BlueLinx Holdings Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS About Our Business 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, siding, millwork, outdoor living, specialty lumber and industrial products. 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, a broad geographic coverage footprint servicing over 45 states, where our locations are in approximately 75 percent of the highest growth metropolitan statistical areas, combined with the strength of a locally focused sales force, we distribute a comprehensive range of products from over 750 suppliers. Our suppliers include some of the leading manufacturers in the industry, such as Allura, Arauco, Fiberon, Georgia-Pacific, Huber Engineered Woods, James Hardie, Louisiana-Pacific, Oldcastle APG, Ply Gem, Roseburg, Royal and Weyerhaeuser. We supply products to a broad base of over 15,000 total customers including national home centers, pro dealers, cooperatives, specialty distributors, regional and local dealers and industrial manufacturers. Many of our customers serve residential and commercial builders, contractors and remodelers 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 a 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 repair and remodel and residential new construction, 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 estimate the remaining approximately 15 percent of end market mix is accounted for by commercial construction. Certain recent changes in macro-economic factors, such as escalating home prices, may put pressure on the overall housing market, including the residential repair and remodel and residential new construction end markets. Given these developments, we anticipate a slowdown of the housing industry over the coming quarters. However, we believe that several factors, including the current high levels of home equity, recent work from home trends, the undersupply of housing in the United States, and the strength of housing starts compared to pre-COVID levels, among others, will continue to support demand for our products and drive long-term growth across the end markets in which we operate. 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 16 new construction, particularly for exterior products that are exposed to the elements and where maintenance is less likely to be deferred for long periods of time. We expect that current 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. 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 142 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. 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. 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 a portion of our business is correlated, is driven by demographic and population shifts, mortgage interest rates (which are low compared to the 40-year average), 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. We believe our large footprint, strong customer relationships, and comprehensive offering of leading products and brands position us to capitalize on continued growth in the new housing market. According to the U.S. Census Bureau and the U.S. Department of Housing and Urban Development, June 2022 single family housing starts in the United States were approximately two percent lower compared to that of May 2022, but approximately 28 percent higher than that of February 2020, prior to the COVID-19 pandemic. The monthly single family residential home supply is in line with the 25-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 opportunity in the residential new home construction end-market for building products of which we are well positioned to serve. Seasonality We are exposed to fluctuations in quarterly sales volumes and expenses due to seasonal factors common in the building products distribution industry, such as weather conditions and other seasonal factors. As a result, our quarterly sales volumes may trend higher in quarters when weather conditions and other seasonal factors are more favorable, reflecting an increase in activity in the residential repair and remodel and residential new home construction markets. Conversely, when weather conditions and other seasonal factors are less favorable, we may experience declines in sales volumes. 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 two years 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. 17 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. This includes enhancing the customer experience; accelerating organic growth within specific product and solutions offerings where the Company is uniquely advantaged; and deploying capital to drive sustained margin expansion, grow cash flow and maintain continued profitable growth. 2. Migrate sales mix toward higher-margin specialty product categories. The Company intends to pursue a revenue mix increasingly weighted toward higher-margin, specialty product categories such as engineered wood, siding, millwork, outdoor living, specialty lumber and industrial products. Additionally, the Company intends to expand its value-added service offerings designed to simplify complex customer sourcing requirements, together with marketing, inventory and pricing services afforded by the Company’s national platform. 