Objective
The following discussion of our financial condition, results of operations and
statistical disclosures is intended to supplement the data provided elsewhere in
this Form 10-K. Management's discussion and analysis examines our operating
results with supplemental data, metrics and market considerations utilized by
Company management to evaluate results and make operating decisions. This
discussion is intended to enhance the reader's understanding of the context in
which our operational results were achieved, the quality and variability of
earnings and cash flow, and to support conclusions regarding the likelihood that
past performance could be replicated in the future. This discussion is qualified
in its entirety by reference to the statements under the caption "Cautionary
Statement Relevant to Forward-Looking Information for the Purpose of "Safe
Harbor" Provisions of the Private Securities Litigation Reform Act of 1995" set
forth earlier in this Form 10-K.
Overview
We are a distributor of building materials used principally in new residential
construction and in home improvement, remodeling and repair work. We distribute
our products through 25 distribution centers serving 41 states and sell
primarily to building materials dealers, national buying groups, home centers
and industrial users, including makers of manufactured homes. Our products fall
into three categories: (i) millwork, which includes doors, windows, moulding,
stair parts and columns, (ii) general building products, which includes
connectors, fasteners, composite decking, housewrap, roofing products and
insulation, and (iii) wood products, which includes engineered wood products,
such as floor systems, as well as wood panels and lumber.
Industry Conditions
Our sales depend heavily on the strength of local and national new residential
construction, home improvement and remodeling markets. New housing activity has
shown improvement each year since 2009, the trough period of the downturn. In
2021, total housing starts increased approximately 16%, to 1.6 million, crossing
the Historical Average. Based on the current level of housing activity, interest
rates and industry forecasts, we expect new housing activity in 2022 to be
comparable with 2021, but we cannot be certain.
Various factors have historically caused our results of operations to fluctuate
from period to period. These factors include levels of construction, home
improvement and remodeling activity, weather, prices of commodity wood and steel
products, interest rates, competitive pressures, availability of credit and
other local, regional, national economic and political conditions, and most
recently the impact of a pandemic. Many of these factors are cyclical or
seasonal in nature. We anticipate that further fluctuations in operating results
between reporting periods will continue in the future. Our first and fourth
quarters are generally adversely affected by winter weather patterns in the
Northwest, Midwest and Northeast regions of the United States, which typically
cause seasonal decreases in construction activity in these areas. Because much
of our overhead and expenses remain relatively fixed throughout the year, our
operating profits tend to be lower during the first and fourth quarters.
We believe we have the product offerings, distribution channel, personnel,
systems infrastructure, financial, and competitive resources necessary for
continued operations. Our future revenues, costs and profitability, however, are
all likely to be influenced by a number of risks and uncertainties, including
those set forth in Part I, Item 1A-"Risk Factors."
Critical Accounting Policies
We prepare our consolidated financial statements in accordance with
U.S. generally accepted accounting principles, which require management to make
estimates and assumptions. Management bases these estimates and assumptions on
historical results and known trends as well as management forecasts. Actual
results could differ from these estimates and assumptions.
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Inventory-Inventories are valued at the lower of cost or market. We utilize the
last-in, first-out ("LIFO") cost method to value the majority of our
inventories. We review inventories on hand and record a provision for
slow-moving and obsolete inventory based on historical and expected sales.
Contingencies-We accrue expenses when it is probable that an asset has been
impaired or a liability has been incurred and we can reasonably estimate the
expense. Contingencies for which we have made accruals include environmental and
certain other legal matters. It is possible that future results of operations
for any particular quarter or annual period and our financial condition could be
materially affected by changes in assumptions or other circumstances related to
these matters. We accrue an estimate of the cost of resolution of these matters
and make adjustments to the amounts accrued as circumstances change. We expense
legal costs as incurred.
Income Taxes- Deferred tax assets ("DTAs") and liabilities are recognized for
the future tax benefits or liabilities attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates would be
recognized in income in the period that includes the enactment date. We
regularly review our deferred tax assets for recoverability and establish a
valuation allowance when we believe that such assets may not be recovered,
taking into consideration historical operating results, expectations of future
earnings, changes in operations, the expected timing of the reversal of existing
temporary differences and available tax planning strategies. As of December 31,
2021, we carry a valuation allowance for substantially all of our deferred state
tax assets, net.
