Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our consolidated financial statements and related notes and other financial information appearing elsewhere in this Form 10-K. In addition to historical information, the following discussion and other parts of this Form 10-K contain forward-looking information that involves risks and uncertainties. Our actual results could differ materially from those anticipated by this forward-looking information due to the factors discussed under “Risk Factors,” “Cautionary Statement Concerning Forward-Looking Statements,” and elsewhere in this Form 10-K.
This section of this Form 10-K does not address certain items regarding the fiscal year ended December 29, 2018 (“fiscal 2018”). Discussion and analysis of fiscal 2018 and year-to-year comparisons between fiscal 2019 and fiscal 2018 not included in this Form 10-K can be found in “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended December 28, 2019.
Executive Level Overview
Company Background
BlueLinx is a leading U.S. wholesale distributor of residential and commercial building products with both branded and private-label SKUs across product categories such as lumber, panels, engineered wood, siding, millwork, metal building products, and other construction materials. With a strong market position, broad geographic coverage footprint servicing 40 states, and the strength of a locally focused sales force, we distribute our comprehensive range of products to over 15,000 national, regional, and local dealers, specialty distributors, national home centers, and manufactured housing customers. BlueLinx is able to provide a wide range of value added services and solutions to our customers and suppliers. We are headquartered in Georgia, with executive offices located at 1950 Spectrum Circle, Marietta, Georgia, and we operate our distribution business through a broad network of distribution centers.
As a “two-step” wholesale distributor of building products, BlueLinx stocks products from leading manufacturers, such as Huber Engineered Woods, James Hardie, Georgia Pacific, Weyerhaeuser, and Oldcastle, and supplies these products to a broad range of customers, including lumber yards, dealers, home centers, and hardware stores. These customers then serve residential and commercial builders and contractors in their respective geographic areas. BlueLinx plays a critical role in enabling its lumber yard, dealer, and home center customers to offer a broad range of products and brands, as most of BlueLinx’s customers do not have the capability to purchase and warehouse directly from the manufacturers for such a large set of SKUs. Similarly, BlueLinx provides value to its manufacturer partners by enabling access to the fragmented network of lumber yards and dealers that the manufacturers could not adequately serve directly. Our place in this distribution model of building products provides easy access to the marketplace for our suppliers and the value proposition of rapid delivery on an as-needed basis to our customers from our network of warehouse facilities. In addition to its broad portfolio of building products, BlueLinx also offers a wide array of custom cutting and fabrication services for the wood products industry.
Recent Developments
Real Estate Transactions
During the first quarter of fiscal 2020, we completed real estate financing transactions through sale-leaseback arrangements on fourteen of our distribution facilities. Gross proceeds for these transactions were $78.3 million. Net proceeds from these transactions were used to repay indebtedness under our Term Loan Facility. Upon completion of the transactions, we entered into long-term leases with multiple renewal options on the properties. These real estate financing transactions were accounted for as finance leases, in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). Additionally, during the third quarter of fiscal 2020, we completed a real estate financing transaction through a sale-leaseback arrangement on one distribution facility. Gross proceeds for this transaction were $11.0 million and we recognized a gain of $8.7 million on the sale of this facility. Net proceeds from this transaction were used to repay indebtedness under our Term Loan Facility. Upon completion of the transaction, we entered into a long-term lease with multiple renewal options on the property. The real estate financing transaction was accounted for as a sale and the lease was accounted for as an operating lease, in accordance with U.S. GAAP.
These transactions are described in further detail in Note 12, Lease Commitments, in the Notes to the Consolidated Financial Statements.
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Factors That Affect Our Operating Results and Trends
Our results of operations and financial performance are influenced by a variety of factors, including: (i) the commodity nature of the products we manufacture and distribute; (ii) general economic and industry conditions affecting demand in the housing market; and (iii) cost and availability of the products we distribute. These factors have historically produced cyclicality in our results of operations, and we expect this cyclicality to continue in future periods .
Commodity Nature of Our Products
Many of the building products we distribute, including OSB, plywood, and lumber, are commodities that are widely available from various suppliers with prices and volumes determined frequently in a market based on participants' perceptions and expectations of short-term supply and demand factors. The selling price of our commodity products is based on the current market purchase price to replace those products in our inventory, plus adders for our shipping, handling, overhead costs, and our profit margin. At certain times, the selling price for any one or more of the products we distribute, especially those of a commodity nature, may well exceed our purchase price because our prices are based on current replacement cost which, in a dynamic inflationary commodity market, may at times well exceed our purchase price. At certain other times, the selling price for any one or more of the products we distribute, especially those of a commodity nature, may fall below our purchase costs for the same reasons, requiring us to incur short-term losses on specific sales transactions. Therefore, our profitability with respect to these commodity products depends, in significant part, on commodity prices in addition to managing our cost structure, particularly shipping and handling costs, which represent significant components of our operating costs. Composite structural panel and lumber prices have been historically volatile.
The following table represents the percentage price changes on a year over year basis of the average composite panel, including certain panel subcategories, and average composite lumber prices as reflected by Random Lengths, an industry publication, for the periods noted below. In addition to the year-over-year average price changes, 2020 was a year of exceptional price volatility when compared to historical results over the last eight years as both composite panel and composite lumber prices experienced the largest difference between high and low price levels within a calendar year. Pricing for these products declined starting in March, but rebounded during the remaining portion of the second quarter, significantly increasing during most of the third quarter. A two-month decline began in the final weeks of the third quarter and lasted until December. In December 2020, pricing began to rapidly increase towards all-time highs. These market trends resulted in substantial favorable revenue and gross margin comparisons for fiscal 2020 for our structural products and our business as a whole. Wood-based commodity index prices began January at record or near-record highs and remain at elevated levels. There is much uncertainty regarding future trends in lumber and panel index prices. We continue to closely monitor these pricing trends, and work to manage our business, inventory levels, and costs accordingly.
Calendar Year Ended
December 31
2020 versus 2019 2019 versus 2018
Increase (decrease) in composite lumber prices 59% (23)%
Increase (decrease) in Western SPF lumber prices 45% (20)%
Increase (decrease) in Southern pine lumber prices 53% (22)%
Increase (decrease) in composite panel prices 56% (27)%
Increase (decrease) in Western fir plywood prices 22% (16)%
Increase (decrease) in Southern pine plywood prices 29% (18)%
Increase (decrease) in OSB prices 99% (38)%
General Economic and Industry Conditions Affecting Demand
Many of the factors that cause our operations to fluctuate are seasonal or cyclical in nature. Historically, our operating results have also been correlated with the level of single-family residential housing starts in the U.S. The demand for new homes is dependent on a variety of factors, including job growth, changes in population and demographics, the availability and cost of mortgage financing, the supply of new and existing homes, and consumer confidence. The COVID-19 pandemic had a significant negative effect on single family housing starts in April and May. However, housing starts rebounded during the second half of the year. Low interest rates, shortages in existing home inventory, and a potential growing trend toward relocating away from populated metropolitan areas to areas with single-family homes may help sustain the improvement in
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single-family housing starts. We believe the housing market improvement trend will continue in the long term, and that we are well-positioned to support our customers. For additional information regarding the risk factors impacting our business, please refer to Part I, Item 1A, Risk Factors.
Cost And Availability of the Products We Distribute
The structural products we distribute are available from variety of suppliers. The specialty products we distribute are available from select suppliers from which we have established and cultivated relationships in the specific markets we serve. As a result of the COVID-19 pandemic, manufacturing output was impacted on both the structural and specialty sides of our business. Supply constraints which arose from reduced mill output as a result of the pandemic had an impact on both the availability and pricing of our structural products which contributed to increased market prices throughout the year. Reduced manufacturing capacity combined with increased demand for our specialty products also had an impact on the products we distribute in this category, namely vinyl siding. The continued availability of both structural and specialty products may have an impact on our operating results and are discussed in more detail in Part I, Item 1A, Risk Factors .
COVID-19 Pandemic
We began preparations for the COVID-19 pandemic in late February 2020, and in early March 2020 we implemented policies and procedures to protect our associates, serve our customers, and support our suppliers. We also moved quickly to develop and execute plans and take actions designed to give financial and operating flexibility during the pandemic. To date, our business has been designated as “essential” in all states in which we operate, and we have continued to operate and provide service to our customers and suppliers.
During fiscal 2020, and into 2021, we have continued to practice safety and hygiene protocols consistent with the Centers for Disease Control and Prevention (“CDC”) and local guidance. We also continued our efforts to reduce operating costs and optimize liquidity and took actions designed to sustain many of our first and second quarter cost reduction actions long-term. Cost structure and liquidity will remain areas of acute focus for us as the pandemic continues.
While the pandemic impacted many aspects of our business and operations during fiscal 2020, that impact was offset by the recovery in single-family residential housing starts and the escalation in wood-based commodity pricing. Our net sales and gross margin increased, largely driven by the significant increase in wood-based pricing. For fiscal 2020, net sales increased $460.1 million compared to fiscal 2019 and net income improved $98.5 million as we moved from a net loss for fiscal 2019 to net income for fiscal 2020.
The extent of the impact of the pandemic on our business for fiscal 2021 will depend on future developments, including, among others, the duration of the pandemic, the success of actions taken by governmental authorities to contain the pandemic and address its impact, the success of local return to work and business reopening plans, and the impact the COVID-19 pandemic has on the supply chain, pricing, and demand in the markets we service. The trajectory of the pandemic continues to evolve rapidly, and we cannot predict the extent to which our financial condition, results of operation, or cash flows will ultimately be impacted. We are closely monitoring the impact of the pandemic on industry conditions, the progress of local return to work and reopening plans, and any pandemic related restrictions that may have an impact on our business.
CARES Act
In an attempt to assist businesses during the COVID-19 pandemic, Congress enacted the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act on March 27, 2020. The CARES Act contained several provisions, including tax-based measures, meant to counteract the effects of the COVID-19 pandemic. After review of the many provisions, we took advantage of several of the provisions, including the deferral of our defined benefit plan pension contribution, deferral of the payment of employer payroll taxes, and the increase in the percentage of allowable percentage of interest expense under Section 163(j) of the Internal Revenue Code (“IRC”).
During fiscal 2020, as a result of the CARES Act, we were able to recognize discrete tax benefits during the year of $4.8 million resulting from the release of the valuation allowance associated with nondeductible interest expense as the CARES Act increased the allowable percentage from 30 percent to 50 percent of adjusted taxable income. We also elected to defer the payment of employer payroll taxes that would normally be paid during fiscal 2020. These taxes are required to be paid in two tranches, with 50 percent due by the end of 2021 and 50 percent due by the end of 2022. We expect to make payments of $3.2 million by December 2021 and the remaining $3.1 million by December 2022. Finally, we elected to defer defined benefit plan pension contributions totaling $0.6 million required during fiscal 2020 until December 31, 2020. We were required to pay
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interest on the contributions in accordance with the provision included in the CARES Act. We made the contributions, including interest, of $0.6 million, on December 15, 2020.
Results of Operations
Fiscal 2020 Compared to Fiscal 2019
The following table sets forth our results of operations for fiscal 2020 and fiscal 2019, which were comprised of 53 and 52 weeks, respectively.
Fiscal 2020 % of
Net
Sales Fiscal 2019 % of
Net
Sales
($ in thousands)
Net sales $ 3,097,328 100.0% $ 2,637,268 100.0%
Gross profit 477,734 15.4% 356,915 13.5%
Selling, general, and administrative 314,228 10.1% 291,526 11.1%
Depreciation and amortization 28,901 0.9% 30,232 1.1%
Amortization of deferred gains on real estate (4,008) (0.1)% (3,960) (0.2)%
Gains from sales of property (10,529) (0.3)% (13,082) (0.5)%
Other operating expenses 6,901 0.2% 17,045 0.6%
Operating income 142,241 4.6% 35,154 1.3%
Interest expense, net 47,414 1.5% 54,218 2.1%
Other (income) expense, net (254) 0.0% 2,544 0.1%
Income (loss) before provision for (benefit from) income taxes 95,081 3.1% (21,608) (0.8)%
Provision for (benefit from) income taxes 14,199 0.5% (3,952) (0.1)%
Net income (loss) $ 80,882 2.6% $ (17,656) (0.7)%
The following table sets forth changes in net sales by product category. Prior year amounts have been reclassified to conform to the current year mix of structural and specialty products.
Fiscal 2020 Fiscal 2019
($ in thousands)
Net sales by category
Structural products $ 1,232,203 39.8 % $ 861,687 32.7 %
Specialty products 1,865,125 60.2 % 1,775,581 67.3 %
Total net sales $ 3,097,328 100.0 % $ 2,637,268 100.0 %
The following table sets forth gross margin dollars and percentages by product category versus comparable prior periods. Prior year amounts have been reclassified to conform to the current year product mix of structural and specialty products.
Fiscal 2020 Fiscal 2019
($ in thousands)
Gross profit $ by category:
Structural products $ 158,157 $ 74,957
Specialty products 319,577 281,958
Total Gross Profit $ 477,734 $ 356,915
Gross margin % by category
Structural products 12.8 % 8.7 %
Specialty products 17.1 % 15.9 %
Total gross margin % 15.4 % 13.5 %
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Discussion of Results of Operations
Net sales. Net sales of $3.1 billion in fiscal 2020 increased by 17.4 percent, or $0.5 billion, from fiscal 2019. The sales increase was primarily a result of wood-based commodity price inflation, partially offset by a slight decline in sales volume attributable to supply outages in structural products occurring during the second half of fiscal 2020. The COVID-19 pandemic created unprecedented market conditions on the supply and demand of our products. As the severity of the COVID-19 pandemic initially became apparent, manufacturers ran fewer shifts out of an abundance of caution creating supply bottlenecks. In addition, productivity was negatively impacted by COVID-19 employee illnesses from our supply partners. At the same time, after an initial decline in single family housing starts and repair and remodeling activities, the housing market became more robust during fiscal year 2020 and the growth rate for single family housing starts was 11.5 percent, while housing repair and remodeling activity was estimated to have grown by 3.5 percent. The impact of the reduced supply coupled with increasing demand led to a historically high increase in wood-based commodity prices after the pandemic began. Full year structural product net sales, which includes products such as lumber, plywood, oriented strand board, rebar, and remesh, were $1.2 billion and the impact of the record wood-based commodity price inflation occurring in the second half of the year is estimated to have increased net sales by approximately $210 million to $230 million.
Gross profit. Total gross profit for fiscal 2020 was $477.7 million, compared to $356.9 million in fiscal 2019. Gross margin increased to 15.4 percent in fiscal 2020, compared to 13.5 percent in fiscal 2019. Gross margin percentage increased primarily due to wood-based commodity price inflation in our structural product category as we were selling lower costed inventory during a period of rapidly increasing commodity prices. This was largely a result of the extension of lead times during the increase in the second half of the year and tightened supply due to the pandemic, paired with strong demand. Specialty products margins benefited from mix shifts to higher margin categories, paired with pricing strategies focused in key products categories such as engineered wood and millwork products.
Selling, general, and administrative expenses. Selling, general, and administrative (“SG&A”) expenses for fiscal 2020 were $314.2 million, compared to $291.5 million, for fiscal 2019. The increase was primarily due to higher variable incentive compensation of approximately $13.1 million, higher sales commissions of approximately $10.0 million, and increased operational expenses related to higher than anticipated sales volume. Our cost reduction actions taken in the second quarter, focused primarily on labor, realized approximately $10.5 million of savings for the Company, annualized to $13.9 million. These savings were offset by additional payroll and other operating expenses attributable to the additional fiscal week in fiscal 2020.
Depreciation and amortization expense. Depreciation and amortization expense for fiscal 2020 was $28.9 million, compared to $30.2 million, for fiscal 2019, a decrease of $1.3 million. This decrease was primarily due to certain assets becoming fully depreciated during 2020.
Gains from sales of property. Total gains from sales of property in fiscal 2020 were $10.5 million compared to $13.1 million in fiscal 2019, a decrease of 19.5 percent. In fiscal 2020, the majority of our real estate transactions were sale leaseback transactions where we were not allowed to recognize a gain under U.S. GAAP, with the exception of the sale leaseback of our Denver facility. In fiscal 2019, the majority of our real estate transactions were largely typical sale transactions where we were allowed to recognize a gain under U.S. GAAP.
Other operating expenses. Other operating expenses were $6.9 million in fiscal 2020 compared to $17.0 million in fiscal 2019, a decrease of 59.5 percent. The decrease is primarily due to a decrease in spending related to the integration of the Cedar Creek acquisition, partially offset by severance expense incurred in relation to headcount reductions that occurred throughout the period.
Interest expense, net. Interest expense for fiscal 2020 was $47.4 million, compared to $54.2 million for fiscal 2019. The decrease of $6.8 million was largely attributable to a decrease in the bank debt balance of $141.8 million, comprised of decreases in our Term Loan Facility of $103.5 million and Revolving Credit Facility of $38.3 million, respectively, as well as a reduction in the variable LIBOR rate that is a component of the interest rate on our bank debt instruments.
Other expense (income), net. Other expense (income), net was $(0.3) million in fiscal 2020 compared to $2.5 million in fiscal 2019, a decrease of $2.8 million. The decrease was due to expenses related to the lump sum payout offer made in fiscal 2019 to certain eligible retirees in the BlueLinx Hourly Retirement plan instead of receiving their typical payment streams.
Provision for (benefit from) income taxes. Our effective tax rate was 14.9 percent and 18.3 percent for fiscal 2020 and fiscal 2019, respectively. Primary drivers of the decline in our effective tax rate in fiscal 2020 versus fiscal 2019 included the
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release of valuation allowances associated with state net operating losses and our previously nondeductible interest expense, both of which we believe we will be able to realize based on our positive taxable income for fiscal 2020.
Our effective tax rate for fiscal 2020 was impacted by the effect of the release of our valuation allowance for disallowed interest expense stemming from federal tax reforms, and the CARES Act , the partial release of our valuation allowance for state net operating losses that we anticipate being able to utilize, the tax benefit related to the lapse of statutes of limitations from uncertain tax positions (FIN 48), changes in the state effective tax rate used to value deferred tax assets, and the permanent addback of certain nondeductible expenses including executive compensation and nondeductible meals and entertainment.
Our effective tax rate for fiscal 2019 was impacted by the effect of the valuation allowance for disallowed interest expense stemming from federal tax reforms and certain state net operating losses, the tax benefit related to the lapse of statutes of limitations from uncertain tax positions (FIN 48), changes in the state effective tax rate used to value deferred tax assets, and the permanent addback of certain nondeductible expenses including executive compensation and nondeductible meals and entertainment.
Our effective tax rate moving forward will continue to be subject to fluctuations in quarters throughout the year because of various factors. These factors include the impact of permanent items combined with the timing of discrete items such as equity compensation windfalls and/or shortfalls, which occur as our equity compensation grants become vested throughout the year, any potential releases of our valuation allowance against net operating loss carryforwards, and the annual impact of the expiration of the statute of limitations associated with our uncertain tax positions (FIN 48). The magnitude of the impact to our effective tax rate in any given quarter resulting from the vesting of our equity compensation grants can vary depending in our stock price at the time of vesting. The impact to our effective rate tax rate resulting from the expiration of the statute of limitations associated with our uncertain tax positions (FIN 48) occurred in the fourth quarter of both fiscal 2020 and 2019, the timing of which we expect to continue into future periods.
Liquidity and Capital Resources
We expect our primary sources of liquidity to be cash flows from sales in the normal course of our operations and availability from our Revolving Credit Facility. We expect that these sources will be sufficient to fund our ongoing cash requirements for the foreseeable future, including at least the next twelve months.
Sources and Uses of Cash
Operating Activities
Fiscal 2020 cash flows provided by operating activities totaled $55.0 million. This cash activity was primarily driven by net income of $80.9 million, which included a non-cash gain on sale of property of $10.5 million and changes in working capital components. The changes in working capital components included an increase in cash due to a decrease in inventory of $3.7 million and an increase in accounts payable of $32.8 million and a decrease in cash due to an increase in accounts receivable of $100.8 million.
Fiscal 2019 cash flows used in operating activities totaled $10.3 million. This cash activity was primarily driven by a net loss of $17.7 million, which included a non-cash gain on sale of property of $13.1 million and changes in working capital components. The changes in working capital components included an increase in cash due to a decrease in accounts receivable of $15.6 million and a decrease in cash due to an increase in inventory of $4.0 million and a decrease in accounts payable of $16.8 million.
Investing Activities
During fiscal 2020, our net cash provided by investing activities was $9.2 million, which was substantially driven by cash received from the sale of real estate of $12.8 million, offset by cash paid for investments in equipment of $3.7 million.
During fiscal 2019, our net cash provided by investing activities was $21.1 million, which was substantially driven by cash received from the sale of real estate of $19.9 million, in addition to $6.0 million of cash returned from escrow related to the acquisition of Cedar Creek, offset by cash paid for investments in equipment of $4.8 million.
Financing Activities
Net cash used in financing activities was $75.7 million during fiscal 2020, which primarily reflected repayments on our term loan of $103.5 million and net repayments on our Revolving Credit Facility of $38.3 million, in addition to payments on
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finance leases of $8.7 million and debt financing costs of $3.4 million, all of which were partially offset by proceeds from real estate financing transactions of $78.3 million.
Net cash used in financing activities was $8.1 million during fiscal 2019, which primarily reflected repayments on our term loan of $32.4 million and net repayments on our Revolving Credit Facility of $6.8 million, in addition to payments on our finance leases of $10.0 million and debt financing costs of $3.6 million, all of which were partially offset by proceeds from real estate financing transactions of $44.9 million.
Operating Working Capital
Operating working capital is an important measurement we use to determine the efficiencies of our operations and our ability to readily convert assets into cash. Operating working capital is defined as the sum of cash, receivables, and inventory less accounts payable. Management of operating working capital helps us monitor our progress in meeting our goals to enhance our return on working capital assets.
Selected financial information
January 2, 2021 December 28, 2019
(In thousands)
Current assets:
Cash $ 82 $ 11,643
Receivables, less allowance for doubtful accounts 293,643 192,872
Inventories, net 342,108 345,806
$ 635,833 $ 550,321
Current liabilities:
Accounts payable $ 165,163 $ 132,348
$ 165,163 $ 132,348
Operating working capital $ 470,670 $ 417,973
Operating working capital increased to $470.7 million as of January 2, 2021, from $418.0 million as of December 28, 2019. The increase in operating working capital is primarily due to an increase in accounts receivable of $100.8 million, offset by a decrease in cash of $11.6 million and an increase in accounts payable of $32.8 million. The increases in accounts receivable and accounts payable are due primarily to wood-based commodity price inflation, which impacted sales dollars and the cost of inventory as reflected in accounts receivable and accounts payable balances.
Debt and Credit Sources
As of January 2, 2021 and December 28, 2019, long-term debt consisted of the following:
January 2, 2021 December 28, 2019
(In thousands)
Revolving Credit Facility $ 288,247 $ 326,496
Term Loan Facility 43,204 146,674
Finance lease obligations 273,118 198,011
604,569 671,181
Unamortized debt issuance costs (9,010) (12,555)
595,559 658,626
Less: current maturities of long-term debt 6,846 8,662
Long-term debt, net of current maturities $ 588,713 $ 649,964
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Revolving Credit Facility
In April 2018 we amended and restated our Revolving Credit Facility, which is secured by substantially all of our assets, to provide for a senior secured revolving loan and letter of credit facility of up to $600 million and an uncommitted accordion feature that permits us to increase the facility by an aggregate additional principal amount of up to $150 million. If we obtain the full amount of the additional increases in commitments, the Revolving Credit Facility will allow borrowings of up to $750 million. Borrowings under the Revolving Credit Facility are subject to availability under the “Borrowing Base” (as that term is defined in the Revolving Credit Facility). The Borrowing Base is calculated based upon our outstanding accounts receivable, subject to certain adjustments. Letters of credit in an aggregate amount of up to $30 million are also available under the Revolving Credit Facility, which would reduce the amount of the revolving loans available under the facility. The Revolving Credit Agreement provides for interest at a rate per annum equal to (i) LIBOR plus a margin ranging from 1.75 percent to 2.25 percent, with the margin determined based upon average excess availability for the immediately preceding fiscal quarter for loans based on LIBOR, or (ii) the administrative agent’s base rate plus a margin ranging from 0.75 percent to 1.25 percent, with the margin based upon average excess availability for the immediately preceding fiscal quarter for loans based on the base rate.
If excess availability under the Revolving Credit Facility falls below the greater of (i) $50 million and (ii) 10 percent of the lesser of (a) the borrowing base and (b) the maximum permitted credit at such time, we will be required to maintain a fixed charge coverage ratio of 1.0 to 1.0 until excess availability has been at least the greater of (i) $50 million and (ii) 10 percent of the lesser of (a) the borrowing base and (b) the maximum permitted credit at such time for a period of 30 consecutive days.
In January 2020, we amended the Revolving Credit Facility to (i) modify the “Seasonal Period” to run from November 15, 2019, through July 15, 2020, for the calendar year 2019, and to run from December 15 of each calendar year through April 15 of each immediately succeeding calendar year for the calendar year 2020 and thereafter, and (ii) extend the measurement period in the definition of “Cash Dominion Event” from three consecutive business days to five consecutive business days. The amendment better aligns advance rates under the facility with the seasonality associated with our business.
As of January 2, 2021, we had outstanding borrowings of $288.2 million and excess availability of $184.3 million under our Revolving Credit Facility. As of December 28, 2019, we had outstanding borrowings of $326.5 million and excess availability of $80.0 million under our Revolving Credit Facility. Our average effective interest rate under the facility was approximately 3.3 percent and 4.8 percent for the years ended January 2, 2021 and December 28, 2019, respectively.
We were in compliance with all covenants under the Revolving Credit Facility as of January 2, 2021.
Term Loan Facility
In April 2018, we entered into a Credit and Guaranty Agreement with HPS Investment Partners, LLC, and other financial institutions as party thereto. The agreement provides for a Term Loan Facility of $180.0 million secured by substantially all of our assets. Borrowings under the Term Loan Facility may be made as Base Rate Loans or Eurodollar Rate Loans. The Base Rate Loans will bear interest at the rate per annum equal to (i) the greatest of the (a) U.S. prime lending rate published in The Wall Street Journal, (b) the Federal Funds Effective Rate plus 0.50 percent, and (c) the sum of the Adjusted Eurodollar Rate of one month plus 1.00 percent, provided that the Base Rate shall at no time be less than 2.00 percent per annum; and (ii) plus the Applicable Margin, as described below. Eurodollar Rate Loans will bear interest at the rate per annum equal to (i) the ICE Benchmark Administration LIBOR Rate, provided that the Adjusted Eurodollar Rate shall at no time be less than 1.00 percent per annum; plus (ii) the Applicable Margin. The Applicable Margin will be 6.00 percent with respect to Base Rate Loans and 7.00 percent with respect to Eurodollar Rate Loans.
In October 2019, we amended the Term Loan Facility to, among other things, permit real estate sale leaseback transactions. During fiscal 2020, in December 2019, we amended the Term Loan Facility to extend the period for satisfying the designated outstanding principal balance level, and the principal balance level was satisfied on January 31, 2020, through repayments from real estate financing transactions. On February 28, 2020, we further amended our Term Loan Facility to provide that we will not be subject to the facility’s quarterly “Total Net Leverage Ratio” covenant from and after the time, and then for so long as, the principal balance outstanding under the facility is less than $45 million. During the fourth quarter of 2020, we reduced the principal balance outstanding under the Term Loan Facility below $45 million and were no longer subject to this covenant. We do not anticipate future borrowings under the Term Loan Facility and expect to not be subject to the Total Net Leverage ratio covenant in the future.
The Term Loan Facility permits us to enter into real estate sale leaseback transactions with the net proceeds therefrom to be used for repayment of indebtedness under the facility, subject to payment of an applicable prepayment premium. In addition,
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proceeds from the sale of “Specified Properties” will be used for the repayment of indebtedness under the Term Loan Facility, subject to payment of an applicable prepayment premium, or, under certain circumstances, repayment of indebtedness under our Revolving Credit Facility. Prepayment premiums associated with the repayment of indebtedness were $3.0 million and $0.5 million for fiscal 2020 and 2019, respectively.
We had outstanding borrowings of $43.2 million and $146.7 million under our Term Loan Facility as of January 2, 2021 and December 28, 2019, respectively. Our average interest rate under the facility, exclusive of fees and prepayment premiums, was approximately 8.2 percent and 9.3 percent for the years ended January 2, 2021 and December 28, 2019, respectively.
We were in compliance with all covenants under the Term Loan Facility as of January 2, 2021.
Finance Lease Commitments
Our finance lease liabilities consist of leases related to equipment and vehicles, and to real estate, with the majority of those finance lease commitments relating to the real estate financing transactions that we have completed in recent years. During fiscal 2017 and 2018, we completed real estate financing transactions on six warehouse facilities, during fiscal 2019, we completed real estate financing transactions on two warehouse facilities; and during fiscal 2020, we completed real estate financing transactions on fourteen warehouse facilities. We recognized financing lease assets and obligations as a result of each of these transactions. Our total finance lease commitments, including the properties associated with these transactions, totaled $273.1 million and $198.0 million as of January 2, 2021 and December 28, 2019, respectively. Of the $273.1 million of finance lease commitments as of January 2, 2021, $243.7 million related to real estate and $29.4 million related to equipment. Of the $198.0 million of finance lease commitments as of December 28, 2019, $165.5 million related to real estate and $32.5 million related to equipment.
Investments in Capital Assets
Our investments in capital assets consist of cash paid for owned assets and the inception of financing lease arrangements for long-lived assets to support our distribution infrastructure. The gross value of these assets are included in their respective category in the “Property and equipment, at cost” section on our consolidated balance sheet. For fiscal 2020, we invested $3.7 million in cash related to investments in long-lived assets and entered into finance leases totaling $3.8 million, for a total investment of $7.5 million. For fiscal 2019, we invested $4.8 million in cash related to investments in long-lived assets and entered into finance lease agreements totaling $15.0 million, for a total investments of $19.8 million.
Pension Funding Obligations
We were required to make cash contributions of during 2020 and 2021 totaling approximately $0.9 million, relating to our fiscal 2020 funding year pension contributions. We continue to evaluate pension funding obligations and requirements in order to meet our obligations while maintaining flexibility for working capital requirements. See Note 8, Employee Benefits , in the Notes to the Consolidated Financial Statements.
Interest Rates
Our Revolving Credit Facility and our Term Loan Facility include available interest rate options based on LIBOR. It is widely expected that LIBOR will be discontinued after 2021, and the U.S. and other countries are currently working to replace LIBOR with alternative reference rates. The consequences of these development with respect to LIBOR cannot be entirely predicted; however, we do not believe that the discontinuation of LIBOR as a reference rate in our loan agreements will have a material adverse effect on our financial position or materially affect our interest expense.
Off-Balance Sheet Arrangements
As of January 2, 2021, we did not have any material off-balance sheet arrangements.
Critical Accounting Policies
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the U.S., which require management to make estimates, judgments, and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. We believe that our most critical accounting policies and estimates relate to: (1) revenue recognition; (2) goodwill; and (3) income taxes.
Accounting estimates and assumptions discussed in this section are those that we consider to be the most critical to an understanding of our financial statements because they involve significant judgments and uncertainties. All of these estimates reflect our best judgment about current, and for some estimates future, economic and market conditions and their potential
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effects based on information available as of the date of these financial statements. If these conditions change from those expected, it is reasonably possible that the judgments and estimates described below could change, which may result in our recording additional pension liabilities, or increased tax liabilities, among other effects.
Management has discussed the development, selection, and disclosure of critical accounting policies and estimates with the Audit Committee of the Company’s Board of Directors. While our estimates and assumptions are based on our knowledge of current events and actions we may undertake in the future, actual results ultimately may differ from these estimates and assumptions. For a discussion of the Company’s significant accounting policies, see Note 1, Summary of Significant Accounting Policies , in the Notes to Consolidated Financial Statements.
Revenue Recognition
We recognize revenue when the following criteria are met: (1) Contract with the customer has been identified; (2) Performance obligations in the contract have been identified; (3) Transaction price has been determined; (4) The transaction price has been allocated to the performance obligations; and (5) When (or as) performance obligations are satisfied. For us, this generally means that we recognize revenue when title to our products is transferred to our customers. Title usually transfers upon shipment to, or receipt at, our customers’ locations, as determined by the specific sales terms of each transaction. Our customers can earn certain incentives including, but not limited to, cash discounts and rebates. These incentives are deducted from revenue recognized. In preparing the financial statements, management must make estimates related to the contractual terms, customer performance, and sales volume to determine the total amounts recorded as deductions from revenue. Management also considers past results in making such estimates. The actual amounts ultimately paid may be different from our estimates, and recorded once they have been determined.
Goodwill
Goodwill is not subject to amortization, and is tested for impairment at least annually. We perform our annual goodwill impairment test as of the first day of our fiscal fourth quarter. This test requires us to assign goodwill to a reporting unit and to determine if the fair value of the reporting unit’s goodwill is less than its carrying amount. We have identified that we have a single reporting unit and we assign our goodwill to that reporting unit. As of January 2, 2021, our goodwill was $47.8 million.
We also evaluate goodwill for impairment between annual impairment tests if an event occurs or circumstances change that would indicate the carrying amounts may be impaired. Such events and indicators may include, without limitation, significant declines in the industries in which our products are used, significant changes in capital market conditions, and significant changes in our market capitalization.
Income Taxes
Our annual tax rate is based on our income, statutory tax rates, and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax expense and in evaluating our tax positions. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that the positions become uncertain based upon one of the following: (1) the tax position is not “more likely than not” to be sustained; (2) the tax position is “more likely than not” to be sustained, but for a lesser amount; or (3) the tax position is “more likely than not” to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information, (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings, and case law and their applicability to the facts and circumstances of the tax position, and (3) each tax position is evaluated without considerations of the possibility of offset or aggregation with other tax positions taken. We adjust these reserves, including any impact on the related interest and penalties, in light of changing facts and circumstances, such as the progress of a tax audit. Refer to Note 5, Income Taxes , in the Notes to the Consolidated Financial Statements.
A number of years may elapse before a particular matter for which we have established a reserve is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the “more likely than not” recognition threshold would be recognized in our income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is “more likely than not” to be sustained; (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation; or (3) the statute of limitations for the tax position has expired. Settlement of any particular issue would usually require the use of cash.
On March 27, 2020, the U.S. government enacted the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, which contained a tax provision that increased the allowable deductible percentage of interest expense from 30 percent to 50
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percent. This resulted in the company being able to immediately recognize a $3.9 million benefit in the first quarter of 2020. As a result of our income in 2020, we were able to release the remaining valuation allowance at year end.
Tax law requires items to be included in the tax return at different times than when these items are reflected in the consolidated financial statements. As a result, the annual tax rate reflected in our consolidated financial statements is different from that reported in our tax return (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year and manner in which the differences are expected to reverse. Based on the evaluation of all available information, we recognize future tax benefits, such as net operating loss carryforwards, to the extent that realizing these benefits is considered more likely than not.
We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results, the reversal of existing taxable temporary differences, taxable income in prior carryback years (if permitted), and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. As of January 2, 2021, positive evidence continued to outweigh negative evidence, so no valuation allowance was deemed necessary except to the extent of certain state NOLs. The valuation allowances related to our NOLs approximate $7.3 million. See Note 5, Income Taxes , in the Notes to Consolidated Financial Statements.
Recently Issued Accounting Pronouncements
For a summary of recent accounting pronouncements applicable to our consolidated financial statements, see Note 1, Summary of Significant Accounting Policies , in the Notes to Consolidated Financial Statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a smaller reporting company, we are not required to provide this information.
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