3. Maintain a disciplined capital structure and pursue high-return investments that increase the value of the Company. The Company intends to maintain a disciplined capital structure while at the same time investing in its business to modernize its tractor fleet and distribution facilities and to improve operational performance. The Company also continues to evaluate potential acquisition targets that complement its existing capabilities, grow its specialty products business, increase customer exposure, expand its geographic reach, or a combination thereof. We invested $4.4 million and $6.9 million in capital for our business during the three and six month periods ending July 2, 2022, respectively, to improve operational performance and productivity. Factors That Affect 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; competition; changes in the supply and/or demand for products that we distribute; the cyclical nature of the industry in which we operate; housing market conditions; 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; potential acquisitions and the integration and completion of such acquisitions; business disruptions; effective inventory management relative to our sales volume or the prices of the products we produce; information technology security risks and business interruption risks; the ability to attract, train, and retain highly qualified associates and other key personnel while controlling related labor costs; exposure to product liability and other claims and legal proceedings related to our business and the products we distribute; natural disasters, catastrophes, fire, wars 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; the COVID-19 pandemic and other contagious illness outbreaks and their potential effects on our industry; regulations concerning mandatory COVID-19 vaccines; fluctuations in our operating results; our level of indebtedness and our ability to incur additional debt to fund future needs; the covenants of the instruments governing our indebtedness limiting the discretion of our management in operating the business; variable interest rate risk under certain indebtedness; the fact that we have consummated certain sale leaseback transactions with resulting long-term non-cancelable leases, many of which are or will be finance leases; 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; inability to raise funds necessary to finance a required repurchase of our senior secured notes; inability to successfully execute the ASR; a lowering or withdrawal of debt ratings; changes in our product mix; increases in petroleum prices; shareholder activism; changes in insurance-related deductible/retention reserves based on actual loss experience; the possibility that the value of our deferred tax assets could become impaired; changes in our expected annual effective tax rate could be volatile; changes in actuarial assumptions for our pension plan; the costs and liabilities related to our 18 participation in multi-employer pension plans could increase; the risk that our cash flows and capital resources may be insufficient to service our existing or future indebtedness; the possibility that we could be the subject of securities class action litigation due to stock price volatility; activities of activist shareholders; indebtedness terms that limit our ability to pay dividends on common stock; and changes in, or interpretation of, accounting principles. 19 Results of Operations The following table sets forth our results of operations for the second quarter of fiscal 2022 and fiscal 2021: Second Quarter of Fiscal 2022 % of Net Sales Second Quarter of Fiscal 2021 % of Net Sales (In thousands) (In thousands) Net sales $ 1,239,379 100.0% $ 1,307,913 100.0% Gross profit 201,408 16.3% 251,172 19.2% Selling, general, and administrative 91,338 7.4% 87,010 6.7% Depreciation and amortization 6,518 0.5% 7,080 0.5% Amortization of deferred gains on real estate (984) (0.1)% (984) (0.1)% Gains from sales of property (144) 0.0% — 0.0% Other operating expenses 626 0.1% 871 0.1% Operating income 104,054 8.4% 157,195 12.0% Interest expense, net 11,255 0.9% 9,143 0.7% Other expense (income), net 139 0.0% (314) (0.0)% Income before provision for income taxes 92,660 7.5% 148,366 11.3% Provision for income taxes 21,388 1.7% 34,908 2.7% Net income $ 71,272 5.8% $ 113,458 8.7% The following table sets forth our results of operations for the first six month periods of fiscal 2022 and fiscal 2021: First Six Months of Fiscal 2022 % of Net Sales First Six Months of Fiscal 2021 % of Net Sales (In thousands) (In thousands) Net sales $ 2,541,684 100.0% $ 2,333,382 100.0% Gross profit 492,459 19.4% 431,564 18.5% Selling, general, and administrative 182,627 7.2% 162,569 7.0% Depreciation and amortization 13,264 0.5% 14,545 0.6% Amortization of deferred gains on real estate (1,968) (0.1)% (1,967) (0.1)% Gains from sales of property (144) 0.0% (1,287) (0.1)% Other operating expenses 1,464 0.1% 983 