Currently, we have $24.9 million of DTAs, of which $6.6 million is related to
state net operating loss carry-forwards that can be used to offset taxable
income in future periods and reduce our income taxes payable in those future
periods. The state tax loss carryforwards will begin expiring in 2022. We
maintain a $6.0 million deferred tax asset valuation allowance for state net
operating losses ("NOLs") that are more likely than not to expire before
utilization. The deferred tax valuation allowance is assessed each reporting
period and the amount of net deferred tax assets considered realizable could be
adjusted in future periods based on the Company's financial performance. Our
federal tax loss carryforwards of $41.4 million were fully utilized in 2021. The
state net operating loss carryforwards remain available to offset future taxable
income. Although we believe our estimates to be reasonable, differences in our
future operating results from these projections could significantly change our
estimates of and realization of these deferred tax assets in future periods.
We operate within multiple taxing jurisdictions and are subject to audit in
these jurisdictions. These audits can involve complex issues, which may require
an extended period of time to resolve. We regularly review our potential tax
liabilities for tax years subject to audit. Changes in our tax liability may
occur in the future as our assessment changes based on the progress of tax
examinations in various jurisdictions and/or changes in tax regulations. In
management's opinion, adequate provisions for income taxes have been made for
all years presented.
Results of Operations
This section discusses our results of operations for the year ended December 31,
2021 as compared to the year ended December 31, 2020. For a discussion and
analysis of the year ended December 31, 2020, compared to the same period in
2019 refer to Management's Discussion and Analysis of Financial Condition and
Results of Operations included in Part II, Item 7 of our Annual Report on Form
10-K for the year ended December 31, 2020, filed with the SEC on March 2, 2021.
Continuing Operations
Net sales were $937.8 million in 2021, an increase of $145.5 million, or
approximately 18.4%, compared to $792.3 million in 2020. Net sales in 2020 were
significantly affected by the onset of the pandemic. Our net sales growth in the
fourth quarter of 2021 was 24.8%, representing strong growth as compared to a
growth rate of 16.4% for the nine months ending September 30, 2021. Our 2021
sales growth, although moderated by restructuring activities announced in the
second quarter of 2020 and by our 2020 product rationalization activities, was
driven by an improved residential construction market, a favorable pricing
environment, including elevated levels of inflation, and by growth in certain
strategic product categories. The inflationary environment was elevated by
demand-driven pricing with
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higher input costs throughout the channel, including labor and materials, and is
reflective of the challenges within the supply chain and labor markets
experienced throughout much of 2021.
Net sales in our major product categories changed as follows in 2021 from 2020:
millwork sales increased 15.5% to $412.2 million, building product sales
increased 18.2% to $447.9 million, and wood products increased 38.0% to
$77.7 million. Millwork sales, although most impacted by the disruption in our
supply chain and by our 2020 restructuring and product rationalization
activities, performed well and benefited from improved demand and market
pricing. Demand for our value-added millwork products exceeded supply, creating
an input-constrained ability to produce. Building products sales increased due
to consistent high levels of demand for certain product lines within the
category, including certain strategic product lines such as Huttig Grip
fasteners; however, sales growth in this category was also affected by supply
chain disruption, and by product rationalization activities related to our
objective of focusing on higher-margin, non-commoditized products. Wood product
sales benefited from higher market prices on a year-over-year basis.
Gross margin increased $48.6 million, or 30.5%, to $208.0 million in 2021 as
compared to $159.4 million in 2020. Gross margin as a percentage of net sales
increased to 22.2% in 2021 compared to 20.1% in 2020. Gross margins were
favorably impacted by our continued focus on non-commoditized, strategic product
lines which carry higher margins, as well as effective pricing management. We
also benefited from increased purchasing incentives in 2021. The increase in our
gross margin percentage from these actions more than offset the impact from a
disproportionate increase in lower-margin direct sales in 2021 compared to 2020.
We use the last-in, first-out (LIFO) inventory valuation method to value
inventories. In 2021, this resulted in gross margins that were $18.3 million
lower, representing 2.0% of net sales, than if the first-in, first-out (FIFO)
inventory valuation method had been used. In 2020, the LIFO inventory valuation
method reduced gross margins by $2.4 million, representing 0.3% of net sales.
For the previous ten years, on an annual basis, the LIFO inventory valuation
method resulted in an average reduction in gross margins of approximately 0.2%
of net sales as compared to the FIFO inventory valuation method. The significant
impact in 2021 as compared to historical levels reflects pricing inflation
within certain product lines as well as higher inventory levels to support
increased demand compared to 2020.
Operating expenses, increased $10.2 million, or 7.0%, to $155.8 million, or
16.6% of net sales, in 2021, compared to $145.6 million, or 18.4% of net sales,
in 2020. Personnel expenses increased $10.4 million, reflecting increased
variable incentive compensation from improved operating results, wage increases
and reinstatement of compensation and other cost reductions taken in 2020 as a
result of the pandemic. These increases were partially offset by lower medical
costs and a $1.5 million Cares Act Employee Retention Tax Credit. Non-personnel
expenses decreased $0.2 million in 2021, primarily benefitting from a $2.1
million class action settlement received during the fourth quarter related to
interior doors, as well as an improved bad debt provision, mostly offset by
higher fuel, insurance and tax costs. Overall, our cost structure was levered
against higher sales volume.
Operating income in 2020 includes a restructuring charge of $1.5 million and
goodwill impairment charge of $9.5 million. There were no charges recorded for
these items in 2021.
Net interest expense was $2.5 million in 2021 compared to $3.6 million in 2020.
The lower interest expense in 2021 reflected both lower average outstanding
borrowings and lower interest rates.
We recognized income tax expense from continuing operations of $2.2 million for
the year ended December 31, 2021 compared to income tax expense of $0.1 million
for the year ended December 31, 2020. Income tax expense was mitigated in 2021
by utilization of $41.4 million of federal tax loss carryforwards. See Note 13 -
"Income Taxes" of the Notes to Consolidated Financial Statements in Part II,
Item 8 for more information.
As a result of the foregoing factors, we reported net income from continuing
operations of $49.1 million in 2021 as compared to a net loss of $0.9 million in
2020.
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Discontinued Operations
We recorded a $0.6 million after-tax loss from discontinued operations in 2021,
due to an increase in the estimated costs of environmental obligations,
primarily related to a site of a former operation. See Note 10 - "Commitments
and Contingencies" of the Notes to Consolidated Financial Statements in Part II,
Item 8 for more information regarding the environmental liability. See Note
16-"Discontinued Operations" of the Notes to the Consolidated Financial
Statements in Part II, Item 8 for more information regarding discontinued
operations.
Stockholder Rights Plan
On May 18, 2016, the Board entered into a rights agreement (the "Rights
Agreement") with ComputerShare Trust Company, N.A. and declared a dividend of
one preferred share purchase right (a "Right") for each outstanding share of
common stock, $0.01 par value per share, of the Company. The dividend was paid
at close of business on May 31, 2016 to the stockholders of record on that
date. The Board adopted the Rights Agreement to protect stockholder value by
protecting the Company's ability to capture the value of its net operating
losses used to reduce potential future federal income tax obligations. The
Rights Agreement was approved by the Company's stockholders at the 2017 annual
meeting of stockholders. On May 6, 2019 the Board approved and we entered into a
First Amendment to Rights Agreement between the Company and ComputerShare Trust
Company, N.A., as rights agent. The amendment, among other things, (i) extended
the final expiration date (as defined in the Rights Agreement) from May 18, 2019
to May 18, 2022; (ii) changed the initial purchase price (as defined in the
Rights Agreement) from $13.86 to $13.39; and (iii) increased the period pursuant
to which the Board has to consider an exemption request (as defined in the
Rights Agreement) from ten business days to 20 business days. The Rights
Agreement will expire on the earliest of (i) May 18, 2022, (ii) the time at
which the Rights are redeemed or exchanged, as provided for in the Rights
Agreement, (iii) the repeal of Section 382 of the Internal Revenue Code of 1986,
as amended, if the Board determines that the Rights Agreement is no longer
necessary for the preservation of the Company's NOLs, and (iv) the beginning of
a taxable year of the Company to which the Board determines that no NOLs may be
carried forward. We adopted the Rights Agreement to protect stockholder value by
attempting to diminish the risk that our ability to use our NOLs to reduce
potential future federal income tax obligations may become substantially
limited.
See Note 15 - "Rights Agreement" of the Notes to Consolidated Financial
Statements in Part II, Item 8 for more information regarding the Rights
Agreement.
Liquidity and Capital Resources
We depend on cash flow from operations and funds available under our revolving
credit facility to finance seasonal working capital needs, capital expenditures,
additional investment in our product lines, and any acquisitions that we may
undertake. Typically, our working capital requirements are greatest in the
second and third quarters, reflecting the seasonal nature of our business. The
second and third quarters also tend to be our strongest operating quarters,
largely due to more favorable weather throughout many of our markets compared to
the first and fourth quarters. We typically generate cash from working capital
reductions in the fourth quarter of the year and build working capital during
the first quarter in preparation for our second and third quarters. We also
maintain significant inventories to meet the rapid delivery requirements of our
customers and to enable us to obtain favorable pricing, delivery and service
terms with our suppliers. As part of our COVID-19 readiness and response plan,
we significantly reduced our inventory levels in 2020. During 2021, cost
management and focus on strategic products enabled us to continue generating
cash and reducing debt, even as working capital, defined as accounts receivable,
inventories, and net of accounts payable, increased $29.1 million in 2021.
As a percentage of total current assets, inventories were 54% and 57% and
accounts receivable were 37% and 37%, each respectively at December 31, 2021 and
2020. We closely monitor operating expenses and inventory levels during
seasonally affected periods and, to the extent possible, manage variable
operating costs to minimize seasonal effects on our profitability.
Borrowings under our credit agreement are collateralized by substantially all of
our assets, including accounts receivable, inventory, real estate and equipment.
We are also subject to certain operating limitations commonly applicable to a
loan of this type, which, among other things, place limitations on indebtedness,
liens, investments, mergers and acquisitions, dispositions of assets, cash
dividends, stock repurchases and transactions with affiliates. A
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minimum fixed charge coverage ratio (FCCR) must be tested on a pro forma basis
prior to consummation of certain significant business transactions outside the
ordinary course of our business.
Our existing asset-based senior secured revolving credit facility with JPMorgan
Chase provides a maximum of $250 million of borrowing capacity and matures on
September 29, 2026.
Operations-Cash provided by operating activities was $27.5 million in 2021 as
compared to cash provided by operations of $42.6 million in 2020. Net income was
$48.5 million in 2021 and net loss was $0.9 million in 2020. Operating cash flow
benefitted primarily from improved profitability as we began to capture benefits
from our strategic initiatives and strategic rationalization of product lines,
as well as favorable management of working capital. Cash used for operating
leases was $12.1 million in 2021 compared to $12.7 million in 2020. Our
inventories increased $23.1 million in 2021 compared to a decrease of $33.7
million in 2020. The inventory reduction in 2020 resulted from execution of our
COVID-19 readiness and response plan, enacted in anticipation of COVID-related
sales declines, and from restructuring activities and rationalization of
non-strategic product lines. Cash used in discontinued operations related to the
formerly owned property in Montana was $0.8 million and $0.2 million in 2021 and
2020, respectively. Cash used for discontinued operations increased in 2021 due
to a resumption of site work after a pause during the COVID-19 pandemic in 2020.
Investing-Net cash provided by investing activities was $0.4 million in 2021, as
compared to cash used in investing activities of $1.5 million in 2020. In 2021
and 2020, we invested $1.3 million and $1.7 million, respectively, in property
and equipment at various locations. In 2021 and 2020, we received $1.7 million
and $0.2 million, respectively, from the sale of capital assets. The cash
received in 2021 was primarily from the sale of our former Selkirk property,
which we closed in 2020.
Financing-Cash used in financing activities was $24.9 million in 2021 compared
to $43.0 million in 2020. In 2021, the activity reflected net repayments of
$22.7 million under our credit facility and net repayments of $1.9 million for
other debt obligations and $0.3 million for the net settlement of withholding
taxes on stock-based awards. In 2020, we recorded net repayments of
$41.5 million under our credit facility and net repayment of $1.5 million for
other debt obligations. Cash used to repay debt in 2021 was primarily sourced
from operational performance, and in 2020 was primarily sourced from operational
performance and a reduction of working capital requirements.
While we believe that our cash on hand, borrowing capacity available under our
credit facility, and cash flows from operations for the next twelve months will
be sufficient to service our liquidity needs, we cannot predict whether future
developments associated with the COVID-19 pandemic will materially adversely
affect our liquidity position. Our liquidity assumptions and our ability to meet
our credit facility covenants are dependent on many additional factors,
including the "Risk Factors" in Part I, Item 1A in this Annual Report on Form
10-K.
In 2021, the fixed charge coverage ratio (FCCR) was not required to be tested as
excess borrowing availability was greater than the minimum threshold. Though not
required to be tested, we did meet the ratio at December 31, 2021. If we are
unable to maintain excess borrowing availability of more than the applicable
amount in the range of $15.0 million to $25.0 million and we do not meet the
minimum FCCR, the lenders may, at their option, terminate the loan commitments
and accelerate repayment of the entire amount outstanding under the senior
credit facility. The lenders could also foreclose on our assets securing the
credit facility. If the credit facility is terminated, we would be forced to
seek alternative sources of financing, which may not be available on terms
acceptable to us, or at all.
Credit Facility-See Note 7 - "Debt" in the Notes to Consolidated Financial
Statements in Part II, Item 8 for information on our credit facility.
Goodwill Analysis
We have reviewed goodwill annually for impairment, or more frequently if Company
or market conditions indicated reporting units may be at risk of impairment. Our
last review was performed as of March 31, 2020 following a broad market selloff
over concerns of the impact of COVID-19 on macroeconomic conditions; our market
capitalization had declined below the carrying value of equity. Therefore, we
reassessed the implied value of our reporting units relative to their net book
value. As a result of our interim goodwill impairment test, we recognized a
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goodwill impairment charge of $9.5 million in the first quarter of 2020. We have
no remaining goodwill on our balance sheet.
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