BlueLinx Holdings Inc. 10-K

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 28, 2019 (“fiscal 2019”). Discussion and analysis of fiscal 2019 and year-to-year comparisons between fiscal 2020 and fiscal 2019 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 January 2, 2021. Executive Level Overview Company Background BlueLinx is 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 over 40 states, and the strength of a locally focused sales force, as a two-step wholesale distributor, we distribute a 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, Allura, James Hardie, Fiberon, Royal, Oldcastle APG, Louisiana-Pacific, and Weyerhaeuser. We 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 whom then serve residential and commercial builders and contractors in their respective geographic areas and local markets. As a 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 the 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. Significant Recent Transactions and Developments Term Loan Facility As of January 2, 2021, we had outstanding borrowings of $43.2 million under our senior secured term loan facility. On April 2, 2021, we repaid the remaining outstanding principal balance under the facility and the facility was terminated. As a result, as of January 1, 2022, we had no outstanding borrowings under the term loan facility. In connection with our repayment of the 26 facility, we expensed $5.8 million of debt issuance costs during the first quarter of fiscal 2021 that we had been amortizing in connection with the facility. These costs are included within interest expense, net, on the Consolidated Statements of Operations and reported separately as an adjustment to net income in our Consolidated Statements of Cash Flows. While the facility was paid in full as of April 2, 2021, our average interest rate under the facility, exclusive of fees and prepayment premiums, was 8.2 percent and 8.0 percent for the years ended January 2, 2021 and January 1, 2022, respectively. Amendment of our Revolving Credit Facility On August 2, 2021, we amended our revolving credit facility to, among other things, (i) extend the maturity date of the facility from October 10, 2022, to August 2, 2026, (ii) amend the Borrowing Base (as such term is defined under the facility) to include a certain portion of the assets of acquired companies prior to the conduct of a field exam or appraisals thereof by the agent, (iii) modify certain definitions and various affirmative and negative covenants to provide additional flexibility for the Company, and (iv) add customary LIBOR replacement language. In addition, the amended revolving credit facility now provides for interest on borrowings at a rate per annum equal to (i) LIBOR plus a margin ranging from 1.25 percent to 1.75 percent, with the amount of such margin determined based upon the average of our excess availability for the immediately preceding fiscal quarter as calculated by the agent, for loans based on LIBOR, or (ii) the base rate plus a margin ranging from 0.25 percent to 0.75 percent, with the amount of such margin determined based upon the average of our excess availability for the immediately preceding fiscal quarter as calculated by the agent, for loans based on the base rate, reflecting a decrease of 0.50 percent to the upper limit of each respective margin tier. As of January 1, 2022, we had zero outstanding borrowings on our revolving credit facility. Share Repurchase Program On August 23, 2021, we announced our Board of Directors approved a stock repurchase program pursuant to which we may repurchase up to $25 million of our common stock. Under the program, 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 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 repurchased no shares under this program. Senior Secured Notes Transaction During the fourth quarter of 2021, we completed a private offering of $300 million of our six percent senior secured notes due 2029 (the “2029 Notes”). The 2029 Notes were issued to investors at 98.625 percent of their principal amount and will mature on November 15, 2029. The majority of net proceeds from the offering of the 2029 Notes were used to repay borrowings under our revolving credit facility. In conjunction with this offering, we also amended the revolving credit facility to reduce the credit limit from $600 million to $350 million. In conjunction with the reduction of the credit limit of our revolving credit facility, we expensed approximately $1.6 million of debt issuance costs during the fourth quarter of 2021. These costs are included within interest expense, net, on the Consolidated Statements of Operations and reported separately as an adjustment to net income in our Consolidated Statements of Cash Flows. Real Estate Transactions During fiscal 2021, we sold two non-operating facilities that were previously identified as “held for sale”. During the first quarter, we sold our non-operating facility located in Birmingham, Alabama, and recognized a gain of $1.3 million in the Consolidated Statement of Operations and Comprehensive Income, as a result of this sale. Proceeds from this transaction was used to pay down our term loan facility. Additionally, during the fourth quarter, we sold our non-operating facility located in Houston, Texas. We recognized a gain of $7.1 million in the Consolidated Statement of Operations and Comprehensive Income as a result of this sale. 