0.0% Operating income 297,216 11.7% 256,721 11.0% Interest expense, net 22,548 0.9% 25,377 1.1% Other expense (income), net 1,277 0.1% (628) (0.0)% Income before provision for income taxes 273,391 10.8% 231,972 9.9% Provision for income taxes 68,710 2.7% 56,654 2.4% Net income $ 204,681 8.1% $ 175,318 7.5% 20 The following table sets forth net sales by product category for the three and six month periods ending July 2, 2022 and July 3, 2021: Three Months Ended Six Months Ended July 2, 2022 July 3, 2021 July 2, 2022 July 3, 2021 Net sales by product category (In thousands) (In thousands) Specialty products $ 787,860 $ 675,189 $ 1,555,767 $ 1,237,811 Structural products 451,519 632,724 985,917 1,095,571 Total net sales $ 1,239,379 $ 1,307,913 $ 2,541,684 $ 2,333,382 Percentage of total net sales by product category Specialty products 63.6 % 51.6 % 61.2 % 53.0 % Structural products 36.4 % 48.4 % 38.8 % 47.0 % Total net sales 100.0 % 100.0 % 100.0 % 100.0 % The following table sets forth gross profit and gross margin percentages by product category for the three and six month periods ending July 2, 2022 and July 3, 2021: Three Months Ended Six Months Ended July 2, 2022 July 3, 2021 July 2, 2022 July 3, 2021 Gross profit by product category (In thousands) (In thousands) Specialty products $ 180,254 $ 164,995 $ 364,353 $ 273,530 Structural products 21,154 86,177 128,106 158,034 Total gross profit $ 201,408 $ 251,172 $ 492,459 $ 431,564 Gross margin % by product category Specialty products 22.9 % 24.4 % 23.4 % 22.1 % Structural products 4.7 % 13.6 % 13.0 % 14.4 % Total gross margin % 16.3 % 19.2 % 19.4 % 18.5 % The following table sets forth our structural product gross profit and gross margin percentage, excluding the impact of our lower of cost or net realizable value reserve, for the three and six month periods ending July 2, 2022 and July 3, 2021: Three Months Ended Six Months Ended Structural products July 2, 2022 July 3, 2021 July 2, 2022 July 3, 2021 (In thousands) (In thousands) Net sales $ 451,519 $ 632,724 $ 985,917 $ 1,095,571 Gross profit, as reported 21,154 86,177 128,106 158,034 Add: lower of cost or net realizable value reserve 9,776 16,693 9,776 16,693 Gross profit, excluding reserve $ 30,930 $ 102,870 $ 137,882 $ 174,727 Gross margin %, excluding reserve 6.9 % 16.3 % 14.0 % 15.9 % 21 Second Quarter of Fiscal 2022 Compared to Second Quarter of Fiscal 2021 For the second quarter of fiscal 2022, we generated net sales of $1.2 billion, a decrease of $68.5 million when compared to the second quarter of fiscal 2021 and overall gross margin percentage decreased from 19.2 percent to 16.3 percent year over year. Our second quarter net income was $71.3 million, or $7.48 per diluted share, versus $113.5 million, or $11.61 per diluted share, in the prior-year period. The significant decrease in wood-based commodity prices is the primary contributor to the decline in our overall sales and profitability year over year, partially offset by improvements in pricing of our specialty products. Net sales of specialty products, which includes products such as engineered wood, siding, millwork, outdoor living, specialty lumber and industrial products, increased $112.7 million to $787.9 million in the second quarter of fiscal 2022 compared to the second quarter of fiscal 2021. Strategic pricing of our specialty products throughout the second quarter of fiscal 2022 resulted in improved revenue and gross profit growth, partially offset by slightly lower volume when compared to the prior-year period, where we saw historically strong demand. Specialty products gross profit increased $15.3 million to $180.3 million, with a year-over-year decline of 150 basis points in specialty gross margin to 22.9 percent for the second quarter of fiscal 2022 compared to 24.4 percent in the second quarter of fiscal 2021. The decrease in specialty gross margin percentage over the prior-year period is primarily attributable to some price volatility during the second quarter of fiscal 2022 related to certain of our specialty products, such as treated lumber and panels. Net sales of structural products, which includes products such as lumber, plywood, oriented strand board, rebar, and remesh, decreased $181.2 million to $451.5 million in the second quarter of fiscal 2022. The significant decrease in wood-based commodity prices of our structural products resulted in the decrease of revenue and gross profit for the second quarter of fiscal 2022. Our structural gross margin percentage for the second quarter of fiscal 2022 was 4.7 percent, down from 13.6 percent in the prior-year period, also primarily attributable to the significant decrease in wood-based commodity prices. Our structural gross margin percentage includes a lower of cost or net realizable value reserve of $9.8 million recorded as of the end of the second quarter of fiscal 2022 compared to $16.7 million recorded as of the end of the second quarter of fiscal 2021, both of which were recorded in response to the decline in wood-based commodity prices as of the end of each fiscal quarter. Excluding the