BlueLinx Holdings Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS About Our Business We are BlueLinx: a leading wholesale distributor of residential and commercial building products in the United States. We are a “two-step” distributor. Two-step distributors purchase products from manufacturers and distribute those products to dealers and other suppliers in local markets, who then sell those products to end users. We carry a broad portfolio of both branded and private-label stock keeping units (“SKUs”) across two principal product categories: specialty products and structural products. Specialty products include items such as engineered wood, industrial products, cedar, moulding, siding, metal products, and insulation. Structural products include items such as lumber, plywood, oriented strand board, rebar, and remesh. We also provide a wide range of value-added services and solutions aimed at relieving distribution and logistics challenges for our customers and suppliers, while enhancing their marketing and inventory management capabilities. We sell products through three main distribution channels, consisting of warehouse sales, reload sales, and direct sales. Warehouse sales, which generate the majority of our sales, are delivered from our warehouses to our customers. Reload sales are similar to warehouse sales but are shipped from warehouses, most of which are operated by third-parties, where we store owned products to enhance operating efficiencies. This channel is employed primarily to service strategic customers that would be less economical to service from our warehouses, and to distribute large volumes of imported products from port facilities. Direct sales are shipped from the manufacturer to the customer without our taking physical possession of the inventory and, as a result, typically generate lower margins than our warehouse and reload distribution channels. This distribution channel, however, requires the lowest amount of committed capital and fixed costs. With a strong market position, broad geographic coverage footprint servicing 40 states, and the strength of a locally focused sales force, as a two-step wholesale distributor, we distribute our comprehensive range of products from over 750 suppliers, including some of the leading manufacturers in the industry, such as Ply Gem, Huber Engineered Woods, Georgia-Pacific, James Hardie, Fiberon, Oldcastle APG and Weyerhaeuser, and supply products to a broad base of over 15,000 national, regional, and local dealers, specialty distributors, national home centers, and manufactured housing customers. Many of our customers then serve residential and commercial builders and contractors in their respective geographic areas and local markets. As a truly entrenched value-added partner in a complex and demanding building products supply chain, we play a critical role in enabling our customers to offer a broad range of products and brands, as most of our customers do not have the capability to purchase and warehouse products directly from manufacturers for such a large set of SKUs. The depth of our geographic footprint supports meaningful customer proximity across all markets in which we operate, enabling faster and more efficient service. Similarly, we provide value to our supplier partners by enabling access to the large and fragmented network of lumber yards and dealers that those suppliers could not adequately serve directly. Our position in this distribution model for 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. Industry Overview Our products are available across large and attractive end markets, including residential new construction and residential repair and remodel, which together account for approximately 85 percent of the end market mix for our addressable building material market served via two-step distribution based on our estimates. We also estimate the remaining 15 percent is accounted for by commercial construction. We believe that there are favorable underlying fundamental factors that will drive long-term growth across the end markets in which we operate. Residential New Construction We estimate that residential new home construction (including single-family and multi-family homes) accounts for approximately 40 percent of the end market mix for our addressable building material market served via two-step distribution. The pace of housing starts, with which our business is correlated, is driven by demographic and population shifts, mortgage interest rates (which remain at historic lows), the ability of builders to obtain skilled labor, and builders’ economic outlook. U.S. single family housing starts peaked in 2005, before experiencing a downturn through 2011. Since 2011, we have experienced the continuing recovery of residential new construction, which has translated into increased demand for the products we sell. Our large footprint, strong customer relationships, and comprehensive offering of leading products and brands positions us to capitalize on continued growth in the new housing market. 17 According to the U.S. Census Bureau and the U.S. Department of Housing and Urban Development, 2020 single family housing starts in the United States were approximately 1 million, an increase of 12 percent above 2019 housing starts. We believe there is significant pent-up demand for housing and the market will see continued growth. The monthly single family residential home supply continues to remain in line with the 20-year average and significantly below the peak levels observed in 2008 and 2009. For most of the last decade, housing production has lagged population growth and household formation and Freddie Mac estimates that the housing supply at the end of 2020 was 3.8 million units short of the level needed to match long-term demand. Harvard University’s Joint Center for Housing Studies estimates total annual housing construction through 2028 should be on the order of 1.5 million units, or about 120,000 higher than in 2020. Based on these data points, we believe there are fundamental factors driving significant opportunity in the residential new home construction end-market for building products of which we are well positioned to serve. Residential Repair and Remodel We estimate that residential repair and remodel spending accounts for approximately 45 percent of the end market mix for our addressable building material market served via two-step distribution. Repair and remodel sales tend to be less cyclical than new construction, particularly for exterior products that are exposed to the elements and where maintenance is less likely to be deferred. We expect that factors including the total installed base of U.S. homes, overall age of the U.S. housing stock, rising home prices supporting increased underlying home equity and availability of consumer capital will drive continued growth in repair and remodel spending. The Leading Indicator of Remodeling Activity (LIRA) projects spending on home improvement projects to rise 9.2 percent year-over-year in 2021 and 12.3 percent year-over-year for the four quarters ending in the third quarter of fiscal 2022. According to the U.S. Census Bureau and Department of Housing and Urban Development, the median home age in the U.S. increased from 23 years in 1985 to 39 years in 2019 and approximately 80 percent of the current housing stock was built prior to 1999. We believe the increasing average age of the nation’s 125 million