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 27 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 monthly composite prices for lumber, including certain lumber subcategories, and average monthly composite prices for panels, including certain panel subcategories, as reflected by Random Lengths, an industry publication, for the periods noted below. In addition to the year-over-year average monthly price changes, 2020 and 2021 were years of exceptional price volatility when compared to historical prices over the last seven years. During 2021, both composite lumber and composite panel prices experienced the largest difference between high and low price levels within a calendar year than any year in the last seven years. Calendar Year Ended December 31 2021 versus 2020 2020 versus 2019 Increase (decrease) in composite lumber prices 50% 59% Increase (decrease) in Western SPF lumber prices 57% 53% Increase (decrease) in Southern pine lumber prices 43% 45% Increase (decrease) in composite panel prices 85% 56% Increase (decrease) in Western fir plywood prices 83% 22% Increase (decrease) in Southern pine plywood prices 73% 29% Increase (decrease) in OSB prices 94% 99% During 2020, pricing for these products declined starting in March 2020, 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 2020. 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. In 2021, wood-based commodity index prices began January at record or near-record highs and remained at elevated levels through the first quarter and in to the second quarter. Prices continued to increase to a historical peak in May 2021 and then began to decline through the end of the second quarter and throughout the third quarter of 2021. During the fourth quarter, prices began to rise again ending 2021, and beginning 2022, at historically 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. 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. Favorable interest rates, shortages in existing home inventory, expanding use of telework and a potential growing trend toward relocating away from populated 28 metropolitan areas to areas with single-family homes may help sustain the improvement in 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 specialty products we distribute are available from select suppliers from which we have established and cultivated relationships in the specific markets we serve. The structural products we distribute are available from a variety of suppliers. As a result of the COVID-19 pandemic, manufacturing output was impacted on both the specialty and structural 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 specialty and structural 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. During fiscal 2021, we 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. Our cost structure and liquidity have and 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 2021, that impact was offset by the recovery in single-family residential housing starts, supply and demand imbalances for the products we distribute, and the escalation in wood-based commodity pricing. 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 continuity plans, stabilizing in the labor markets 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 labor markets, 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 elected to defer the payment of employer payroll taxes that would normally be paid during fiscal 2020. The total amount of our payroll tax deferral under the CARES Act was approximately $7.3 million. 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 made payments of approximately $3.2 million in December 2021 and will make payments for the remaining $3.1 million by December 2022. 29 Results of Operations Fiscal 2021 Compared to Fiscal 2020 The following table sets forth our results of operations for fiscal 2021 and fiscal 2020, which were comprised of 52 weeks and 53 weeks, respectively. Fiscal 2021 % of Net Sales Fiscal 2020 % of Net Sales ($ in thousands) Net sales $ 4,277,178 100.0% $ 3,097,328 100.0% Gross profit 778,427 18.2% 477,734 15.4% Selling, general, and administrative 322,205 7.5% 314,228 10.1% Depreciation and amortization 28,192 0.7% 28,901 0.9% Amortization of deferred gains on real estate (3,935) (0.1)% (4,008) (0.1)% Gains from sales of property (8,427) (0.2)% (10,529) (0.3)% Other operating expenses 2,315 0.1% 6,901 0.2% Operating income 438,077 10.2% 142,241 4.6% Interest expense, net 45,507 1.1% 47,414 1.5% Other (income) expense, net (1,306) 0.0% (254) 0.0% Income before provision for income taxes 393,876 9.2% 95,081 3.1% Provision for income taxes 97,743 2.3% 14,199 0.5% Net income $ 296,133 6.9% $ 80,882 2.6% The following table sets forth changes in net sales by product category. Fiscal 2021 Fiscal 2020 ($ in thousands) Net sales by category Specialty products $ 2,520,305 58.9 % $ 1,865,125 60.2 % Structural products 1,756,873 41.1 % 1,232,203 39.8 % Total net sales $ 4,277,178 100.0 % $ 3,097,328 100.0 % The following table sets forth gross margin dollars and percentages by product category versus comparable prior periods. Fiscal 2021 Fiscal 2020 ($ in thousands) Gross profit $ by category: Specialty products $ 561,520 $ 319,577 Structural products 216,907 158,157 Total gross profit $ 778,427 $ 477,734 Gross margin % by category Specialty products 22.3 % 17.1 % Structural products 12.3 % 12.8 % Total gross margin % 18.2 % 15.4 % 30 Discussion of Results of Operations Net sales of $4.3 billion in fiscal 2021, an increase of 38.1 percent, or $1.2 billion, from fiscal 2020. When normalized for the additional week in our fiscal year 2020, our fiscal year 2021 sales increased 40.7 percent. This increase was driven by robust demand for home building products amid broad-based supply constraints across the U.S. home building products industry, significant year-over-year inflation in the average price of wood-based commodity products, and disciplined pricing strategies. Total volume decreased modestly year-over-year reflecting the impact of supply constraints offset by strategic actions we implemented to emphasize growth in higher value specialty product categories. Our fiscal 2021 results also reflect a more