impact of the lower of cost or net realizable value reserve, our structural gross margin percentage for the second quarter of fiscal 2022 and 2021 would have been 6.9 percent and 16.3 percent, respectively. Our selling, general, and administrative expenses increased 5.0 percent, or $4.3 million, compared to the second quarter of fiscal 2021. The increase in selling, general, and administrative expenses is due primarily to increases in logistical expenses of $5.3 million related to inflation in our delivery costs, including third-party delivery services and fuel costs, along with net increases of $3.2 million related to higher payroll costs and other strategic investments in our workforce and business. These net increases were partially offset by reduced variable incentive compensation, which includes sales commissions and stock compensation, of $4.2 million. Depreciation and amortization expense decreased 7.9 percent, compared to the second quarter of fiscal 2021. The decrease in depreciation and amortization is due to a lower base of amortizable and depreciable assets throughout the second quarter of fiscal 2022 when compared to the prior-year period. The increase in gains from sales of property in the amount of $0.1 million is due to the sale of assets previously classified as held for sale during the second quarter of fiscal 2022 compared to no sale of property during the second quarter of fiscal 2021. Other operating expenses decreased $0.2 million compared to the second quarter of fiscal 2021 primarily due to lower other operating expenses incurred in the second quarter of fiscal 2022. Interest expense, net, increased by 23.1 percent, or $2.1 million, compared to the second quarter of fiscal 2021. The increase is primarily due to capital structure mix changes, as our senior secured notes carry a higher interest rate than our former revolving credit facility. Our effective tax rate was 23.1 percent and 23.5 percent for the second quarter of fiscal 2022 and 2021, 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. Each period also includes a benefit from the vesting of restricted stock units, which had a greater impact on the three months ended July 2, 2022 and July 3, 2021 due to the timing of the vesting of our restricted stock awards. Our effective tax rate for the three months ended July 3, 2021 also benefited from the partial release of our valuation allowance for state net operating loss carryforwards we anticipated being able to utilize based on our taxable income through the end of the second quarter of fiscal 2021. For the second quarter of fiscal 2022, our net income decreased by $42.2 million from the prior-year period due primarily to a decrease in gross profit driven by a significant decrease in wood-based commodity prices, in conjunction with some increases in our operating expenses along with higher interest expense. This was partially offset by a decrease in our income tax expense. 22 First Six Months of Fiscal 2022 Compared to First Six Months of Fiscal 2021 For the first six months of fiscal 2022, we generated net sales of $2.5 billion, an increase of $208.3 million when compared to the first six months of fiscal 2021, and overall gross margin percentage increased from 18.5 percent to 19.4 percent year over year. Our net income for the first six months of fiscal 2022 was $204.7 million, or $21.07 per diluted share, versus $175.3 million, or $18.15 per diluted share, in the prior-year period. Strategic pricing of our specialty products is the primary contributor to the increase in our overall sales and profitability year over year, partially offset by a decline in wood-based commodity prices impacting our structural products. Net sales of specialty products, which includes products such as engineered wood, siding, millwork, outdoor living, specialty lumber and industrial products, increased $318.0 million to $1.6 billion in the first six months of fiscal 2022. Strategic pricing of our specialty products during the first six months of fiscal 2022 resulted in improved revenue and gross profit growth compared to the prior-year period. Specialty products gross profit increased $90.8 million to $364.4 million, with a year-over-year improvement of 130 basis points in specialty gross margin to 23.4 percent for the first six months of fiscal 2022 compared to 22.1 percent in the first six months of fiscal 2021. The increase in specialty gross margin percentage over the prior-year period is primarily attributable to benefits from strategic pricing for our specialty products. Net sales of structural products, which includes products such as lumber, plywood, oriented strand board, rebar, and remesh, decreased $109.7 million to $985.9 million in the first six months of fiscal 2022. The decrease in wood-based commodity prices of our structural products is the primary contributor to the decrease of revenue and gross profit for the first six months of fiscal 2022. Our structural gross margin percentage for the first six months of fiscal 2022 was 13.0 percent, down from 14.4 percent in the prior-year period, also