DERIVATIVE FINANCIAL INSTRUMENTS

12 Months Ended

Dec. 31, 2011

DERIVATIVE FINANCIAL INSTRUMENTS [Abstract]

DERIVATIVE FINANCIAL INSTRUMENTS

11. DERIVATIVE FINANCIAL INSTRUMENTS

The Company at times enters into certain derivative financial instruments, on a cost-effective basis, to mitigate its risk associated with changes in interest rates.  The Company does not use derivative financial instruments for speculative purposes. All derivatives are recognized on the consolidated statements of financial position at their fair value.  Changes in fair value are recognized periodically in earnings or accumulated other comprehensive income within shareholders' equity, depending on the intended use of the derivative and whether the derivative has been designated by management as an ineffective hedging instrument.  Changes in fair value of derivative instruments not designated as effective hedging instruments are recognized in earnings in the current period.  Additional derivative disclosures can be found in Notes 2, 12 and 13.

Interest Rate Swap Agreements

In March 2005 and July 2007, the Company entered into two separate interest rate swap agreements with JPMorgan Chase Bank, N.A. (“JPMorgan”) to hedge against increases in variable interest rates.  Effective with the Second Amendment dated December 11, 2008 (the “Second Amendment”) to the 2007 Credit Agreement (as defined herein), the interest rates on the obligation were adjusted and the Company determined that its two swap agreements were ineffective as hedges against changes in interest rates and, as a result, the swaps were de-designated.  Until the early termination of the swaps on March 25, 2011 discussed below, (i) losses on the swaps included in other comprehensive income as of the de-designation date were amortized into net income (loss) over the original life of the swaps utilizing the straight-line method which approximates the effective interest method, and (ii) changes in the fair value of the de-designated swaps were recorded within earnings on the consolidated statements of operations.

The absolute value of the notional amounts of these two derivative contracts for the Company approximated $6.8 million and $10.0 million, respectively, at December 31, 2010.   In accordance with the terms of the swap agreements, the Company paid a fixed interest rate of 4.78% and 5.60%, respectively.  The Company received variable rates, based on LIBOR (as defined herein), calculated on the notional amount, with net receipts or payments being recognized as adjustments to interest expense.  The total fair value of these swap agreements, which was $1.2 million at December 31, 2010, is included in the deferred compensation and other line on the consolidated statements of financial position.  The effective portion of the cash flow hedge has been recorded, net of taxes, as a reduction of shareholders' equity as a component of accumulated other comprehensive loss.

In anticipation of entering into the 2011 Credit Facility, the interest rate swap agreements were terminated on March 25, 2011, resulting in a $1.1 million cash settlement to JPMorgan.  The swap agreements had a total fair value in the amount of $1.1 million on the termination date.    After the termination of the two swap agreements on March 25, 2011, the Company has not entered into any new swap agreements.

For the years ended December 31, 2011, 2010 and 2009, amortized losses of $0.7 million, $0.3 million and $0.3 million, respectively, were recognized in interest expense on the consolidated statements of operations.  The amortized loss on the swaps of $0.7 million for the year ended December 31, 2011 included $79,000 related to the amortization of the losses on the swaps in the first quarter of 2011 that was included in other comprehensive income as of the de-designation date and $0.6 million related to the write-off of the remaining unamortized loss on the swaps as of March 25, 2011, the date upon which it became probable the forecasted swap transactions, as specified in the original swap agreements, would not occur.    In addition, the change in the fair value of the de-designated swaps for the years ended December 31, 2011, 2010 and 2009 resulted in a credit to interest expense and a decrease in the corresponding liability of $0.1 million, $0.3 million and $0.7 million, respectively.

Warrants Subject to Revaluation

2008 Warrants

In conjunction with the Second Amendment, the Company issued a series of warrants (the “2008 Warrants”) to its then existing lenders to purchase an aggregate of 474,049 shares of the Company's common stock, subject to adjustment related to anti-dilution provisions, at an exercise price of $1.00 per share. The Company accounts for the 2008 Warrants as derivative financial instruments.  The calculated fair value of the 2008 Warrants is classified as a liability and is periodically remeasured with any changes in value recognized in the stock warrants revaluation line on the consolidated statements of operations.   Guidance related to the accounting of the warrants became effective for the Company as of January 1, 2009.  Accordingly, the fair value of the warrants as of that date was reclassified from shareholders' equity to long-term liabilities.  

Pursuant to the anti-dilution provisions, the number of shares of common stock issuable upon exercise of the 2008 Warrants was increased to an aggregate of 483,742 shares and the exercise price was adjusted to $0.98 per share as a result of the issuance on May 21, 2009 and on June 22, 2009, pursuant to the Patrick Industries, Inc. 1987 Stock Option Program, as amended and restated (the “1987 Plan”), of restricted shares at a price less than, and options to purchase common stock with an exercise price less than, the warrant exercise price then in effect.

Pursuant to the anti-dilution provisions, the number of shares of common stock issuable upon exercise of the 2008 Warrants was further increased to an aggregate of 496,397 shares and the exercise price was adjusted to $0.96 per share as a result of the issuance on March 31, 2011, of warrants to purchase common stock with an exercise price less than the warrant exercise price then in effect (see “March 2011 Warrants” below).

In May 2011 and August 2011, two of the members of the Company's former bank lending group exercised their 2008 Warrants to purchase 22,586 shares and 59,815 shares of the Company's common stock, respectively.  In connection with the cashless exercises, 12,956 and 32,219 net shares of common stock were issued, respectively.  The fair value of the shares in the aggregate of $0.1 million was reclassified to shareholders' equity on the consolidated statements of financial position.  Following these exercises, there were in aggregate 413,996 shares of common stock issuable upon exercise of the then remaining 2008 Warrants.

Pursuant to the anti-dilution provisions, the number of shares of common stock issuable upon exercise of the then remaining 2008 Warrants was increased to an aggregate of 419,646 shares and the exercise price was adjusted to $0.94 per share as a result of the issuance on September 16, 2011, of warrants to purchase common stock with an exercise price less than the warrant exercise price then in effect (see “September 2011 Warrants” below).

In September 2011, one of the members of the Company's former bank lending group exercised its 2008 Warrants to purchase 91,477 shares of the Company's common stock.  In connection with the cashless exercise, 45,881 net shares of common stock were issued.  The fair value of the shares of $0.1 million was reclassified to shareholders' equity on the consolidated statements of financial position.  As of December 31, 2011, there were in aggregate 328,169 shares of common stock issuable upon exercise of the remaining 2008 Warrants.

March 2011 Warrants

On March 31, 2011, as partial consideration for the March 2011 Notes (as defined herein), the Company issued to each of Tontine Capital Overseas Master Fund II, L.P., a Cayman Islands limited partnership (“TCOMF2”) and Northcreek warrants to purchase 125,000 shares of the Company's common stock at an exercise price of $0.01 per share (the ‘‘March 2011 Warrants”).  The March 2011 Warrants are immediately exercisable, subject to anti-dilution provisions and expire on March 31, 2016.   The debt discount of $0.7 million, which is equal to the fair value of the March 2011 Warrants as of March 31, 2011, is being amortized to interest expense over the life of the March 2011 Notes beginning in the second quarter of 2011.

The calculated fair value of the March 2011 Warrants was classified as a liability beginning in the second quarter of 2011 and was periodically remeasured with any changes in fair value recognized in the stock warrants revaluation line on the consolidated statements of operations.  Northcreek and TCOMF2 exercised their warrants to purchase in the aggregate 250,000 shares of the Company's common stock at an exercise price of $0.01 per share in April 2011 and June 2011, respectively.  The $0.6 million fair value of the 250,000 shares was reclassified to shareholders' equity on the consolidated statements of financial position.

September 2011 Warrants

On September 16, 2011, in connection with the September 2011 Notes (as defined herein), the Company issued to Northcreek and an affiliate of Northcreek, warrants to purchase, in the aggregate, 135,000 shares of the Company's common stock at an exercise price of $0.01 per share (the ‘‘September 2011 Warrants”).  The September 2011 Warrants are immediately exercisable, subject to anti-dilution provisions, and expire on March 31, 2016.   The debt discount of $0.3 million, which is equal to the fair value of the September 2011 Warrants as of September 16, 2011, is being amortized to interest expense over the life of the September 2011 Notes beginning in the third quarter of 2011.

The calculated fair value of the September 2011 Warrants was classified as a liability beginning in the third quarter of 2011 and was periodically remeasured with any changes in fair value recognized in the stock warrants revaluation line on the consolidated statements of operations.   Northcreek and an affiliate of Northcreek exercised their warrants to purchase in the aggregate 135,000 shares of the Company's common stock at an exercise price of $0.01 per share in November 2011.  The $0.3 million fair value of the 135,000 shares was reclassified to shareholders' equity on the consolidated statements of financial position.

The 2008 Warrants, the March 2011 Warrants, and the September 2011 Warrants are measured at fair value on a recurring basis using Level 2 valuation methodologies.  The Company utilizes inputs such as its stock trading value, price volatility, risk-free interest rate and the warrants' expected life for valuation purposes.  The total fair value of the outstanding warrants as of and for the years ended December 31, 2011 and 2010 is as follows:

(thousands)	Dec. 31, 2011			Dec. 31, 2010
Balance at beginning of period	$	770		$	1,031
Fair value of March and September 2011 Warrants (debt discount)		954			-
Reclassification of fair value of exercised warrants to shareholders' equity		(1,232	)		-
Change in fair value, included in earnings		699			(261	)
Balance at end of period	$	1,191		$	770