disciplined approach to structural inventory purchases in order to manage risk associated with fluctuations in wood-based commodity prices. This approach resulted in less on-hand market-sensitive inventory for our structural products category which impacted the volume of structural products we had available to sell throughout the year. Net sales of specialty products, which includes engineered wood, industrial products, cedar, moulding, siding, metal products and insulation, increased $655.2 million to $2.5 billion in fiscal year 2021. This increase was primarily driven by favorable demand and strategic pricing actions. Gross profit within our specialty products, increased $241.9 million to $561.5 million, with a year-over-year improvement of approximately 75.7 percent. The increase in our specialty products gross margin percentages during fiscal 2021 was the result of substantial increases in pricing, driven by an increased demand paired with the supply constrained environment, although overall volume was down compared to fiscal year 2020. Net sales of structural products, which includes products such as lumber, plywood, oriented strand board, rebar, and remesh, increased $524.7 million to $1.8 billion during fiscal 2021 due to commodity wood products price inflation. Structural sales volumes declined overall versus the prior-year period given our reduction in purchases in response to historic fluctuations in the wood-based commodity markets. Our structural gross margin percentage for fiscal 2021 was 12.3%, slightly down from 12.8% in the prior year period. Fiscal 2021, selling, general, and administrative expenses increased 2.5 percent, or $8.0 million, compared to fiscal 2020. The increase in sales, general, and administrative expenses is due to net increases in our variable compensation, such as sales commissions and incentives of approximately $5.9 million, general and administration cost of approximately $4.5 million. These increases were partially offset by a decrease in payroll and related cost of approximately $1.4 million and logistics decrease of approximately $1.0 million. When normalized for the additional operating week in fiscal 2020, our fiscal 2021 selling, general and administrative expenses increased $13.9 million. Depreciation and amortization expense decreased 2.5 percent, or $0.7 million, compared to 2020. The decrease in depreciation and amortization expense is due to a lower base of amortizable and depreciable assets throughout fiscal 2021 when compared to the prior year period. During the fourth quarter 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 $10.5 million during the fourth quarter. During fiscal year 2021, we completed the sale of two non-operational properties resulting in a gain of $8.4 million. Our Birmingham property, which we sold in the first quarter of fiscal year 2021, resulted in a gain of $1.3 million, and our Houston property, which we sold in the fourth quarter, resulted in a gain from the sale of $7.1 million. Other operating expenses decreased 66.5 percent, or $4.6 million, compared to fiscal 2020 primarily due to a decrease in spending related to integration and restructuring related costs reported during fiscal 2021. Our interest expense, net, for fiscal 2021, decreased by 4.0 percent, or $1.9 million, compared to the prior year period. The decrease is primarily due to 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 either our revolving credit facility or our senior secured notes. Interest savings were further driven by lower interest costs resulting from the renegotiation of our revolving credit facility in the third quarter of fiscal 2021. This was offset by the $7.4 million in debt issuance costs expensed during the first and third quarters of fiscal 2021 related to the extinguishment of our former term loan facility and credit limit reduction of our revolving credit facility. Our effective tax rate was 24.8 percent and 14.9 percent for 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 fiscal 2020 was additionally impacted by a 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. 31 Our net income for fiscal 2021 increased $215.3 million from the prior year period primarily due to the increase in gross profit resulting from substantial price increases benefiting our specialty products combined with benefits from commodity price inflation when compared to prior year. Increases in gross profit were further supported by gains from the sales of non-operational property, our former Birmingham and Houston properties, during the fiscal year 2021 offset by an increase in our selling, general and administrative expense resulting primarily from higher commissions arising from our higher gross profit during the year. Additionally, net income benefited from slightly lower interest expense offset by higher income tax expense resulting from our higher effective tax rate. Liquidity and Capital Resources We expect our material cash requirements for the next twelve months will be for our: • Periodic estimated income tax payments, as required; • Periodic interest payments associated with our senior secured notes, as discussed in Note 6; • Lease agreements which have fixed lease payment obligations, as discussed in Note 11. We expect our primary sources of liquidity to be cash flows from sales and operating activities in the normal course of our operations and availability from our revolving credit facility, as needed. 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 2021 cash flows provided by operating activities totaled $145.0 million. This cash activity was primarily driven by net income of $296.1 million, which included a non-cash charge for debt-issuance costs expensed during the period for our extinguished term loan facility and reduced revolving credit facility of $7.4 million in addition to a non-cash adjustment for our gains on sales of property of $8.4 million combined with changes in our working capital components. The changes in working capital components resulted in a decrease in cash due to an increase in accounts receivables of $46.0 million and an increase inventory of $146.4 million offset by an increase in cash due to an increase in accounts payable of $14.8 million. Fiscal 2020 cash flows used in operating activities totaled $55.0 million. This cash activity was primarily driven by net income of $80.9 million, which included a non-cash adjustment for our gains on sale of properties of $10.5 million and changes in working capital components. The changes in working capital components included a decrease in cash due to an increase in accounts receivable of $100.8 million offset by an increase in cash due to a decrease in inventory of $3.7 million and an increase in accounts payable of $32.8 million. Investing Activities During fiscal 2021, our net cash used by investing activities was $4.1 million, which was substantially driven by cash received from the sale of real estate of $10.3 million, offset by cash paid for investments in property and equipment of $14.4 million. In 2021, $9.0 million in cash was invested in the fourth quarter and of that $9.0 million, approximately $6.4 million was for new curtain side trailers for our delivery fleet. 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. Financing Activities Net cash used in financing activities was $55.8 million during fiscal 2021, which primarily reflected the repayments of the remaining $43.2 million balance on our term loan and net repayments on our revolving credit facility of $286.6 million, in addition to payments on finance leases of $11.2 million, debt financing costs of $5.5 million and repurchase of shares to satisfy employee tax withholdings on the vesting of restricted stock units of $5.2 million, all of which were offset by proceeds from the sale of our senior secured notes, net of discount, of $295.9 million. 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 our 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. 32 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 1, 2022 January 2, 2021 (In thousands) Current assets: Cash and cash equivalents $ 85,203 $ 82 Accounts receivable, less allowance for doubtful accounts 339,637 293,643 Inventories, net 488,458 342,108 $ 913,298 $ 635,833 Current liabilities: Accounts payable $ 180,000 $ 165,163 $ 180,000 $ 165,163 Operating working capital $ 733,298 $ 470,670 Operating working capital increased to $733.3 million as of January 1, 2022, from $470.7 million as of January 2, 2021. The increase in operating working capital is primarily due to an increase in cash of $85.1 million, accounts receivable of $46.0 million, and inventory of $146.4 million, offset by an increase in accounts payable of $14.8 million. The increases in cash resulted from primarily from the issuance of our senior secured notes in October 2021. Accounts receivable increases were attributable to our higher sales. Inventory and accounts payable increases were driven largely by increases in the cost of our inventory in addition to year-end inventory build-up activities in preparation for 2022. Debt and Credit Sources As of January 1, 2022, and January 2, 2021, long-term debt consisted of the following: January 1, 2022 January 2, 2021 (In thousands) Senior secured notes (1) $ 300,000 $ — Revolving credit facility (2) — 288,247 Term loan facility (3) — 43,204 Finance lease obligations (4) 274,717 273,118 574,717 604,569 Unamortized debt issuance costs (4,701) (9,010) Unamortized bond discount costs (4,028) — 565,988 595,559 Less: current maturities of long-term debt 7,864 6,846 Long-term debt, net of current maturities $ 558,124 $ 588,713 (1) For the twelve months ended January 1, 2022, our long-term debt was comprised of $300 million of senior secured notes issued in October 2021. These notes are presented under the long-term debt caption of our balance sheet at $291.3 million which is net of their discount of $4.0 million and the combined carrying value of our debt issuance costs of $4.7 million. Our senior secured notes are presented in this table at their face value . (2) The average effective interest rate was 2.5 percent and 3.3 percent for the years ended January 1, 2022 and January 2, 2021, respectively. (3) The average interest rate, exclusive of fees and prepayment penalties, was 8.0 percent and 8.2 percent for the years ended January 1, 2022 and January 2, 2021, respectively. (4) Refer to Note 11, Lease Commitments, for interest rates associated with finance lease obligations. 33 Term Loan Facility As of January 2, 2021, we had outstanding borrowings of $43.2 million under our senior secured term loan facility. On April 2, 2021, we repaid the remaining outstanding principal balance under the facility and the facility was terminated. As a result, as of January 1, 2022, we had no outstanding borrowings under the term loan facility. In connection with our repayment of the facility, we expensed $5.8 million of debt issuance costs during the first quarter of fiscal 2021 that we had been amortizing in connection with the facility. These costs are included within interest expense, net, on the Consolidated Statements of Operations and reported separately as an adjustment to net income in our Consolidated Statements of Cash Flows. While the facility was paid in full as of April 2, 2021, our average interest rate under the facility, exclusive of fees and prepayment premiums, was 8.2 percent and 8.0 percent for the years ended January 2, 2021 and January 1, 2022, respectively. Amendment of our Revolving Credit Facility On August 2, 2021, we amended our revolving credit facility to, among other things, (i) extend the maturity date of the facility from October 10, 2022, to August 2, 2026, (ii) amend the Borrowing Base (as such term is defined under the facility) to include a certain portion of the assets of acquired companies prior to the conduct of a field exam or appraisals thereof by the agent, (iii) modify certain definitions and various affirmative and negative covenants to provide additional flexibility for the Company, and (iv) add customary LIBOR replacement language. In addition, the amended revolving credit facility now provides for interest on borrowings at a rate per annum equal to (i) LIBOR plus a margin ranging from 1.25 percent to 1.75 percent, with the amount of such margin determined based upon the average of our excess availability for the immediately preceding fiscal quarter as calculated by the agent, for loans based on LIBOR, or (ii) the base rate plus a margin ranging from 0.25 percent to 0.75 percent, with the amount of such margin determined based upon the average of our excess availability for the immediately preceding fiscal quarter as calculated by the agent, for loans based on the base rate, reflecting a decrease of 0.50 percent to the upper limit of each respective margin tier. As of January 1, 2022, we had zero outstanding borrowings on our revolving credit facility. Senior Secured Notes Transaction During the fourth quarter of 2021, we completed a private offering of $300 million of our six percent senior secured notes due 2029 (the “2029 Notes”). The 2029 Notes were issued to investors at 98.625 percent of their principal amount and will mature on November 15, 2029. The majority of net proceeds from the offering of the 2029 Notes were used to repay borrowings under our revolving credit facility. In conjunction with this offering, we also amended the revolving credit facility to reduce the credit limit from $600 million to $350 million. In conjunction with the reduction of the credit limit of our revolving credit facility, we expensed approximately $1.6 million of debt issuance costs during the fourth quarter of 2021. These costs are included within interest expense, net, on the Consolidated Statements of Operations and reported separately as an adjustment to net income in our Consolidated Statements of Cash Flows. 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 completed in recent years. During fiscal 2020, we completed real estate financing transactions on two warehouse facilities; and during fiscal 2021, we completed real estate financing transactions on fourteen warehouse facilities. We recognized financing lease assets and obligations as a result of each of these real estate transactions. We also entered into new finance lease agreements for new tractors for our fleet totaling $3.8 million and $10.5 million during fiscal 2020 and 2021, respectively. Our total finance lease commitments, including the properties associated with these transactions, totaled $274.7 million and $273.1 million as of January 1, 2022 and January 2, 2021, respectively. Of the $274.7 million of finance lease commitments as of January 1, 2022, $244.0 million related to real estate and $30.7 million related to equipment. 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. 34 Investments in Property and Equipment Our investments in property and equipment 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 2021, we invested $14.4 million in cash related to investments in long-lived assets and entered into finance leases totaling $10.5 million, for a total investment of $24.9 million. For fiscal 2020, we invested $3.7 million in cash related to investments in long-lived assets and entered into finance lease agreements totaling $3.8 million, for a total investments of $7.5 million. Pension Funding Obligations We were required to make cash contributions during 2021 and 2020 totaling approximately $0.3 million and $0.8 million, respectively, relating to our fiscal 2021 and also 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 includes available interest rate options based on LIBOR. It is widely expected that LIBOR will be discontinued after June 30, 2023, 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 1, 2022, we did not have any 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) pension benefit obligation; (2) revenue recognition; (3) goodwill; and (4) 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 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. Pension Benefit Obligation As discussed in Note 8 of the consolidated financial statements, our pension benefit obligation was $105.9 million and exceeded the fair value of pension plan assets of $94.3 million, resulting in an unfunded obligation of $11.6 million. The estimation of the pension benefit obligation is dependent on actuarial methods and the selection of assumptions, such as the applicable discount rate and mortality rates. These assumptions have a significant effect on the projected benefit obligation. 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 35 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 1, 2022, 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 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. During fiscal year 2021, we had no impact to our income tax provision resulting from the CARES Act. 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 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 36 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 1, 2022, positive evidence continued to outweigh negative evidence, as such no valuation allowance was deemed necessary except to the extent of certain state net operating losses. The valuation allowances related to our net operating losses as of January 1, 2022 was approximately $4.3 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. 37