primarily attributable to the decrease in wood-based commodity prices impacting our structural products. Our structural gross margin percentage for the first six months of fiscal 2022 and the first six months of fiscal 2021 was also impacted by a lower of cost or net realizable value reserve of $9.8 million and $16.7 million, respectively, recorded as of the end of the second quarter of both comparable periods in response to the decline in wood-based commodity prices. Excluding the impact of the lower of cost or net realizable value reserve, our structural gross margin percentage for the first six months of fiscal 2022 and 2021 would have been 14.0 percent and 15.9 percent, respectively. Our selling, general, and administrative expenses increased 12.3 percent, or $20.1 million, compared to the first six months of fiscal 2021. The increase in sales, general, and administrative expenses is due primarily to increases in logistical expenses of $10.6 million related to inflation in our delivery costs, including third-party delivery services and fuel costs, along with net increases of $5.7 million related to higher payroll costs and other strategic investments in our workforce and business, combined with increases in variable incentive compensation, which includes sales commissions and stock compensation, of $3.8 million. Depreciation and amortization expense decreased 8.8 percent, compared to the first six months of fiscal 2021. The decrease in depreciation and amortization is due to a lower base of amortizable and depreciable assets throughout the first six months of fiscal 2022 when compared to the prior-year period. The decrease in gains from sales of property in the amount of $1.1 million is due to the sale of our Birmingham property during the first six months of fiscal 2021, which resulted in a larger gain as compared to the sale of assets previously held for sale during the same period in 2022. Other operating expenses increased $0.5 million compared to the first six months of fiscal 2021 primarily due to restructuring related costs, including severance, incurred in the first six months of fiscal 2022. Interest expense, net, decreased by 11.1 percent, or $2.8 million, compared to the first six months of fiscal 2021. The decrease is primarily due to $5.8 million in debt issuance costs expensed in the first six months of fiscal 2021 related to the extinguishment of our former term loan facility, partially offset by an increase due to capital structure mix changes, as our senior secured notes carry a higher interest rate than our former revolving credit facility. Other expense (income), net, increased $1.9 million compared to the first six months of fiscal 2021 primarily due to an increase in other non-operating expenses. Our effective tax rate was 25.1 percent and 24.4 percent for the first six months of fiscal 2022 and 2021, 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. Each period also includes a benefit from the vesting of restricted stock units, which had a greater impact on the three months ended July 2, 2022 and July 3, 2021 due to the timing of the vesting of our restricted stock awards. Our effective tax rate for the six months ended July 3, 2021 also benefited from the partial release of our valuation allowance for state net operating loss carryforwards we anticipated being able to utilize based on our taxable income through the end of the first six months of fiscal 2021. For the first six months of fiscal 2022, our net income increased by $29.4 million from the prior-year period due primarily to an increase in gross profit driven by strategic pricing of our specialty products, in conjunction with lower interest expense. This was partially offset by increases in our operating expenses and income tax expense. 23 Liquidity and Capital Resources 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 of our revolving credit facility, as needed. We expect that these sources will be sufficient to fund our ongoing cash requirements for the foreseeable future. Senior Secured Notes In October 2021, we entered into an indenture (the “Indenture”) with the guarantors party thereto and Truist Bank, as trustee and collateral agent, in connection with 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, as defined below. Revolving Credit Facility In April 2018, we entered into a revolving credit facility with Wells Fargo Bank, National Association, as administrative agent (“the Agent”), and certain other financial institutions party thereto. In August 2021, we entered into a second amendment to our revolving credit facility to, among other things, extend the maturity date of the facility to August 2, 2026, and reduce the interest rate on borrowings under the facility (as amended, the “Revolving Credit Facility”). As amended, the Revolving Credit Facility provides for a senior secured asset-based revolving loan and letter of credit facility of up to $350 million. The Borrowers’ obligations under the Revolving Credit Facility are secured by a security interest in substantially all of our and our subsidiaries’ assets (other than real property), including inventories, accounts receivable, and proceeds from those items. Borrowings under the Revolving Credit Facility bear interest at a rate per annum equal to (i) London Inter-bank Offered Rate (“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 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. Borrowings under the Revolving Credit Facility are subject to availability under the Borrowing Base (as that term is defined in the revolving credit agreement). The Borrowers are required to repay revolving loans thereunder to the extent that such revolving loans exceed the Borrowing Base then in effect. The Revolving Credit Facility may be prepaid in whole or in part from time to time without penalty or premium, but including all breakage costs incurred by any lender thereunder. As of July 2, 2022, we had zero outstanding borrowings and excess availability, including cash in qualified accounts, of $451.4 million under our Revolving Credit Facility. As of January 1, 2022, we had zero outstanding borrowings and excess availability, including cash in qualified accounts, of $431.7 million under our Revolving Credit Facility. Our average effective interest rate under the facility was zero percent and 2.5 percent for the quarters ended July 2, 2022 and July 3, 2021, respectively. The Revolving Credit Facility contains certain financial and other covenants, and our right to borrow under the Revolving Credit Facility is conditioned upon, among other things, our compliance with these covenants. We were in compliance with all covenants under the Revolving Credit Facility as of July 2, 2022. Term Loan Facility On April 2, 2021, we repaid the remaining outstanding principal balance of the term loan facility, and, as a result, as of January 1, 2022 and July 2, 2022, we had zero 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 of debt issuance costs that we were 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 and six month period ended July 2, 2022. There were no prepayment premiums associated with the repayment of indebtedness for the three month period ended July 3, 2021. Prepayment premiums were $0.9 million for the six month period ended July 3, 2021. 24 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. Our total finance lease commitments totaled $271.4 million as of July 2, 2022. Of the $271.4 million of finance lease commitments as of July 2, 2022, $243.8 million related to real estate and $27.6 million related to equipment. For the three and six months ended July 2, 2022, we recognized $2.3 million in new finance leases for tractors acquired as a component of our fleet investment plan. For the three and six months ended July 3, 2021, we recognized $0.3 million and $10.5 million, respectively, in new finance leases for tractors acquired to support our fleet investment plan in fiscal 2021. Interest Rates Our Revolving Credit Facility includes available interest rate options based on LIBOR. Certain LIBOR rates were 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 six months of fiscal 2022 was $103.4 million, compared to net cash provided by operating activities of $22.6 million in the first six months of fiscal 2021. The increase in cash provided by operating activities during the first six months of fiscal 2022 was primarily a result of working capital changes, including the reduction of accounts receivable, which resulted in $60.6 million more cash provided by operating activities in the current-year period compared to the prior-year period, and the $29.4 million increase in net income for the current-year period compared to the prior-year period. Investing Activities Net cash used in investing activities for the first six months of fiscal 2022 was $6.4 million, compared to net cash used in investing activities of $0.8 million in the first six months of fiscal 2021. The increase in net cash used in investing activities was primarily due to higher capital investments during the first six months of fiscal 2022. Financing Activities Net cash used in financing activities totaled $77.3 million for the first six months of fiscal 2022, compared to net cash used in financing activities of $21.7 million for the first six months of fiscal 2021. The increase in net cash used in financing activities is primarily due to the $66.4 million spent repurchasing our common stock under our announced repurchase program, including the ASR Agreement, as defined below, during the first six months of fiscal 2022, with no such transactions completed in the first six months of fiscal 2021. Additionally, we made $649.2 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 borrowings of $638.2 million from our revolving credit facility, in the first six months of fiscal 2021, with no such transactions completed in the first six months of fiscal 2022. 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. On May 3, 2022, we announced that our Board of Directors increased our share repurchase authorization to $100.0 million, up $75.0 million from the previous program, and that we entered into an Accelerated Share Repurchase Agreement (“ASR Agreement”) with Jefferies LLC (“Jefferies”) to repurchase $60.0 million of our common stock. 