseling. Mr. Wells has particular knowledge of our Company and the industries to which we sell our products, experience in corporate management and leadership, and strategic planning. He possesses financial acumen and has been determined to be an “audit committee financial expert” under the SEC’s rules and regulations by our Board. Mr. Wells currently serves as the Chairman of the Company’s Compensation Committee and as a member of the Company’s Corporate Governance and Nominations Committee and the Audit Committee. He has served as a director of the Company since 2001.
MANAGEMENT DISCUSSION FROM LATEST 10K
EXECUTIVE SUMMARY
Company Overview and Business Segments
Patrick is a major manufacturer of component products and distributor of building products serving the recreational vehicle (“RV”), manufactured housing (“MH”), kitchen cabinet, household furniture, retail fixtures and commercial furnishings, marine, and other industrial markets and operates coast-to-coast through locations in 12 states. Patrick's major manufactured products include decorative vinyl and paper panels, wrapped profile mouldings, cabinet doors and components, countertops, interior passage doors, exterior graphics and slotwall and slotwall components. The Company also distributes pre-finished wall and ceiling panels, drywall and drywall finishing products, electronics, wiring, electrical and plumbing products, cement siding, interior passage doors, roofing products, laminate flooring, shower doors, furniture, fireplace and slide-out surrounds and fascia, and other miscellaneous products. The Company has two reportable business segments: Manufacturing and Distribution, which contributed approximately 76% and 24%, respectively, to 2011 net sales.
Overview of Markets and Related Industry Performance
While the ongoing uncertainty surrounding the future course of the global economy and fluctuating market conditions have had an impact on business conditions in our three primary markets, RV, MH and industrial markets, in prior periods, we have seen a recovery in certain markets and have executed a number of strategic initiatives which have helped mitigate the negative impact of these macro-economic factors.
The RV industry, which is our primary market and which represented 61% of the Company’s 2011 sales, continued to strengthen in 2011 as evidenced by higher production levels and wholesale unit shipments versus the prior year. According to the Recreational Vehicle Industry Association (“RVIA”), shipment levels of 252,300 units in 2011 represented an increase of 4% versus the prior year, resulting in eight out of nine quarter over quarter increases in shipments following declines in the previous 13 fiscal quarters. Although the 2011 year marked the fourth year in the last ten years that shipment levels were below the 300,000-unit level, it represented the second consecutive year in which shipment levels increased after declines in the previous three years. Industry-wide retail sales and the related production levels of RV’s will depend to a significant extent on the course of the economy and consumer confidence. Continued high or increased fuel prices could negatively impact RV retail unit sales in the short-term; however, we believe there is a positive correlation between consumer confidence and RV shipment levels and, therefore, we believe the RV industry has a positive longer-term outlook as overall economic conditions and consumer confidence continue to improve. Although 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. Based on current market conditions, the RVIA is predicting a 5% increase in full year 2012 unit shipments compared to 2011.
The MH industry, which represented approximately 24% the Company’s sales in 2011, continues to be negatively impacted by a lack of financing and credit availability, job losses, and excess foreclosed residential housing inventories. According to industry sources, wholesale unit shipments, which continue to be well below historical levels, increased approximately 3% from 2010. Although we believe the MH industry has bottomed and should resume moderate growth given the recalibration of quality credit standards and it being a cost effective alternative for those individuals and families seeking relatively less expensive homes or whose credit ratings have been impacted by the economic and jobs environment over the past three years, or who have not yet established credit, the significant number of vacant and repossessed homes in the marketplace and less than favorable lending conditions are expected to dampen growth in the MH industry for at least the next 18-24 months. Factors that may favorably impact production levels 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. Federal Emergency Management Agency (“FEMA”) units helped to bolster shipments in the MH industry in 2011. Based on the industry’s current annualized run rates, the Company projects MH industry unit shipments for the full year 2012 to increase by 0.2% compared to 2011.
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 15% of the Company’s sales in 2011, saw new housing starts for 2011 increase by approximately 3% from 2010 (as reported by the U.S. Department of Commerce). We estimate approximately 57% 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. 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, 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.
In addition, higher energy costs, the impact of the Tsunami in Japan, and increased demand in certain market sectors have driven up the costs of certain raw materials. The Company continues to explore alternative sources of raw materials and components, both domestically and from overseas.
Acquisitions and Consolidations of Facilities
In June 2011, the Company acquired certain assets of The Praxis Group (“Praxis”), an Elkhart, Indiana-based manufacturer and distributor of countertops, foam products, shower doors,electronics, and furniture products to the RV industry, for $0.5 million. This acquisition expanded the Company’s product offerings to its existing customer base in the RV industry. Approximately $0.4 million of intangible assets were recorded in the Distribution segment as a result of the acquisition.
In September 2011, the Company acquired certain assets of Syracuse, Indiana-based A.I.A. Countertops, LLC (“AIA”), a fabricator of solid surface, granite, and laminated countertops, backsplashes, tables, signs, and other products for the RV and commercial markets, for $5.5 million. This acquisition expanded the Company’s product offerings to its existing customer base in the RV industry and industrial market sectors. Approximately $4.9 million of intangible assets were recorded in the Manufacturing segment as a result of the acquisition.
In December 2011, the Company acquired certain assets of Elkhart, Indiana-based Performance Graphics, a designer, producer and installer of exterior graphics for the RV, marine, automotive, racing and enclosed trailer industries, for $1.3 million. This acquisition expanded the Company’s product offerings in the RV and industrial market sectors. Approximately $0.5 million of intangible assets were recorded in the Manufacturing segment as a result of the acquisition. See Notes 4 and 9 to the Consolidated Financial Statements for further details regarding these acquisitions.
These 2011 acquisitions, combined with the acquisition of Blazon International Group (“Blazon”) in the third quarter of 2010, contributed to an increase in our RV market sales concentration in 2011 compared to earlier periods.
Certain manufacturing cells were consolidated during 2011 to improve operating efficiencies in the plants through increased capacity utilization and to continue the Company’s efforts to reduce its leverage position. In 2011, we incurred charges stemming from the consolidation of the newly acquired countertop manufacturing business of Praxis into one of our existing manufacturing facilities in Elkhart, Indiana that engages in similar activities. In addition, we consolidated the solid surface operations of one of our existing manufacturing facilities located in Elkhart into the larger manufacturing facility acquired with our acquisition of AIA.
2011 Initiatives and Challenges
In fiscal year 2011, our primary focus was on refinancing our credit facility, gaining market share through the introduction of new products to the marketplace and the execution of strategic acquisitions, maximizing operating efficiencies, managing and developing our talent pool, and embedding our “Customer First” performance oriented culture. Additionally, as we have strengthened our balance sheet over the past three years and completed the refinancing of our previous credit facility, our internal focus and drivers have expanded to include priorities related to increasing net income and earnings per share, maximizing earnings before interest, taxes, depreciation, and amortization (“EBITDA”), cash management, maximizing our borrowing base availability, exceeding our customers’ expectations related to delivery schedules and dates, quality service and products, building relationships, and improving our content per unit.
Fiscal Year 2012 Outlook
All three of the primary markets we serve continue to be impacted by general economic conditions, extremely tight credit and lending conditions, and low jobs growth, particularly in the manufacturing sector. Although RV market conditions continued to improve in 2011, we anticipate that the market will continue to be impacted by the residual effects of the recession and consumer confidence levels during 2012, as consumers remain cautious when deciding whether or not to purchase discretionary items such as RVs. In addition, the recent sharp increase in gasoline prices, political uncertainty in the Middle East, and the debt crisis in Europe could negatively affect RV demand. The full restoration of RV sales to prior levels is projected to be slow and uneven. As a result of these factors and the improved economic environment, we anticipate a 5% increase in RV unit shipment levels in 2012. In addition, although we anticipate an increase in production levels in the MH industry in 2012, it will continue to be well below 2004-2007 sales levels. New housing starts in 2012 are estimated to improve by approximately 17% year-over-year as forecasted by the National Association of Home Builders as of February 29, 2012) consistent with slowly improving overall economic conditions.
Net Sales . Net sales increased $29.6 million or 10.6%, to $307.8 million from $278.2 million in 2010. The increase in net sales is primarily attributable to the contributions of four business acquisitions completed since August 2010: Blazon in August 2010; Praxis in June 2011; AIA in September 2011; and Performance Graphics in December 2011. In addition, sales benefited from price increases on a number of commodity products throughout the year, improved retail fixture sales in the industrial market as a result of our diversification efforts, and improved market penetration in the RV market.
Blazon generated sales of $19.8 million in 2011, a $15.0 million increase compared to the prior year. In addition, the Praxis and AIA acquisitions accounted for $7.7 million of sales in 2011 with no comparable amount in 2010. Performance Graphics did not contribute materially to Patrick’s 2011 operating results. According to industry associations, wholesale unit shipments in the RV industry, which represented approximately 61% of the Company’s 2011 sales, increased approximately 4% compared to the prior year.
In addition, a 16% growth in sales to the industrial market in 2011 contributed to the year-over-year increase in the Company’s consolidated sales compared to the prior year. The industrial market sector, which accounted for 15% of the Company’s twelve months sales, saw new housing starts increase by approximately 3% for 2011 when compared to the prior year (as reported by the U.S. Department of Commerce). We estimate that approximately 57% of our industrial revenue base is directly linked to the residential housing market. 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 residential housing market declines, we have focused on diversification and have targeted certain sales efforts towards market segments that are either indirectly or not tied to residential demand including the institutional fixture, furniture, and countertop markets. As a result, we have seen a shift in our product mix which has had a positive financial impact on revenues in the industrial markets.
Revenue from the MH market was down 6% for the full year due in part to the impact of the vertical integration efforts of one of the Company’s larger MH customers that is now producing in-house one of the product lines for certain of its facilities that the Company had previously been supplying. Additionally, while unit shipments in the MH industry, where the Company’s dollar content per unit shipped is higher than in the RV industry, and which represented 24% of the Company’s 2011 sales, were up approximately 3% from 2010, MH floor shipments declined approximately 3% year-over-year.
Cost of Goods Sold. Cost of goods sold increased $14.9 million or 6.0%, to $263.5 million in 2011 from $248.6 million in 2010. As a percentage of net sales, cost of goods sold decreased during the year to 85.6% from 89.3%. Cost of goods sold as a percentage of net sales was positively impacted during the year primarily by margin improvements that were in line with the Company’s expectations and ongoing organizational and process changes that enhanced labor efficiencies, reduced scrap and returns, and increased material yields at two of the Company’s Midwest manufacturing divisions, one of which had underperformed in 2010 compared to historical levels.
The Company’s cost of goods sold, which is generally lower in its Distribution segment than in the Manufacturing segment, will continue to benefit from increased Distribution sales resulting from the Blazon and Praxis acquisitions. Cost of goods sold also benefited in 2011 from our ongoing efforts to keep operating costs aligned with our sales base and operating needs.
Gross Profit. Gross profit increased $14.7 million or 49.5%, to $44.3 million in 2011 from $29.6 million in 2010. As a percentage of net sales, gross profit increased to 14.4% in 2011 from 10.7% in the same period in 2010. The acquisitions noted above provided positive contribution to gross profit during 2011, and we believe these acquisitions will provide positive contribution to our operating profitability going forward. The change in gross profit from period to period is primarily attributable to the factors described above.
Warehouse and Delivery Expenses . Warehouse and delivery expenses increased $1.9 million or 16.6%, to $13.6 million in 2011 from $11.7 million in 2010. As a percentage of net sales, warehouse and delivery expenses were 4.4% for 2011 and 4.2% for 2010. The increase as a percentage of net sales for 2011 reflected incremental common carrier expenses, fuel costs and surcharges, and freight charges, partially offset by efficiency improvements.
Selling, General and Administrative (SG&A) Expenses . SG&A expenses increased $2.8 million or 20.0%, to $16.6 million in 2011 from $13.8 million in 2010. The increase in SG&A expenses in 2011 primarily reflected a net increase in selling and administrative wages and incentives and unemployment taxes from the recent acquisitions compared to the prior year. As a percentage of net sales, SG&A expenses were 5.4% in 2011 compared to 5.0% in the prior year.
Amortization of Intangible Assets . 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 increased $48,000 in 2011 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 increased $95,000 compared to 2010.
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 will be amortized over periods ranging from 3 to 10 years beginning in the first quarter of 2012 as a result of the final determination of the fair value of the intangible assets in the first quarter of 2012.
Amortization also increased approximately $122,000 in 2011 related to the Blazon acquisition in August 2010. Total amortization expense increased $0.3 million in 2011 as a result of the Praxis, AIA and Blazon acquisitions when compared to the prior year.
Gain on Sale of Fixed Assets and Acquisition of Business . 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 in the second quarter of 2011. The gain is included in this line item for the year ended December 31, 2011 in the consolidated statements of operations, as well as a gain on the sale of fixed assets for 2011 of $61,000. During the first quarter of 2010, the Company sold the facilities housing its manufacturing and distribution operations in Oregon and California and recorded pretax gains on sale of approximately $0.8 million and $2.0 million, respectively. Because the Company is currently operating in the same facility in California under a lease agreement with the purchaser, an additional $0.7 million of a pretax gain on the sale was deferred during the first quarter of 2010 and is being offset against future lease payments that are included in cost of goods sold. See Note 6 to the Consolidated Financial Statements for further details.
Operating Income. Operating income increased $7.1 million to $13.5 million in 2011 from $6.4 million in 2010. The change in operating income from period to period is primarily attributable to the items discussed above.
Stock Warrants Revaluation. The stock warrants revaluation expense of $0.7 million in 2011 and the credit of $0.3 million in 2010 represent non-cash charges/credits related to mark-to-market accounting for common stock warrants (i) issued to certain of the Company’s former senior lenders in conjunction with the December 2008 amendment to the 2007 Credit Agreement (the “2008 Warrants”); (ii) issued to TCOMF2 and Northcreek in connection with the refinancing of the Company’s previous credit facility in March 2011 (the “March 2011 Warrants); and (iii) issued to Northcreek and an affiliate of Northcreek in connection with the financing of the AIA acquisition in September 2011 (the “September 2011 Warrants”).
In 2011, three members of the Company’s former bank lending group exercised their 2008 Warrants to purchase 173,878 shares of the Company’s common stock. In connection with the cashless exercises, 91,056 net shares of common stock were issued. Additional exercises of the 2008 Warrants are expected to impact the revaluation of these warrants in future periods. Northcreek and TCOMF2 exercised their March 2011 Warrants to purchase in the aggregate 250,000 shares of the Company’s common stock in April 2011 and June 2011, respectively. Northcreek and an affiliate of Northcreek exercised their September 2011 Warrants to purchase in the aggregate 135,000 shares of the Company’s common stock in November 2011. See Note 11 to the Consolidated Financial Statements (“Warrants Subject to Revaluation”) for further details.
Interest Expense, Net. Interest expense decreased $1.0 million from $5.5 million in 2010 to $4.5 million in 2011 primarily due to improved borrowing rates under the 2011 Credit Facility. In addition, a net reduction in total debt outstanding due to scheduled principal payments on the Company’s term loan under the previous credit facility and industrial revenue bonds, and the application of the net proceeds from the sales of certain manufacturing and distribution facilities in the first quarter of 2010, contributed to the decline in interest expense in 2011 compared to the prior year. Going forward, the Company anticipates that interest expense will decline (exclusive of any acquisitions) based on the improved borrowing rates mentioned above. Interest expense in 2011 includes the write-off of $0.6 million of financing costs related to our previous credit facility and a $0.6 million charge related to the write-off of the remaining unamortized loss on interest rate swaps that were terminated and paid off in the first quarter of 2011.
Income Tax Benefit – Continuing Operations. The Company had a tax valuation allowance for deferred tax assets net of deferred tax liabilities not expected to be utilized as of December 31, 2011 and December 31, 2010 . Deferred tax assets will continue to require a tax valuation allowance until the Company can demonstrate their realizability through sustained profitability and/or from other factors. The tax valuation allowance does not impact the Company’s ability to utilize its net operating loss carryforwards to offset taxable earnings in the future. The effective tax rate varies from the expected statutory rate primarily due to the recognition in 2011 and 2010 of the deferred tax asset resulting from the utilization of federal and state net operating loss carryforwards. A tax benefit from continuing operations of $0.2 million and $0.1 million was recognized in 2011 and 2010, respectively. The effective tax rate on continuing operations (exclusive of the valuation allowance) was 36.6% for 2011 and 20.1% for 2010.
The effective tax rate for 2011 and 2010 is zero due to the utilization of federal and state tax loss carryforwards and the aforementioned valuation allowance on the net deferred tax assets. At December 31, 2011, the Company had a federal net operating loss carryforward of approximately $21.0 million that will begin to expire in 2028 and state net operating loss carryforwards of approximately $27.1 million that will expire in varying amounts between 2012 and 2029. At December 31, 2011, the Company’s federal and state net operating loss carryforwards exceeded taxable income for 2011.
Net Income. Net income was $8.5 million or $0.83 per diluted share in 2011 compared to $1.2 million or $0.12 per diluted share for 2010. The changes in the net income reflect the impact of the items previously discussed.
Average Diluted Shares Outstanding. Average diluted shares outstanding increased 3.0% in 2011 compared to 2010 principally reflecting the impact of the issuance of stock warrants during the year. See Note 11 to the Consolidated Financial Statements for additional details.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
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 pages 37 and 38 of this Report. The Company undertakes no obligation to update these forward-looking statements.
Summary
The second quarter and six 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, tight credit and lending conditions, the European debt crisis, and the impact of the upcoming November 2012 elections in the U.S, among other things, we are anticipating moderate and steady industry growth to continue through at least the remainder of 2012 in all three of our primary markets with seasonal patterns tracking consistent with the prior year. As we look ahead to the fourth quarter of 2012 and into the first quarter of 2013, we believe the potential exists for the same growth trends, however, the impact on seasonal demand patterns resulting from changing RV dealer show schedules and the milder than normal winter season in the Midwest and other areas remains in question, as well as the impact of the macroeconomic conditions described above.
For full year 2012, we are currently projecting an approximate 8% 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 August 1, 2012) is forecasting a 23% increase in new housing starts in 2012 compared to 2011 that is consistent with slowly improving overall economic conditions.
RV Industry
The RV industry, which is our primary market and represented 69% of the Company’s six months 2012 sales, continued to strengthen in the first half of 2012, as evidenced by an increase of approximately 8% in wholesale unit shipments in the first six months of 2012 versus the comparable 2011 period, according to the Recreational Vehicle Industry Association (“RVIA”). In the second quarter of 2012, unit shipment levels increased 6% 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. According to the RVIA, buyers aged 35-54 are the largest segment of RV owners. 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.
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 second quarter and first half of 2012 when compared to the prior year periods.
MH Industry
The MH industry, which showed signs of a mild recovery in the first half of 2012, represented approximately 19% of the Company’s six months 2012 sales. This industry continues to be negatively impacted by slow jobs growth, a lack of 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 11% from the second quarter of 2011 and 20% 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. While the current economic environment described above is expected to dampen growth in the MH industry for the next 18-24 months, 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 7% compared to 2011.
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 half of 2012, saw new housing starts for the second quarter of 2012 and the first six months of 2012 increase by approximately 29% 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, and sizing our credit facility to support our future growth needs. Additional focus areas include:
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sales into additional commercial/institutional markets to diversify revenue base;
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further improvement of operating efficiencies in all manufacturing operations and corporate functions;
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acquisition of businesses/product lines that meet established criteria;
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aggressive management of inventory quantities and pricing, and the addition of select key commodity suppliers; and
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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 six months of 2012, capital expenditures were approximately $2.2 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. We are currently forecasting capital expenditures for fiscal 2012 to be approximately $6.7 million and expect to amend our 2011 Credit Agreement (as defined herein) to accommodate the increased capital expenditure needs described above.
Net Sales . Net sales in the second quarter of 2012 increased $33.0 million or 39.9%, to $115.6 million from $82.6 million in the comparable prior year period. The sales increase in the quarter reflected a 61% increase in the Company’s revenue from the RV industry and a 15% increase in revenue from the MH industry. Approximately $16.2 million of the revenue improvement was attributable to four acquisitions completed since mid-June 2011: The Praxis Group (“Praxis”) in June 2011; A.I.A. Countertops, LLC (“AIA”) in September 2011; Performance Graphics in December 2011; and Décor Mfg., LLC (“Décor”) in March 2012. The remaining $16.8 million increase is primarily attributable to increased RV market penetration and a 6% increase in quarterly wholesale unit shipments in the RV industry. The RV industry represented approximately 69% of the Company’s sales in the second quarter of 2012.
For the six months ended July 1, 2012, net sales increased $66.2 million or 43.5%, to $218.3 million from $152.1 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 $27.8 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 six months of 2012, saw wholesale unit shipments increase by approximately 8% in the first six months of 2012 compared to 2011.
The MH industry, which represented 20% of the Company’s second quarter 2012 sales, experienced an 11% 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 six 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 20% from 2011.
The industrial market sector accounted for approximately 11% and 12% of the Company’s second quarter and six months 2012 sales, respectively. 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 29% and 27% for the second quarter and first six 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 10% in the first six months of 2012 from the prior year period.
Cost of Goods Sold. Cost of goods sold increased $27.2 million or 38.5%, to $97.8 million in second quarter 2012 from $70.6 million in 2011. For the first six months of 2012, cost of goods sold increased $51.8 million or 39.2%, to $184.0 million from $132.2 million in the prior year period. As a percentage of net sales, cost of goods sold decreased during the quarter to 84.6% from 85.4% in 2011. For the first six months of 2012, cost of goods sold as a percentage of net sales decreased to 84.3 % from 86.9% in the prior year period.
Cost of goods sold as a percentage of net sales was positively impacted during the second quarter and first six 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 second quarter and six months periods in 2011, (iv) actions to reduce or eliminate negative margins on certain products, and (v) ongoing organizational and process changes that enhanced labor efficiencies, reduced scrap and returns, and increased material yields.
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 $5.8 million or 48.4%, to $17.8 million in second quarter 2012 from $12.0 million in second quarter 2011. For the six months periods, gross profit increased $14.4 million or 72.2%, to $34.3 million in 2012 from $19.9 million in 2011. As a percentage of net sales, gross profit increased to 15.4% in second quarter 2012 from 14.6% in the same period in 2011 and increased to 15.7% in the first six months of 2012 from 13.1% in the prior year period. The improvement in gross profit dollars and percentage of net sales in the 2012 periods 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 in the manufacture of 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 balance of 2012 to be in a range consistent with gross profit margins for the full year 2011 and the first two quarters of 2012 subject to the above and other factors.
Warehouse and Delivery Expenses . Warehouse and delivery expenses increased $0.5 million or 13.6%, to $4.0 million in second quarter 2012 from $3.5 million in second quarter 2011. For the six months, warehouse and delivery expenses increased $1.0 million or 15.7%, to $7.6 million in 2012 from $6.6 million in 2011. The expense increase in both the second quarter and the first six months of 2012 was attributable to increased sales volumes. As a percentage of net sales, warehouse and delivery expenses were 3.4% and 4.2% in second quarter 2012 and 2011, respectively, and 3.5% and 4.4% for the comparable six months periods. The decrease as a percentage of net sales for both the second quarter and first six 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.
Selling, General and Administrative (SG&A) Expenses . SG&A expenses increased $1.8 million or 45.8%, to $5.9 million in second quarter 2012 from $4.1 million in second quarter 2011. For the six months, SG&A expenses increased $2.9 million or 36.9%, to $10.8 million in 2012 from $7.9 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 second quarter and first six months of 2012 compared to the prior year periods. As a percentage of net sales, SG&A expenses were 5.1% and 4.9% in second quarter 2012 and 2011, respectively, and were 5.0% in the first six months of 2012 compared to 5.2% in 2011.
Amortization of Intangible Assets . In the aggregate, amortization of intangible assets increased $163,000 and $307,000 in the second quarter and first six 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 $24,000 in the second quarter of 2012 and $47,000 in the first six months of 2012 compared to the prior year periods.
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 second quarter of 2012 and $190,000 in the first six 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 second quarter of 2012 and $22,000 in the first six 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 $33,000 in the second quarter of 2012 and $48,000 in the first six months of 2012, respectively, compared to the prior year periods.
Operating Income. Operating income increased $3.1 million to $7.6 million in second quarter 2012 from $4.5 million in the prior year. For the six months, operating income was $15.1 million in 2012 compared to $5.3 million in 2011. The change in operating income is primarily attributable to the items discussed above.
Stock Warrants Revaluation. The stock warrants revaluation expense of $0.1 million and the credit of $0.3 million in the second quarter of 2012 and 2011, respectively, 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 six months, the stock revaluation expense was $1.8 million in 2012 compared to a credit of $7,000 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, 154,109 net shares of common stock were issued. The fair value of these shares was reclassified to shareholders’ equity on the condensed consolidated statements of financial position as of the exercise dates.
In the second quarter of 2012, one member of the Company’s former bank lending group exercised its 2008 Warrants to purchase 74,319 shares of the Company’s common stock. In connection with the cashless exercise 69,106 net shares of common stock were issued. The fair value of these shares was reclassified to shareholders’ equity on the condensed consolidated statements of financial position as of the exercise date. As of July 1, 2012, there were 74,319 shares of common stock issuable upon exercise of the remaining 2008 Warrants. Additional exercises of the 2008 Warrants are expected to impact the revaluation of these warrants in future periods. See Note 10 to the Condensed Consolidated Financial Statements (“Warrants Subject to Revaluation”) for further details.
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Fund Letters