existing homes will continue to drive demand for repair and remodel projects. The annual U.S. homes installed base is projected to continue to increase through 2025, which is positive for both residential repair and remodel spending as well as for residential construction. We are positioned to capitalize on this projected growth, as repair and remodel spending drives a significant portion of our sales. Increased home improvement spending has also benefited from the COVID-19 pandemic, as homeowners are spending more time at home and are investing more in their homes as a result. Outdoor and exterior projects make heavy use of outdoor living products like composite decking and fencing, and other aesthetically focused exterior products like siding and trim, which are key and growing product categories for us. Impact of the COVID-19 Pandemic on Our Industry and Our Business Beginning in mid-March 2020, local, state, provincial and federal authorities began issuing stay-at-home orders in response to the spread of the coronavirus disease, or COVID-19, which quickly spread throughout the United States and worldwide. As COVID-19 began to have an effect in North America, the resulting stay-at-home orders significantly impacted new home starts, as builders responded to a sharp drop in buyer traffic and contracts for new homes. Housing starts dropped in March and April of 2020, typically months of robust homebuilding activity as the start of the construction season. Following a mid-2020 pause, new construction rebounded quickly. Likewise, the National Association of Homebuilders’ Builder Confidence Index, recovered to pre-pandemic levels in 2020 and remains above the 20-year average. The COVID-19 pandemic has motivated many urban high-rise condominium and apartment dwellers to seek out single-family residences in suburban areas where they will have more space for working from home and outdoor spaces for leisure. This trend has generated additional demand for new single-family homes and spurred builders to increase the pace of new construction. Like many other companies in the United States and globally, our results were impacted by the COVID-19 pandemic during the early spring of 2020. However, throughout the pandemic, our business was designated as “essential” and as the stay-at-home orders have eased and as residential construction has recovered, our performance has similarly improved. Since the onset of the COVID-19 pandemic, we have focused on protecting the health and safety of our team members while maintaining our operations and continuing to meet the needs of our customers. We undertook a number of precautionary measures during 2020 in order to ensure we maintained a strong liquidity position, including reducing operating expenses and management and board salaries, extending payment terms, furloughing a portion of our salaried workforce initially and ultimately eliminating several of those salaried employees by year end, and freezing most discretionary capital expenditures throughout the initial phases of the pandemic. In 2021, we benefited from a leaner cost structure, improved operational efficiency, lower working capital 18 requirements, pricing discipline and better inventory management. In addition, while some of our suppliers and other parts of the supply chain were disrupted by the lockdown measures, lumber and panel prices have returned to more normalized levels following a period of record prices and high volatility in the second half of 2020 and the first nine months of 2021 due to heightened overall demand for construction and labor pressures across the supply chain. However, as a result of the rise of the COVID-19 variants in certain parts of the United States, some governmental authorities may reconsider the re-institution of various restrictive measures. The extent of the impact of the pandemic on our business and sales for the remaining three months of fiscal 2021 will depend on future developments, including, among others, the extent and scope of the rise of existing and additional COVID-19 variants, the success of vaccination efforts, the success of actions taken by governmental authorities to contain these variants, or future ones, and the pandemic and address their impact, the overall duration of the pandemic, the success of local return to work and business reopening plans, and the impact the COVID-19 pandemic has on demand in the markets we serve. The trajectory of the pandemic continues to evolve rapidly, and we cannot predict the extent to which our financial condition, results of operations, or cash flows will ultimately be impacted. We are closely monitoring the development and spread of COVID-19 variants, the impact of the pandemic on industry conditions, the progress of local return to office and reopening plans, and any pandemic-related restrictions. We are in the process of implementing return to work plans for our corporate headquarters and warehouse facilities, and we continue to practice safety and hygiene protocols consistent with the Center for Disease Control and Prevention (“CDC”) and local guidance. Seasonality We are exposed to fluctuations in quarterly sales volumes and expenses due to seasonal factors common in the building products distribution industry. The first and fourth fiscal quarters are typically our lower volume quarters, due to the impact of less favorable weather on the construction market. Our second and third fiscal quarters are typically our higher volume quarters, reflecting an increase in construction, due to more favorable weather conditions. Depending on the nature and circumstances of our business in any given year, we may increase our inventory in the fourth quarter in anticipation of higher demand in the first half of the coming year to meet expected customer demand for our products. Commodity Markets Our operating results are sensitive to fluctuations in commodity markets, specifically commodity markets for wood-based commodities that we classify as structural products. When prices fluctuate in the commodity markets which impact us, we may immediately adjust the end price of our products to compensate for the changes in market prices, which is common for businesses with inventories impacted by commodity price fluctuations. When we change our prices in response to market fluctuations, we will often see immediate impacts in our operating results. When market prices increase, this impact can be beneficial. Conversely, when market prices decrease, the impact can be negative because we are adjusting the selling prices for inventory often purchased at higher market prices. Fluctuations in the commodity markets during the last 18 months have had a significant impact on our operating results for the periods presented in this quarterly report, of which we discuss in more detail elsewhere in this report. Supply Constraints Our operating results are impacted by the availability of the products we sell in the markets in which we do business. When our inventory supply is constrained, our operating results may be impacted by lower sales volumes. While supply constraints may negatively impact our sales volumes, they may also have a positive impact on our net sales and overall profitability. This is because supply constraints can cause prices to increase. Under these circumstances, we may sell less product by volume but at a higher price which could have a positive impact on our levels of sales and profitability. Conversely, rapid changes in supply levels, such as the sudden increase in availability of a product where the supply was previously constrained, may have a negative impact on our operating results especially in situations where the demand does not also increase proportionally with supply increases. Our Culture and Management Focus We remain committed to driving a culture of profitable growth within new and existing product lines and geographies, while positioning the company for long-term value creation. The following initiatives represent key areas of our management team’s focus: 1. Foster a performance-driven culture committed to profitable growth. We are currently focused on enhancing the customer experience; accelerating organic growth within specific product and solutions offerings where we are 19 uniquely advantaged; and deploying capital to drive sustained margin expansion, grow free cash flow conversion and maintain continued profitable growth. 2. Migrate revenue mix toward higher-margin specialty product categories. We intend to pursue a revenue mix increasingly weighted toward higher-margin, in-demand specialty product categories. Management also intends to expand on value-added service offerings designed to simplify complex customer sourcing requirements, together with marketing, inventory and pricing services afforded by our national platform. 3. Maintain a disciplined capital structure and pursue high-return investments that support growth. On a trailing twelve-month basis, we have significantly transformed our balance sheet, underscored by a material reduction in net leverage and improved access to liquidity. Given this, we intend to accelerate capital investments designed to improve the efficiency and reliability of existing assets, including distribution centers and fleet assets. In the fourth quarter 2021, we intend to invest up to $10 million in our fleet and facilities to improve operational performance and productivity. Factors That Affect Our Operating Results Our results of operations and financial performance are influenced by a variety of factors, including the following: pricing and product cost variability; volumes of product sold; changes in the prices, supply, and/or demand for products that we distribute; the cyclical nature of the industry in which we operate; housing market conditions; the COVID-19 pandemic and other contagious illness outbreaks and their potential effects on our industry; effective inventory management relative to our sales volume or the prices of the products we produce; information technology security and business interruption risks; increases in petroleum prices; consolidation among competitors, suppliers, and customers; disintermediation risk; loss of products or key suppliers and manufacturers; our dependence on international suppliers and manufacturers for certain products; exposure to product liability and other claims and legal proceedings related to our business and the products we distribute; natural disasters, catastrophes, fire, or other unexpected events; successful implementation of our strategy; wage increases or work stoppages by our union employees; costs imposed by federal, state, local, and other regulations; compliance costs associated with federal, state, and local environmental protection laws; our level of indebtedness and our ability to incur additional debt to fund future needs; the risk that our cash flows and capital resources may be insufficient to service our existing or future indebtedness; the covenants of the instruments governing our indebtedness limiting the discretion of our management in operating our business; the fact that we lease many of our distribution centers, and we would still be obligated under these leases even if we close a leased distribution center; changes in our product mix; shareholder activism; potential acquisitions and the integration and completion of such acquisitions; the possibility that the value of our deferred tax assets could become impaired; changes in our expected annual effective tax rate could be volatile; the costs and liabilities related to our participation in multi-employer pension plans could increase; the possibility that we could be the subject of securities class action litigation due to stock price volatility; and changes in, or interpretation of, accounting principles. 20 Results of Operations The following table sets forth our results of operations for the third quarter of fiscal 2021 and fiscal 2020: Third Quarter of Fiscal 2021 % of Net Sales Third Quarter of Fiscal 2020 % of Net Sales (In thousands) (In thousands) Net sales $ 970,842 100.0% $ 871,063 100.0% Gross profit 153,327 15.8% 159,460 18.3% Selling, general, and administrative 76,176 7.8% 79,976 9.2% Depreciation and amortization 6,884 0.7% 7,087 0.8% Amortization of deferred gains on real estate (984) (0.1)% (984) (0.1)% Gains from sales of property — —% (8,684) (1.0)% Other operating expenses 212 0.0% 609 0.1% Operating income 71,039 7.3% 81,456 9.4% Interest expense, net 8,313 0.9% 10,776 1.2% Other income, net (704) (0.1)% (238) (0.0)% Income before provision for income taxes 63,430 6.5% 70,918 8.1% Provision for income taxes 16,232 1.7% 15,802 1.8% Net income $ 47,198 4.9% $ 55,116 6.3% The following table sets forth our results of operations for the first nine month periods of fiscal 2021 and fiscal 2020: First Nine Months of Fiscal 2021 % of Net Sales First Nine Months of Fiscal 2020 % of Net Sales (In thousands) (In thousands) Net sales $ 3,304,224 100.0% $ 2,231,909 100.0% Gross profit 584,891 17.7% 353,489 15.8% Selling, general, and administrative 238,746 7.2% 225,258 10.1% Depreciation and amortization 21,429 0.6% 21,785 1.0% Amortization of deferred gains on real estate (2,951) (0.1)% (2,952) (0.1)% Gains from sales of property (1,287) 0.0% (9,209) (0.4)% Other operating expenses 1,197 0.0% 6,736 0.3% Operating income 327,757 9.9% 111,871 5.0% Interest expense, net 33,690 1.0% 36,691 1.6% Other income, net (1,335) 0.0% (58) 0.0% Income before provision for income taxes 295,402 8.9% 75,238 3.4% Provision for income taxes 72,886 2.2% 14,214 0.6% Net income $ 222,516 6.7% $ 61,024 2.7% 21 The following table sets forth net sales by product category for the three and nine month periods ending October 2, 2021, and September 26, 2020: Three Months Ended Nine Months Ended October 2, 2021 September 26, 2020 October 2, 2021 September 26, 2020 Net sales by category ($ in thousands) ($ in thousands) Structural products $ 329,818 $ 375,072 $ 1,425,389 $ 865,302 Specialty products 641,024 495,991 1,878,835 1,366,607 Net sales $ 970,842 $ 871,063 $ 3,304,224 $ 2,231,909 Percentage of total net sales by category Structural products 34 % 43 % 43 % 39 % Specialty products 66 % 57 % 57 % 61 % Total 100 % 100 % 100 % 100 % The following table sets forth gross profit and gross margin percentages by product category for the three and nine month periods of fiscal 2021 and 2020: Three Months Ended Nine Months Ended October 2, 2021 September 26, 2020 October 2, 2021 September 26, 2020 Gross profit $ by category ($ in thousands) ($ in thousands) Structural products $ 5,634 $ 73,370 $ 163,668 $ 120,673 Specialty products 147,693 86,090 421,223 232,816 Gross profit $ 153,327 $ 159,460 $ 584,891 $ 353,489 Gross margin percentage by category Structural products 1.7 % 19.6 % 11.5 % 13.9 % Specialty products 23.0 % 17.4 % 22.4 % 17.0 % Total gross margin % 15.8 % 18.3 % 17.7 % 15.8 % Third Quarter of Fiscal 2021 Compared to Third Quarter of Fiscal 2020 For the third quarter of fiscal 2021, we generated net sales of $970.8 million, an increase of $99.8 million when compared to the third quarter of fiscal 2020 and overall gross margin percentage decreased from 18.3 percent to 15.8 percent year over year. Our third quarter net income was $47.2 million, or $ 4.74 per diluted share, versus $55.1 million, or $5.72 per diluted share, in the prior-year period. The significant decline in the market value of higher-cost commodity wood product inventory sold during the third quarter was the primary contributor to our overall gross profit and gross margin percentage decline and year-over-year decrease in profitability. Net sales of specialty products, which includes engineered wood, industrial products, cedar, moulding, siding, metal products and insulation, increased $145.0 million to $641.0 million in the third quarter. Elevated demand for construction materials, along with continued supply constraints, contributed to multiple supplier-led price increases throughout the third quarter of fiscal 2021, resulting in improved revenue growth. Specialty sales volumes declined by lower-double digits percentages overall versus the prior-year period primarily attributable to widespread supply constraints, which impacted many product categories, including engineered wood and specialty lumber and panels. In contrast, we did see increases in sales volume among certain products within our specialty products category, such as in our moulding, siding, and industrial products. Specialty products gross profit increased $61.6 million to $147.7 million, with a year-over-year improvement of approximately 560 basis points in specialty gross margin to 23.0 percent for the third quarter of fiscal 2021, compared to 17.4 percent in the third quarter of fiscal 2020. The increase in specialty gross margin percentage of 5.6 percent over the prior year period is primarily attributable to substantial increases in pricing for our specialty products. Net sales of structural products, which includes products such as lumber, plywood, oriented strand board, rebar, and remesh, declined $45.3 million to $329.8 million in the third quarter of fiscal 2021 due to price deflation for commodity wood products. Structural sales volumes declined overall versus the prior-year period as we implemented commodity risk mitigation actions in 22 response to historic fluctuations in the commodity markets impacting our structural products. Commodity wood market pricing began to decline in May and continued to drop through August before beginning to stabilize in September to levels more consistent with five-year historical averages. Through centralized purchasing and consignment, we were able to reduce wood-based commodity price deflation risk. Our structural gross margin percentage for the third quarter of fiscal 2021 was 1.7%, down from 19.6% in the prior year period primarily driven by commodity price deflation during the quarter, and was impacted by the release of a lower of cost or net realizable reserve of $16.7 million which we accrued for in the second quarter of fiscal 2021 as commodity prices began a sustained decline. The inventory impacted by this reserve was sold to customers during the third quarter of fiscal 2021. Our selling, general, and administrative expenses decreased 4.8 percent, or $3.8 million, compared to the third quarter of fiscal 2020. The decrease in sales, general, and administrative expenses is due to decreases in our sales commissions and incentive programs of approximately $3.3 million related to a decrease in gross profit, decreases in our delivery and logistical costs of approximately $1.8 million, offset by an increase among remaining general and administrative costs categories, primarily insurance, of approximately $1.3 million. Depreciation and amortization expense decreased 2.9 percent, compared to the third quarter of fiscal 2020. Our decrease in depreciation and amortization is due to a lower base of amortizable and depreciable assets throughout the third quarter of fiscal 2021 when compared the prior year period. The decrease in gains from sales of property in the amount of $8.7 million is due to the sale-leaseback of one of our properties located in Denver, Colorado during the third quarter fiscal 2020 compared to no sale of property during the third quarter fiscal 2021. Other operating expenses decreased 65.2 percent, or $0.4 million, compared to the third quarter of fiscal 2020 primarily due to a decrease in integration and restructuring related costs reported in the third quarter of fiscal 2020. Interest expense, net, decreased by 22.9 percent, or $2.5 million, compared to the third quarter of fiscal 2020. The decrease is primarily due to the reduction of debt, including the repayment in full of our former Term Loan Facility at the end of the first quarter of fiscal 2021, under which borrowings bore a higher interest rate than under our Revolving Credit Facility combined with lower interest costs resulting from the recent amendments to our Revolving Credit Facility. Other expense (income), net, decreased $0.5 million compared to the third quarter of fiscal 2020 due to a benefit of $0.4 million resulting from the re-negotiation of one of our multi-employer pension plan liabilities which resulted in a lower liability estimated over the life of our agreement with the pension plan. Our effective tax rate was 25.6 percent and 22.3 percent for the third quarter of fiscal 2021 and 2020, respectively. Our effective tax rate for both periods was impacted by the permanent addback of certain nondeductible expenses, including meals and entertainment and executive compensation, and the effect of the release of our partial valuation allowance for separate company state income tax losses. Our effective tax rate for the third quarter of fiscal 2020 was additionally impacted by a discrete tax benefit resulting from the effect of the partial release of our valuation allowance for previously nondeductible interest resulting from changes allowed under Section 163(j) of the Internal Revenue Code (“IRC”) as a result of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act that was enacted on March 27, 2020 which raised the allowable percentage of deductible interest from 30 percent to 50 percent of adjusted taxable income. For the third quarter of fiscal 2021, our net income decreased by $7.9 million from the prior year period due primarily to a decrease in gross profit driven by commodity price deflation earlier in the quarter, that had a direct impact on our structural product sales and gross profit, in conjunction with lower gains from sales of property and a higher income tax expense resulting from our higher effective tax rate. This decrease was offset by reductions in our selling, general, and administrative and interest expenses. First Nine Months of Fiscal 2021 Compared to First Nine Months of Fiscal 2020 For the nine months ended October 2, 2021, we generated net sales of $3.3 billion, an increase of $1.1 billion when compared to the prior-year period. Our nine month 2021 net income was $222.5 million, or $22.91 per diluted share, versus $61.0 million, or $6.48 per diluted share, in the prior-year period. A rapid and significant increase in the market pricing for our commodity wood products in the first five months of fiscal 2021 drove