25 Under the ASR Agreement, we received initial delivery of 553,584 shares of common stock on May 3, 2022 representing approximately 65 percent of the total number of shares of common stock initially underlying the ASR Agreement, based on our closing stock price of $70.45 on May 2, 2022. The total number of shares repurchased under the ASR Agreement is based on the average of the daily volume-weighted average price of our common stock during the repurchase period under the ASR Agreement, less a discount and subject to adjustments pursuant to the terms and conditions of the ASR Agreement. At settlement, under certain circumstances, Jefferies may be required to deliver additional shares of common stock to us, or, under certain circumstances, we may be required to make a cash payment or to deliver shares of our common stock to Jefferies. Final settlement of the shares of common stock repurchased under the ASR Agreement could occur as early as the third quarter of fiscal 2022. With the remaining availability under the stock repurchase 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, accelerated share repurchase programs, tender offers or pursuant to a trading plan that may be adopted in accordance with the Securities and Exchange Commission Rule 10b5-1. As of July 2, 2022, we have repurchased 634,915 shares for $66.4 million under this program, including shares purchased through the ASR Agreement, and we have a remaining authorization amount of $33.6 million. Operating Working Capital Operating working capital is an important measurement we use to determine the efficiencies of our operations and our ability to readily convert assets into cash. Operating working capital is defined as the sum of cash, receivables, and inventory, less accounts payable. Management of working capital helps us monitor our progress in meeting our goals to enhance working capital assets. Selected financial information July 2, 2022 January 1, 2022 July 3, 2021 (In thousands) Current assets: Cash and cash equivalents $ 104,952 $ 85,203 $ 179 Receivables, less allowance for doubtful accounts 422,659 339,637 437,217 Inventories, net 577,648 488,458 425,714 $ 1,105,259 $ 913,298 $ 863,110 Current liabilities: Accounts payable $ 239,515 $ 180,000 $ 227,100 $ 239,515 $ 180,000 $ 227,100 Operating working capital $ 865,744 $ 733,298 $ 636,010 Operating working capital of $865.7 million as of July 2, 2022, compared to $733.3 million as of January 1, 2022, increased on a net basis by approximately $132.4 million. The increase in operating working capital is primarily driven by an increase in inventory, which continues to be affected by the inflationary environment for building materials, along with an increase in accounts receivable from our continued increase in net sales. The net increase in current assets was offset by an increase in accounts payable, also affected by the inflationary environment for building products. Operating working capital of $865.7 million as of July 2, 2022, compared to $636.0 million as of July 3, 2021, increased on a net basis by $229.7 million. The increase in operating working capital is primarily driven by an increase in inventory, which continues to be affected by the inflationary environment for building products, along with an increase in cash due to our improved operating performance, including increased net income, as well as a decrease in accounts receivable from our improved collection efforts. The net increase in current assets was offset by an increase in accounts payable, also affected by the inflationary environment for building products. 26 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. For the first six months of fiscal 2022, we invested $9.2 million in long-lived assets primarily related to investments in our distribution branches and to a lesser extent, upgrading our fleet, which includes $6.9 million in cash investments and $2.3 million in new finance leases recognized for tractors acquired as a component of our fleet investment plan. 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 1, 2022. 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; 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 1, 2022, 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: • we may experience pricing and product cost variability; • our earnings are highly dependent on volumes; • our industry is highly fragmented and competitive and if we are unable to compete effectively, our net sales and operating results may be reduced; • 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 our net income; • adverse housing market conditions may negatively impact our business, liquidity, and results of operations, and increase the credit risk from our customers; • consolidation among competitors, suppliers, and customers could negatively impact our business; • we are subject to disintermediation risk; • 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; • our strategy includes pursuing acquisitions, and we may be unsuccessful in making and integrating mergers, acquisitions and investments, and completing divestitures; • we may incur business disruptions resulting from a variety of possible causes; • we may be unable 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; • we are subject to information technology security risks and business interruption risks and may incur increasing costs in an effort to minimize and/or respond to those risks; 27 • our success depends on our ability to attract, train, and retain highly qualified associates and other key personnel while controlling related labor costs; • we are exposed 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; • our business operations could suffer significant losses from climate changes, natural disasters, catastrophes, fire, or other unexpected events; • our operating results depend on the successful implementation of our strategy and we may not be able to implement our strategic initiatives successfully, on a timely basis, or at all; • a significant percentage of our employees are unionized, and wage increases or work stoppages by our unionized employees may reduce our results of operations; • federal, state, local, and other regulations could impose substantial costs and restrictions on our operations that would reduce our net income; • 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; • the ongoing effect of the COVID-19 pandemic and other widespread public health crises may adversely affect our business and results from operations; • our vaccination policies and governmental regulations concerning mandatory COVID-19 vaccination of employees could have a material adverse impact on our business and results of operations; • our future operating results may fluctuate significantly, and our current operating results may not be a good indication of our future performance; • fluctuations in our quarterly financial results could affect our stock price 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; • the instruments 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; • 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; • despite our current levels of debt, we may still incur more debt, which would increase the risks described in these risk factors relating to indebtedness; • we have sold and leased back certain of our distribution centers under long-term non-cancelable leases, and we may enter into similar transactions in the future. All of these leases are (or will be) finance leases, and our debt and interest expense may increase as a result; • many of our distribution centers are leased, and if we close a leased distribution center before expiration of the lease, we will still be obligated under the applicable lease, and we may be unable to renew the leases at the end of their terms; • we may not have or be able to raise the funds necessary to finance a required repurchase of our senior secured notes; • constraints, volatility or disruptions in the capital markets or other factors affecting the amount and timing of share repurchases; • our ability to successfully execute the ASR; • the number of shares that will be delivered to the Company under the ASR; • whether or not the Company will continue, and the timing of, any open market repurchases; • a lowering or withdrawal of the ratings assigned to our debt securities by rating agencies may increase our future borrowing costs and reduce our access to capital; • a change in our product mix could adversely affect our results of operations; • if petroleum or energy prices increase, our results of operations could be adversely affected; • we establish insurance-related deductible/retention reserves based on historical loss development factors, which could lead to adjustments in the future based on actual development experience; • the value of our deferred tax assets could become impaired, which could materially and adversely affect our operating results; • our expected annual effective tax rate could be volatile and materially change as a result of changes in mix of earnings and other factors; • changes in actuarial assumptions for our pension plan could impact our financial results, and funding requirements are mandated by the Federal government; • costs and liabilities related to our participation in multi-employer pension plans could increase; • our cash flows and capital resources may be insufficient to make required payments on our indebtedness or future indebtedness; • 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; • the activities of activist stockholders could have a negative impact on our business and results of operations; 28 • the terms of our revolving credit facility and senior secured notes place restrictions on our ability to pay dividends on our common stock, so any returns to stockholders may be limited to the value of their stock; • changes in, or interpretation of, accounting principles could result in unfavorable accounting changes. 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. 29 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable.