Greetings, and welcome to the BlueLinx Holdings Second Quarter 2021 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Alexandra Lucas of Investor Relations. Thank you. You may begin.

Thank you. Welcome to BlueLinx Holdings second quarter 2021 results conference call. Leading the call today are our President and CEO, Dwight Gibson; and Chief Financial Officer, Kelly Janzen. The presentation we are sharing today is available on our website in the Webcast & Presentations section, and we encourage you to follow along accordingly. Today's discussion contains forward-looking statements about future business and financial expectations. Actual results may differ significantly from those projected in today's forward-looking statements due to various risks and uncertainties, including the risks described in our periodic reports filed with the SEC. Except as required by law, we undertake no obligation to update our forward-looking statements. We are using non-GAAP financial measures in our presentation. The appropriate GAAP financial reconciliations are incorporated into our presentation where available, which is posted on our website. All percentages in today's discussion refer to year-over-year progress, except where noted. At the conclusion of our prepared remarks, we will open the line for questions. With that, I would like to turn the call over to Dwight Gibson for his prepared remarks.

Thank you, Alexandra, and good morning. Before we review our record second quarter results, which by all accounts are a historic achievement for more than 2,100 team members. I want to say how excited I am to be part of the BlueLinx team. This is a great business with great people doing great work each and every day. Since joining BlueLinx as CEO 8 weeks ago, I've had the opportunity to visit with our employees at multiple sites across the country. I, along with members of my leadership team have visited 18 branches across 4 of our 5 regions. These locations represent roughly 45% of our total sales. During these visits, I was impressed by our associates' competitive spirit, their technical expertise, their deep relationships with suppliers and customers and their focused on building a best-in-class building products distribution business. BlueLinx is a national business that serves key national accounts in hundreds of local markets, each of which have their own unique challenges and opportunities. Our teams do an exceptional job understanding the local market dynamics, while leveraging our size and scale to provide an integrated, on demand product and solution suite. I've come across groups of people who show up every day and make it happen, people like Leroy, a material handler in Richmond, who has worked for the company for over 49 years. People like Diana, a territory manager who's new to BlueLinx and delivering great results and people like Nancy, a 20-plus year member for handcrafted panel production team in Aitkin, Minnesota will only allow product out of our facilities that she would be proud to put in her own home. We have a committed group of teammates who I'm now honored to lead. Let me be clear that although our runway is long, there are areas…

Thank you, Dwight. As Dwight mentioned, we reported another record quarter with net sales of $1.3 billion, an increase of $609 million when compared to the prior year period, reflecting broad-based sales growth across both our specialty and structural product lines. Gross margin increased by nearly 480 basis points on a year-over-year basis to 19.2%. This was a result of improved price realization overall and a more favorable specialty product sales mix. We reported net income of $113 million or $11.61 per diluted share versus $7 million or $0.71 per diluted share in the prior year period, and we reported adjusted EBITDA of $166 million in the second quarter, the most we've ever recorded in a quarterly period. This was an increase of $135 million versus the prior year period. We ended the quarter with cash on hand and excess availability under our ABL of approximately $276 million, an increase of $138 million over the prior year period. And earlier this week, we both amended and extended our $600 million ABL for another 5 years. We reduced our fees and interest costs in doing so, and we also obtained greater flexibility to acquire companies and make strategic investments. Within our specialty product line, total quarterly net sales increased by 50% on a year-over-year basis in the second quarter to $675 million, driven by continuing price escalations and an increase in volume, primarily attributable to growth in our engineered wood, industrial products and siding categories. Specialty gross margin expanded 710 basis points year-over-year and 510 basis points sequentially to 24.4%, fueled by elevated demand and supply-driven price increases. Our third quarter-to-date margin is in the 23% to 24% range. And given current market dynamics, where demand is continuing to outpace current supply in several specialty product categories, we expect that specialty…

Thanks, Kelly. Our Q2 performance is a testament to the outstanding efforts of our approximately 2,100 teammates and an illustration of the strong foundation of the business. We are focused on building a great culture that prioritizes our people and enables deep customer relationships, strengthening our market position in strategic product categories and deploying capital in ways that create shareholder value. I'm excited. The team is excited, and we look forward to doing great things together. Thank you.

That concludes our prepared remarks. Operator, please open the line for questions.

[Operator Instructions] Our first questions come from the line of Greg Palm with Craig-Hallum.

And Dwight, pretty impressive quarter. First 1 out of the gate. So welcome onboard again, and congrats again on the quarter. So I guess, a lot to unpack. And I wanted to start off talking about segment results a little bit. So I think what was kind of most surprising in terms of the forward-looking July comments were that structural margins quarter-to-date are in the high single-digit range, even with what's happened in lumber and panel markets recently. So thinking back historically, I know the company has been impacted more. So what's changed recently? And I guess, how have you been able to bypass some of the weakness that others are seeing in the market?

Sure, Greg. And a couple of reasons of how we're managing through this. One, we continue to reiterate that we have kept our inventory low. And I mentioned in the - you'll see in the details in the deck, that we had lower structural volume year-over-year as a result of that. But I think we believe that was definitely the right decision. And so when you have lower inventory, you have lower risk. And that's one - that's the main reason we've been able to do it. We also did go into the quarter with adjusting our lumber inventories a bit down to market pricing. And so that helps as well. And finally, we're holding the line on price, and we're making good decisions around how we how we execute, and we're focused on margin - we're focused on maintaining margin over sacrificing volume at lower prices.

Yes. Makes sense. In terms of specialty, I'm just curious how much of the growth was driven by volume versus price? And on the volume side, do you feel like you're gaining some share versus the market? And if that's the case, what do you attribute that to?

Yes. Well, most of it was price. I think we kind of - hopefully, we laid that out pretty well that the inflation we've seen. And really, it's price escalations that we've seen on the specialty side. We've had more price increases per week in the last few weeks than we've had sometimes in previous years. So - and we've used that as we've kind of worked through that, we've passed that along, and we've maintained price in a very supply-constrained environment. And that's really what's driving the bulk of the expansion. That being said, we definitely did have some volume increase overall, but we had more significant volume increase in key categories like engineered wood, in our siding, our industrial products are doing well. So I think those are definitely areas where we're seeing some market share gains here, especially year-over-year. And hopefully, we'll continue to see growth in those categories. And we'll talk about that further, but specialty is definitely area of focus for us, and I'm very encouraged by that.

Yes. One thing I'll add to that on the engineered wood side, in particular, the team has done a really good job making some investments in increasing our design services capabilities, which is really supportive of growth there and share gain. We're fast to respond to customers' needs. We can provide more services to help them in terms of how they apply and use the products. So things like that are really supportive of, hopefully, us driving share, particularly as supply constraints abate a bit.

Interesting. And Kelly, to be clear, did you say that even in recent weeks? And so even quarter-to-date, you've taken a number of price increases further versus what you saw in Q2?

We are continuing to experience some price increases, and we'll actually expect to get a few - to continue that further into the rest of the year.

And then just moving on, you talked about this $130 million inflationary investment in working capital. Does that completely reverse in the second half? I mean I know you mentioned significant free cash flow potential. Just wanted to get some sense around maybe the magnitude relative to the level of free cash flow you generated in Q2.

Yes. Well, we certainly are going to see some significant cash coming in, in the second half as it relates to deflation, but that number relates to our total working capital. And the deflation is primarily on the commodity side. So it's not going to be the full amount of what's in there. However, when you couple that with strong business and good earnings as a whole, especially as we're seeing that strength in our specialty business, the cash could be significant.

Yes. Okay. And then I guess last one, sort of thinking ahead, how do you think about normalized net leverage? And just in terms of updating all of us on capital allocation, I think you alluded, Dwight, maybe a few items that you're thinking about. But in light of this expected free cash flow generation and just a complete transformation of the balance sheet, should we assume that M&A becomes maybe a bigger focus for you? Or is it sort of too early to tell?

Yes. So it's great to be in a position where we have some flexibility and choice. We're always going to make sure that we deploy capital smartly and thoughtfully in a way that creates value. Still early days. So I'll defer on kind of sharing my long-term capital allocation strategy. But the thing I'll tell you is, as I've mentioned before, there's ample opportunities for us to invest in this business organically to drive growth, particularly as it relates to delivering best-in-class customer service. I think there's some opportunities there as we look at our branches, as we look at our technologies, we look at our equipment. So we're going to deploy capital there. And we do believe this is a environment that's conducive to the right kinds of M&A, right? But it's got to be things that are complementary that allow us to service our customers better, provides deeper strength in our specialty categories and move the business forward. So excited about working with the team to really bottom that out. But really feel good about the direction we're heading in.

Yes. And then just to add on to how that translates into a net leverage ratio. Obviously, it's very low right now, given the TTM numbers. We believe in a normalized environment, our goal would be to stay around 3%. It could be a little higher if we do for a period of time, if we do particular deals or lower depending on the cycle. But that - it's in that range, Greg, is what we would say is reasonable for us.

Our next question is come from the line of Reuben Garner with Benchmark Company.

Maybe - so just a preface to my comments here. I missed the better part of Greg's questions, I got kicked off, so if I'm repetitive, apologies in advance. But just to start on the structural margin performance, can you maybe go into more detail with what you're seeing there? What specific products that you're selling? Is the supply demand dynamic still favorable? Is it all engineered wood products or predominantly that? Or are there other drivers? And then what, I guess, would - what scenario would lead this margin level to not be sustainable? Is it more capacity coming online? Would it require demand rolling over? What - just talk to us about sort of what you're seeing exactly and how sustainable it is?

Yes, sure, Reuben. Just a quick clarifying question. Are you referring to specialty margins?

Specialty, yes. Yes.

Okay. Yes. So specialty margins. Clearly, we've given the supply constraints, primary driver of pricing increases and continued demand have really expanded way beyond what we've seen historically. And as I mentioned in some of my comments earlier that we certainly have seen growth in areas like engineered wood, industrial products, siding and others. We're also very cognizant that there are certain things out there in the market that could make that not totally sustainable, such as we're starting to see some resin impact on some of the inputs that go into specialty products. You have specialty lumber that has some commodity impact that comes in there eventually. We also know that supply could be less constrained over time. So those factors would probably - or why we mentioned that it could reverse to some extent. The timing is a little bit unknown. But we did say we believe that generally, specialty margins would be elevated over the next few months. And I would say that, that's something north of what we experienced in certain - in Q4, Q1 time frame.

And I guess the confusion maybe for me is, typically, distributors, like you mentioned resin costs going up in some of the products. I mean, is it private label products that you sell that leads to maybe your margins being a little bit more volatile there and gives you upside in periods like this? Or is there something else to think about as to why you're - I know in the past, you talked about pricing discipline and that sort of thing. I'm just wondering if there's anything about your model relative to maybe other distributors that leads you to get more margin in this environment?

As it relates to inputs, I think we're all experienced just the same thing that really that drives just constraint. If there's [less rise] in supply issues, then you just ultimately have constrained products, and that leads to the demand supply imbalance. And then after that, I think it's pricing strategy. And I do believe that we've been able to demonstrate that we do a good job on leveraging the market dynamics to bring good pricing to the business, and we've continued to improve and hone that quarter-over-quarter.

Yes. And the other thing I'll add to Kelly's point is that having had the opportunity to kind of go out and spend some time with the team, we can't underestimate the value of the relationships we have with our customers in our local markets and also with our national accounts, right? So we really work hard to truly understand what their needs are and make sure we design and deliver a solution that addresses those needs and create value for both parties. So all those things in combination with the great work the team has done around kind of pricing strategy, pricing discipline, which I still think has opportunity for us that's contributing to this performance.

Perfect. And then on the structural side, the - I think I saw the write-down in the Q. Can you just talk to me about how that flows through to profits was the high single-digit gross margin that you had in July for structural, did that include the impacts of that write down? How does that work? How do we think about that as the quarter progresses?

Yes, that's right. So we looked at the lumber inventory at the end of June, and we adjusted it down to market. And then when you sell that through, which you - our DSIs are relatively low, as we mentioned in some of our materials that bring - that comes back into the quarter as you sell the inventory in. So those high single-digits does include some impact of the fact that we went into the quarter with market pricing.

Got it. Okay. All right. Congrats on the strong results. Dwight, you've set a high bar out of the gates here, so good luck going forward.

I appreciate that. Thank you. Team deserves all the credit.

Our next question is come from the line of Jeffrey Stevenson with Loop Capital.

So my first question is how we should think about structural volumes and inventories as we look out later this year into 2022. So you guys have done a good job managing inventories at the expense of volumes at times to reduce your wood commodity risk. But with lumber prices where they are now, does it give you more flexibility to bring inventories closer to normalized levels and focus on volume growth?

Yes. That's a really good question, Jeff. I think our view right now is that we want to maintain the current approach, especially for the next quarter or two. As we wait and see and make sure those lumber prices have truly stabilized, yes, they're closer to historical averages, but it has been very volatile. And then we have a number of market conditions in play. So we really believe that the current approach is still the right approach. And so I do expect that you could - we would still probably have volumes lower year-over-year to the similar extent that we've seen the last quarter or 2. Is that if - I think that just makes the most sense right now.

Yes. Right, right. That makes sense. When we touched on structural margins moving forward a couple of times. But just that kind of high single-digit rate that you saw in July, I mean, is that a good run rate through the back half of the year? Is there anything else that we should consider?

Yes. So in my - in some of my comments earlier, I did mention that we're still waiting for further deflation on the panel pricing side, and that certainly could impact us probably imminently in the next month or so. That start - that's been coming down over the last few weeks. And we don't know after that. But we do believe that for the rest of the year, unless there was a big change in pricing, we would expect to return to more normalized margins, which in the structural side is between 8% to 9%. It's just a matter of what's the timing of when we would return to that. But our DSIs are fairly quick on the structural side. So hopefully, that would be relatively soon.

Okay. That's helpful. And then can you provide an update on how product shortages and project timing delays have progressed this summer? Has that improved at all?

Yes. Jeff, unfortunately, not too much, right? We're still seeing challenges on the supply side, particularly across the specialty portfolio. A lot of the same things that were creating constraints are continuing to hold access to labor, transportation challenges and the like. So we suspect that, that will be the norm through the second half this year. And hopefully, as things settle out and more capacity comes online, we see some improvement as we move into 2022.

Okay. Great Dwight. And then just on the recent acceleration and housing starts. Just any thoughts on how that could impact demand as we move forward through the back half of the year into 2022? And just kind of what your expectations are for new housing here moving forward?

Yes. So if you take a step back and you look at new housing starts, we're still at a much higher level than we have been over the past decade or so. We've been under 1 million new single-family home starts since 2008. We kind of cracked that level in 2020. And now we're looking at around 1.2 million expected for 2021. I expect that to stay at roughly that level, at least for the next year or so. There's clearly not enough new housing stock given the demand. Mortgage rates are still at historical lows, unemployment heading in the right direction. Some of the data I saw recently in home mortgage and forbearance has come down fairly dramatically. So I think the overall environment is still supportive of new home construction. That being said, the 3-iles, as I like to call them, lumber, land and labor are still creating some tightness there. And that has to work through, but we still feel fairly optimistic about the new home construction environment in the near to medium term.

Okay. Great. No, that's helpful. And then last one, and Dwight I know it's early, so if you can't comment on all the specifics, no worries. But just on the M&A, I know the focus moving forward will be on growing specialty, but any more kind of details on kind of what the focus will be, whether it be kind of bolt-on, any specific geographies you're looking at, I know Western U.S., you have a lot of white space and kind of focus on valuation, those types of information would be helpful.

Yes, sure. So like you said, still early days, but we're going to look at opportunities that make sense for a business that are complementary to what we do. Obviously, things that allow us to be stronger in the specialty side will be interesting. Things that allow us to be closer to some of our core customers in places that we don't have great footprint would also be interesting, and we're going to be prudent users of capital, right? I spent a fair amount of my career in the M&A space and recognize the importance of making good choices and decisions there, and we'll definitely apply that to our thinking here. We are going to look to build out our team on the M&A side. So we're doing that. We have a search in the market as we speak to bring some talent in, but we want to make sure that's thoughtful and part of our overall balanced approach.

There are no further questions at this time. With that, we do thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time. Have a great day.