dramatic improvement in gross profit margins for our structural products, when compared to the same prior year period. Substantial increases in our specialty products also drove increases in our profitability. Net sales of specialty products, which includes engineered wood, industrial products, cedar, moulding, siding, metal products and insulation, increased $512.2 million to $1.9 billion in the first nine months of fiscal 2021. Elevated demand for construction materials, along with continued supply constraints, contributed to multiple supplier-led price increases throughout the first nine months of fiscal 2021, which we capitalized on, resulting in improved revenue growth and margin expansion among our specialty products. Specialty sales volumes were flat versus the prior-year period despite widespread supply constraints which impacted most products within our specialty category. Specialty products gross profit increased $188.4 million to $421.2 23 million, with a year-over-year improvement of approximately 540 basis points in specialty gross margin to 22.4 percent. The increase in our specialty products gross margin percentages during the first nine months of fiscal 2021 was the result of substantial increase in pricing driven by increased demand paired with the supply constrained environment. Net sales of structural products, which includes products such as lumber, plywood, oriented strand board, rebar, and remesh, increased $560.1 million to $1.4 billion in the first nine months of fiscal 2021 due to significant price increases for commodity wood products occurring during in the first five months of fiscal 2021. This price inflation impacted the market value of our existing commodity wood product inventory on-hand through May after which prices declined through August 2021. Structural volumes decreased during the nine month period as we implemented commodity risk mitigation actions in response to historic fluctuations in the commodity markets impacting our structural products. Structural gross profit margins for the first nine months of fiscal 2021 were 11.5 percent compared to 13.9 percent in the prior year period, a decline of approximately 240 basis points, due to wood-based commodity market volatility. For the first nine months of fiscal 2021, selling, general, and administrative expenses increased 6.0 percent, or $13.5 million, compared to the first nine months of fiscal 2020. The increase in sales, general, and administrative expenses is due to increases in our sales commissions and incentives of approximately $7.8 million, payroll and other related cost of $1.7 million, and general and administrative costs of approximately $4.0 million, which includes increases in cost categories such as insurance. Depreciation and amortization expense decreased 1.6 percent, or $0.4 million, compared to the first nine months of fiscal 2020. The decrease in depreciation and amortization expense is due to a lower base of amortizable and depreciable assets throughout the first nine months of fiscal 2021 when compared to the prior year period. During the first nine months of fiscal 2020, we completed the sale leaseback of one of our Denver facilities which resulted in a gain from the sale of property of $8.7 million during the period. During the first quarter of fiscal 2021, we completed the sale of our Birmingham dark property which resulted in a gain from the sale of property of $1.3 million. We completed no additional property sales during the remainder of the first nine months of fiscal 2021 which is resulting in a decrease in gains from sales of property of $7.9 million when compared to the prior year period. Other operating expenses decreased 82.2 percent, or $5.5 million, compared to the first nine months of fiscal 2020 primarily due to a decrease in spending related to integration and restructuring related costs reported during the first nine months of fiscal 2020. Our interest expense, net, for the first nine months of fiscal 2021, decreased by 8.2 percent, or $3.0 million, compared to the prior year period. The decrease is primarily due to reduction of interest expense of $8.8 million resulting from lower debt, including the repayment in full of our former Term Loan Facility at the end of the first quarter of fiscal 2021, under which borrowings bore a higher interest rate than under our Revolving Credit Facility. Interest savings resulting from the repayment of our term loan facility at the end of the first quarter of fiscal 2021 combined with lower interest costs resulting from the renegotiation of our revolving credit facility in the third quarter of fiscal 2021. This was offset by the $5.8 million in debt issuance costs expensed during the first quarter of fiscal 2021 related to the extinguishment of our former Term Loan Facility. Our other expense (income), net, also decreased by $1.3 million compared to the first nine months of fiscal 2020. The decrease in other expense (income), net is resulting from a benefit of $0.4M resulting from the re-negotiation of one of our multi-employer pension plan liabilities which resulted in a lower estimated liability over the life of our agreement with the pension plan combined with the reduction of other immaterial expenses incurred in the prior year period. Our effective tax rate was 24.7 percent and 18.9 percent for the first nine months of fiscal 2021 and 2020, respectively. Our effective tax rate for both periods was impacted by the permanent addback of certain nondeductible expenses, including meals and entertainment and executive compensation, and the effect of our partial release of our valuation allowance for separate company state income tax losses. Our effective tax rate for the first nine months of fiscal 2020 was additionally impacted by a discrete tax benefit resulting from the effect of the partial release of our valuation allowance for previously nondeductible interest resulting from changes allowed under Section 163(j) of the Internal Revenue Code (“IRC”) as a result of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act that was enacted on March 27, 2020 which raised the allowable percentage of deductible interest from 30 percent to 50 percent of adjusted taxable income. Our net income for the first nine months of fiscal 2021 increased $161.5 million from the prior year period primarily due to the increase in gross profit resulting from substantial price increases impacting our specialty products combined with benefits from commodity price inflation during the nine month period when compared to prior year. Increases in gross profit were offset by gains from the sales of property during the nine month period. Additionally, net income benefited from slightly lower interest expense offset by higher income tax expense, resulting from our higher effective tax rate. 24 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 borrowings under our Revolving Credit Facility, among other sources. We expect that these sources will fund our ongoing cash requirements for the foreseeable future. On October 25, 2021, we consummated a $300 million private offering of Senior Secured Notes. We used the majority of net proceeds from the offering to repay borrowings under our ABL credit facility. Closing of Senior Secured Notes of $300M at 6.0% Due 2029 On October 25, 2021, we closed a private offering of $300 million at 6.0% senior secured notes to persons reasonably believed to be “qualified institutional buyers,” as defined in Rule 144A under the Securities Act of 1933, as amended (“The Securities Act”), and to non-U.S. persons outside the United States under Regulation S under the Securities Act. The 2029 Notes were issued to investors at 98.625% of their principal amount and will mature on November 15, 2029. Our obligations under these senior secured notes will be guaranteed by our domestic subsidiaries that are co-borrowers under or guarantee our revolving credit facility. The senior secured notes and the related guarantees will be secured by a first-priority security interest in substantially all of our guarantor’s existing and future assets (other than receivables, inventory, deposit accounts, securities accounts, business interruption insurance and other related assets, subject to certain exceptions and customary permitted liens). The senior secured notes and the related guarantees will also be secured on a second-priority basis by a lien on our revolving credit facility collateral. The majority of net proceeds from the offering of the senior secured notes were used to repay borrowings under our revolving credit facility. Revolving Credit Facility In April 2018, we amended and restated our Revolving Credit Facility with Wells Fargo Bank, National Association, and in August 2021, we amended the facility to, among other things, extend the maturity date of the facility and reduce the interest rate on borrowing under the facility (as amended, the “Revolving Credit Facility”). The Revolving Credit Facility provides for senior secured revolving loan and letter of credit facility of up to $600.0 million and an uncommitted accordion feature that permits us to increase the facility by an aggregate additional principal amount of up to $150.0 million. If we obtain the full amount of the additional increases in commitments, the Revolving Credit Facility will allow borrowings of up to $750.0 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). Letters of credit in an aggregate amount of up to $30.0 million are also available under the Revolving Credit Facility, which would reduce the amount of the revolving loans available thereunder. Borrowings under the Revolving Credit Facility bear interest at a rate per annum equal to (i) LIBOR plus a margin ranging from 1.25 percent to 1.75 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 0.25 percent to 0.75 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 falls below the greater of (i) $50.0 million and (ii) 10 percent of the lesser of (a) the borrowing base and (b) the maximum permitted credit at such time, the Revolving Credit Facility requires maintenance of a fixed charge coverage ratio of 1.0 to 1.0 until excess availability has been at least the greater of (i) $50.0 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. As of October 2, 2021, we had outstanding borrowings of $223.1 million and excess availability of $351.9 million under our Revolving Credit Facility. As of January 2, 2021, we had outstanding borrowings of $288.2 million and excess availability of $184.3 million under out Revolving Credit Facility. Our average effective interest rate was 2.0 percent and 2.8 percent for the quarters ended October 2, 2021 and January 2, 2021, respectively. For the quarter ended September 26, 2020, our average effective interest rate was 2.7 percent. We were in compliance with all covenants under the Revolving Credit Facility as of October 2, 2021. On October 25, 2021, we closed a private offering of $300 million at 6.0% senior secured notes to persons reasonably believed to be “qualified institutional buyers,” as defined in Rule 144A under the Securities Act of 1933, as amended (“The Securities Act”), and to non-U.S. persons outside the United States under Regulation S under the Securities Act. The 2029 Notes were issued to investors at 98.625% of their principal amount and will mature on November 15, 2029. The majority of the net proceeds from the offering of the senior secured notes will be used to repay borrowings under our revolving credit facility. In conjunction with this offering, we have reduced the limit of our revolving credit facility from $600 million to $350 million. All other terms of our revolving credit facility remain the same as our Second Amendment entered on August 2, 2021. 25 Term Loan Facility As of January 2, 2021, we had outstanding borrowings of $43.2 million under our Term Loan Facility. On April 2, 2021, we repaid the remaining outstanding principal balance of the Term Loan Facility and extinguished the debt. As a result, as of October 2, 2021, we had no outstanding borrowings under the Term Loan Facility, which has been extinguished. In connection with our repayment of the outstanding principal balance in full on April 2, 2021, we expensed $5.8 million debt issuance costs during the first quarter of fiscal 2021 that we had been amortizing in connection with our former Term Loan Facility. These costs are included within interest expense, net, on the Condensed Consolidated Statements of Operations and reported separately as an adjustment to net income in our Condensed Consolidated Statements of Cash Flows. There were no prepayment premiums associated with the repayment of indebtedness for the three month period ended October 2, 2021 and for the three month period ended September 26, 2020, prepayment premiums were $0.3 million. Prepayment premiums were $0.9 million and $2.6 million for the nine month periods ended October 2, 2021 and September 26, 2020, respectively. 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 finance lease assets and obligations as a result of each of these transactions. In addition, during the second quarter of fiscal 2021, we recorded finance leases of $0.3 million related to new tractors put into service as part of our mobile fleet. Our total finance lease commitments, including the properties associated with the aforementioned transactions, totaled $276.9 million as of October 2, 2021. Of the $276.9 million of finance lease commitments as of October 2, 2021, $243.2 million related to real estate and $33.7 million related to equipment. LIBOR Interest Rates Our Revolving Credit Facility includes available interest rate options based on the London Inter-bank Offered Rate (“LIBOR”). Certain LIBOR rates will be discontinued after 2021, while other rates will be discontinued in 2023. The U.S. and other countries are currently working to replace LIBOR with alternative reference rates. The consequences of these developments 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 agreement will have a material adverse effect on our financial position or materially affect our interest expense. Sources and Uses of Cash Operating Activities Net cash provided by operating activities for the first nine months of fiscal 2021 was $126.9 million, compared to net cash provided by operating activities of $74.4 million in the first nine months of fiscal 2020. The increase in cash provided by operating activities during the first nine months of fiscal 2021 was primarily a result of the increase in net income and our accounts payable balance compared to the prior year period, partially offset by increases in our accounts receivable and inventory balances compared to the prior year period. The first nine months of fiscal 2021 also included approximately $82.6 million in cash income tax obligations payments when compared to the prior year period, which benefited from our remaining federal net operating loss carry-forward of $80.6 million which were used in fiscal 2020. Investing Activities Net cash used in investing activities for the first nine months of fiscal 2021 was $2.8 million compared to net cash used in investing activities of $8.8 million in the first nine months of fiscal 2020. The decrease in net cash used by investing activities was primarily due to an increase in proceeds received from the sale of several assets during the second quarter of fiscal 2021, combined with the sale of our non-operating facility in Birmingham, Alabama during the first quarter of fiscal 2021, both of 26 which were partially offset by $3.5 million increase in investments in property and equipment, specifically investments in both our fleet and facilities. Financing Activities Net cash used in financing activities totaled $124.0 million for the first nine months of fiscal 2021, compared to net cash used in financing activities of $84.7 million for the first nine months of fiscal 2020. The increase in net cash used in financing activities is primarily due to an increase of $314.3 million in repayments on our Revolving Credit Facility and Term Loan Facility, including the repayment of the remaining outstanding balance on our Term Loan Facility, partially offset by an increase in borrowings of $358.3 million from our Revolving Credit Facility, and $78.3 million in proceeds from real estate financing transactions completed in the first nine months of fiscal 2020, with no such transactions completed in the first nine months of fiscal 2021. Stock Repurchase Program On August 23, 2021, we announced that our Board of Directors approved a stock repurchase program pursuant to which we may repurchase up to $25.0 million of our common stock. Under the stock repurchase program approved by our Board of Directors, we may repurchase our common stock at any time or from time to time, without prior notice, subject to prevailing market conditions and other considerations. Our repurchases, if any, may be made through a variety of methods, which may include open market purchases, privately negotiated transactions or pursuant to a trading plan that may be adopted in accordance with the Securities and Exchange Commission Rule 10b5-1. As of the date of this filing, we have made no repurchases of our common stock under this program. 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 working capital helps us monitor our progress in meeting our goals to enhance working capital assets. Selected financial information October 2, 2021 January 2, 2021 September 26, 2020 (In thousands) Current assets: Cash $ 186 $ 82 $ 10,154 Receivables, less allowance for doubtful accounts 344,974 293,643 308,584 Inventories, net 436,438 342,108 306,030 $ 781,598 $ 635,833 $ 624,768 Current liabilities: Accounts payable $ 210,386 $ 165,163 $ 178,948 $ 210,386 $ 165,163 $ 178,948 Operating working capital $ 571,212 $ 470,670 $ 445,820 Operating working capital of $571.2 million as of October 2, 2021, compared to $470.7 million as of January 2, 2021, increased on a net basis by approximately $100.5 million. The increase in operating working capital was primarily driven by increases in accounts receivable and specialty products inventory, both of which were higher due to the inflationary environment impacting both our net sales and product costs. Accounts payable, also increased due to the inflation of product costs. Operating working capital of $571.2 million as of October 2, 2021, compared to $445.8 million as of September 26, 2020, increased by $125.4 million. The increase in operating working capital was primarily driven by increases in accounts receivable and inventory, offset by an increase in accounts payable, all largely due to the inflationary environment impacting our net sales and product costs. 27 Investments in Property and Equipment 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 “Property and equipment, at cost” on our condensed consolidated balance sheet. During the third quarter of fiscal 2021, we invested $2.5 million in cash in investments in long-lived assets. For the first nine months of fiscal 2021, we invested $5.4 million in cash and entered into finance leases totaling $10.5 million, for a total investment of $15.9 million. In the fourth quarter 2021, we intend to invest up to $10 million in our fleet and facilities to improve operational performance and productivity. Critical Accounting Policies The preparation of our consolidated financial statements and related disclosures in conformity with GAAP requires our management to make judgments and estimates that affect the amounts reported in our condensed consolidated financial statements and accompanying notes. There have been no material changes to our critical accounting policies from the information provided in Item 7 of our Annual Report on Form 10-K for the fiscal year ended January 2, 2021. 28 Forward-Looking Statements This report contains forward-looking statements. Forward-looking statements include, without limitation, any statement that predicts, forecasts, indicates or implies future results, performance, liquidity levels or achievements, and may contain the words “believe,” “anticipate,” “expect,” “estimate,” “intend,” “project,” “plan,” “will be,” “will likely continue,” “will likely result” or words or phrases of similar meaning. Forward-looking statements involve risks and uncertainties that may cause our business, strategy, or actual results to differ materially from the forward-looking statements. The forward-looking statements in this report include statements about the COVID-19 pandemic, its duration and effects, and its potential effects on our business and results of operations; anticipated effects of adopting certain accounting standards; estimated future annual amortization expense; potential changes to estimates made in connection with revenue recognition; the expected outcome of legal proceedings; industry conditions; seasonality; commodity markets; supple constraints and liquidity and capital resources. Forward-looking statements are based on estimates and assumptions made by our management that, although believed by us to be reasonable, are inherently uncertain. Forward-looking statements involve risks and uncertainties that may cause our business, strategy, or actual results to differ materially from the forward-looking statements. These risks and uncertainties include those discussed under the heading “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the year ended January 2, 2021, and those discussed elsewhere in this report (including Item 1A of Part II of this report) and in future reports that we file with the SEC. We operate in a changing environment in which new risks can emerge from time to time. It is not possible for management to predict all of these risks, nor can it assess the extent to which any factor, or a combination of factors, may cause our business, strategy, or actual results to differ materially from those contained in forward-looking statements. Factors that may cause these differences include, among other things: • the risk that we may experience pricing and product cost variability; • the fact that our earnings are highly dependent on volumes; • the fact that our industry is highly fragmented and competitive and, that if we are unable to compete effectively, our net sales and operating results may be reduced; • the fact that our industry is highly cyclical, and prolonged periods of weak demand or excess supply may reduce our net sales and/or margins, which may cause us to incur losses or reduce out net income; • the risk that adverse housing market conditions may negatively impact our business, liquidity, and results of operations, and increase the credit risk from our customers; • the full effect of the COVID-19 pandemic on our business is unknown, and it may adversely affect our business and results from operations; • our ability to effectively manage our inventory relative to our sales volume or as the prices of the products we distribute fluctuate, which could affect our business, financial condition, and operating results; • information technology security risks and business interruption risks, which may cause us to incur increasing costs in an effort to minimize and/or respond to those risks; • the risk of increases in petroleum prices, which could adversely affect our results of operations; • consolidation among competitors, suppliers, and customers could negatively impact our business; • the risk of disintermediation; • the risk of loss of key products or key suppliers and manufacturers could affect our financial health; • our dependence on international suppliers and manufacturers for certain products exposes us to risks that could affect our financial condition; • business disruptions; • the risk of exposure to product liability and other claims and legal proceedings related to our business and the products we distribute, which may exceed the coverage of our insurance; • the risk that our business operations could suffer significant losses from natural disasters, catastrophes, fire, or other unexpected events; • that fact that a significant percentage of our employees are unionized, and wage increases or work stoppages by our unionized employees may reduce our results of operations; • the risk that federal, state, local, and other regulations could impose substantial costs and restrictions on our operations that would reduce our net income; • the fact that we are subject to federal, state, and local environmental protection laws and may have to incur significant costs to comply with these laws and regulations in the future; • our level of indebtedness could limit our financial and operating activities and adversely affect our ability to incur additional debt to fund future needs; • our cash flows and capital resources may be insufficient to make required payments on our indebtedness or future indebtedness; • the instruments, including the notes, governing our indebtedness contain various covenants limiting the discretion of our management in operating our business, including requiring us to maintain a minimum level of excess liquidity; 29 • borrowings under our Revolving Credit Facility bear interest at a variable rate, which subjects us to interest rate risk, which could cause our debt service obligations to increase significantly; • we may still incur more debt, which could increase the risks relating to indebtedness; • the fact that we have sold and leased back certain of our distribution centers under long-term non-cancelable leases, and may enter into similar transactions in the future; • the fact that many of our distribution centers are leased, and if we close a leased distribution center, we will still be obligated under the applicable lease; • changes in our product mix could adversely affect our results of operations; • the risk of adjustments in the future based on actual development experience because we establish insurance-related deductible/retention reserves based on historical loss development factors; • our strategy includes pursuing acquisitions, which we may be unsuccessful in making and integrating mergers, acquisitions, and investments, and completing divestitures; • the risk that the activities of activist stockholders could have a negative impact on our business and results of operations; • the risk that the value of our deferred tax assets could become impaired, which could materially and adversely affect our operating results; • the risk that our expected annual effective tax rate could be volatile and materially change as a result of changes in mix of earnings and other factors; • the risk that changes in actuarial assumptions for our pension plan could impact our financial results, and funding requirements are mandated by the federal government; • the risk that costs and liabilities related to our participation in multi-employer pension plans could increase; • the risk that we could be the subject of securities class action litigation due to stock price volatility, which could divert management’s attention and adversely affect our results of operations; and • the risk that changes in, or interpretation of, accounting principles could result in unfavorable accounting changes. • the notes will be structurally subordinated to all indebtedness of the issuer’s existing and future subsidiaries that are not and do not become guarantors of the notes; • subsidiary guarantees of indebtedness under our secured Revolving Credit Facility may be released in a variety of circumstances, which will cause those guarantors to be released from their guarantees of the notes; • the issuer may not be able to purchase the notes upon a Change of Control Triggering Event; • investors may not be able to determine when a change of control has occurred following a sale of “substantially all” of our assets; • there are significant restrictions on your ability to transfer or resell your notes; • your ability to transfer the notes may be limited by the absence of an active trading market, and an active trading market may not develop for the notes; • U.S. federal and state laws permit courts to void guarantees under certain circumstances; • we are not providing all of the information that would be required if this offering were being registered with the SEC; • redemption may adversely affect your return on the notes; • the credit ratings assigned to the notes may not reflect all risks of an investment in the notes; • changes in our credit ratings could adversely affect the market prices or liquidity of the notes; and • other secured indebtedness, including indebtedness under our Revolving Credit Facility with respect to the Priority RCF Collateral, are senior to the notes to the extent of the value of the collateral securing such indebtedness on a first-priority basis; • the value of the collateral securing the notes may not be sufficient to satisfy our obligations under the notes; • sales of assets by the Company and guarantors could reduce the pool of assets that will secure the notes and the guarantees; and • rights of holders of notes in the collateral may be adversely affected by bankruptcy proceedings. Given these risks and uncertainties, we caution you not to place undue reliance on forward-looking statements. We expressly disclaim any obligation to update or revise any forward-looking statement as a result of new information, future events or otherwise, except as required by law. 30 THIRD-PARTY INFORMATION This report contains references to industry data and information from third parties including U.S. government sources and publicly available market research. While we believe the information is reliable, we have not independently verified it and cannot guarantee its accuracy or completeness. 31 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable.