HAWKINS INC 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion and analysis of our financial condition and results of operations for the three months ended June 28, 2020 as compared to the similar period ended June 30, 2019. This discussion should be read in conjunction with the condensed consolidated financial statements and notes to condensed consolidated financial statements included in this quarterly report on Form 10-Q and Item 8 of our Annual Report on Form 10-K for the fiscal year ended March 29, 2020 . Overview We derive substantially all of our revenues from the sale of chemicals and specialty ingredients to our customers in a wide variety of industries. We began our operations primarily as a distributor of bulk chemicals with a strong customer focus. Over the years, we have maintained the strong customer focus and have expanded our business by increasing our sales of value-added chemicals and specialty ingredients, including manufacturing, blending, and repackaging certain products. Statement on COVID-19 The pandemic caused by COVID-19 has resulted in federal, state and local governments around the world implementing stringent measures to help control the spread of the virus, including quarantines, “shelter in place” and “stay at home” orders, travel restrictions or bans, business curtailments, school closures, and other protective measures. While some areas of the country have begun to open up and ease these restrictions, many still have these restrictions in place or are implementing or contemplating new restrictions. Restrictions will likely remain in place for some time. Financial markets have been volatile in 2020, primarily due to uncertainty with respect to the severity and duration of the pandemic . All of our manufacturing facilities qualify as essential operations (or the equivalent) under applicable federal and state orders. As a result, all of our manufacturing sites and facilities have continued to operate and are doing so safely, with no significant impact to output levels. We are enforcing social distancing and enhanced health, safety and sanitization measures in accordance with guidelines from the Center for Disease Control. We have also implemented necessary procedures and support to enable a significant portion of our office personnel to work remotely. During this public health crisis, we remain focused on the health and safety of our employees, customers and suppliers and maintaining safe and reliable operations of our manufacturing sites. As our operations and products are essential to critical national infrastructure, it is imperative that we continue to supply materials including the products needed to maintain safe drinking water, ingredients essential for large-scale food, pharmaceutical and other health product manufacturing and nutrition products needed to support our critical infrastructure. Our manufacturing sites have continued to operate during the COVID-19 pandemic, with no significant impact to manufacturing. We ended the first quarter of fiscal 2021 with a leverage ratio below 1.0x, net debt of $61.5 million and significant amounts available for borrowing under our Revolving Loan Facility. The COVID-19 pandemic has created tremendous uncertainty in the economy. The financial impact to our company has been mixed, as sales to certain end-markets such as food, bottled bleach and health and nutrition have benefited our reporting segments, while decreased sales to other end-markets such as ethanol, pools and resorts have negatively impacted them. As uncertainty continues with this pandemic, we expect mixed results to continue for the foreseeable future. We will continue to be cautious in our capital expenditures and investments, and delay investments where deemed appropriate, while still investing for the future by opening new Water Treatment branches and making capital investments to drive higher margin business. With our current debt levels and available borrowings, we believe we are well-positioned to weather a continued economic downturn. Financial Results We focus on total profitability dollars when evaluating our financial results as opposed to profitability as a percentage of sales, as sales dollars tend to fluctuate, particularly in our Industrial and Water Treatment segments, as raw material costs rise and fall. The costs for certain of our raw materials can rise or fall rapidly, causing fluctuations in gross profit as a percentage of sales. We use the LIFO method for valuing the majority of our inventory in our Industrial and Water Treatment segments, which causes the most recent product costs for those products to be recognized in our income statement. The valuation of LIFO inventory for interim periods is based on our estimates of fiscal year-end inventory levels and costs. The LIFO inventory valuation method and the resulting cost of sales are consistent with our business practices of pricing to current chemical raw material prices. Inventories in the Health and Nutrition segment are valued using the FIFO method. 13 We disclose the sales of our bulk commodity products as a percentage of total sales dollars for our Industrial and Water Treatment segments. Our definition of bulk commodity products includes products that we do not modify in any way, but receive, store, and ship from our facilities, or direct ship to our customers in large quantities. Results of Operations The following table sets forth the percentage relationship of certain items to sales for the period indicated: Three Months Ended June 28, 2020 June 30, 2019 Sales 100.0 % 100.0 % Cost of sales (78.4) % (80.5) % Gross profit 21.6 % 19.5 % Selling, general and administrative expenses (10.5) % (10.1) % Operating income 11.1 % 9.4 % Interest expense, net (0.3) % (0.5) % Other income 0.3 % 0.1 % Income before income taxes 11.1 % 9.0 % Income tax expense (3.0) % (2.4) % Net income 8.1 % 6.6 % Three Months Ended June 28, 2020 Compared to Three Months Ended June 30, 2019 Sales Sales were $143.2 million for the current quarter, a decrease of $4.1 million, or 2.8%, from sales of $147.3 million for the same period a year ago. Industrial Segment. Industrial segment sales decreased $3.8 million, or 5.1%, to $71.5 million for the current quarter, as compared to $75.3 million for the same period of the prior year. Sales of bulk commodity products in the Industrial segment were approximately 12% of sales dollars in the current quarter and 20% in the same period of the prior year. The decrease in sales dollars from the prior year was driven primarily by a temporary increase in sales in the first quarter last year attributable to heavy rains and flooding along the Mississippi River, which increased demand from certain customers in that quarter. Sales also decreased in the current quarter as a result of weak economic conditions in the ethanol industry, which decreased sales of products into that industry. The decrease was somewhat offset by increased sales of certain of our manufactured, blended and re-packaged products, largely our bottled bleach products as a result of increased demand due to COVID-19, as well as increased sales of certain pharmaceutical, food ingredients and agricultural products. Water Treatment Segment. Water Treatment segment sales decreased $3.6 million, or 8.2%, to $39.7 million for the current quarter, as compared to $43.3 million for the same period of the prior year. Sales of bulk commodity products in the Water Treatment segment were approximately 10% of sales dollars for the current quarter and 11% a year ago. The decrease in sales dollars was driven by decreased volumes sold in the current quarter due, in part, to customers filling up their tanks in March as a result of supply concerns resulting from COVID-19, which decreased their needs in the current quarter, as well as reduced sales to certain end-markets as a result of COVID-19. Health & Nutrition Segment. Sales for our Health and Nutrition segment increased $3.2 million, or 11.1%, to $32.0 million for the current quarter, as compared to $28.8 million for the same period of the prior year. The increase in sales was driven by increased sales of both our manufactured and specialty distributed products, partially as a result of increased demand resulting from COVID-19. Gross Profit Gross profit increased $2.2 million to $31.0 million, or 21.6% of sales, for the current quarter, from $28.8 million, or 19.5% of sales, for the same period of the prior year. During the current and prior year quarters, the LIFO reserve had a nominal impact on gross profit. Industrial Segment. Gross profit for the Industrial segment increased $1.6 million to $12.5 million, or 17.4% of sales, for the current quarter, from $10.9 million, or 14.5% of sales, for the same period of the prior year. During the current and prior year 14 quarters, the LIFO reserve had a nominal impact on gross profit. Industrial segment gross profit increased due to a favorable product mix shift to more sales of our manufactured, blended and re-packaged products. Water Treatment Segment. Gross profit for the Water Treatment segment decreased $0.8 million to $11.3 million, or 28.6% of sales, for the current quarter, from $12.1 million, or 28.0% of sales, for the same period of the prior year. During the current and prior year quarters, the LIFO reserve had a nominal impact on gross profit. Gross profit decreased as a result of decreased sales. Health and Nutrition Segment . Gross profit for our Health and Nutrition segment increased $1.4 million to $7.2 million, or 22.5% of sales, for the current quarter, from $5.8 million, or 20.1% of sales, for the same period of the prior year. The increase in gross profit was a result of higher sales compared to the prior year. Selling, General and Administrative Expenses Selling, general and administrative (“SG&A”) expenses increased $0.2 million to $15.0 million, or 10.5% of sales, for the current quarter, compared to $14.8 million, or 10.1% of sales, for the same period of the prior year. The increase includes a year-over-year increase in compensation expense of $0.4 million related to our non-qualified deferred compensation plan, which is offset by other income. Operating Income Operating income increased $1.9 million to $15.9 million, or 11.1% of sales, for the current quarter, from $14.0 million, or 9.4% of sales, for the same period of the prior year due to the combined impact of the factors discussed above. Interest Expense, Net Interest expense decreased $0.4 million to $0.4 million for the current quarter, from $0.8 million for the same period of the prior year. Interest expense decreased due to lower outstanding borrowings and lower borrowing rates compared to the prior year. Other Income Other income increased $0.4 million to $0.5 million recorded for the current quarter, compared to $0.1 million in the same period of the prior year. This represents gains recorded on investments held for our non-qualified deferred compensation plan. The amount recorded as a gain was offset by the same amount recorded as an increase to compensation expense within SG&A expenses. Income Tax Provision Our effective income tax rate was 26.5% for the current quarter, compared to 26.3% in the same period of the prior year. The effective tax rate is impacted by projected levels of annual taxable income, permanent items, and state taxes. Liquidity and Capital Resources Cash was $4.5 million at June 28, 2020, an increase of $0.2 million as compared with the $4.3 million available as of March 29, 2020. Cash provided by operating activities was $1.6 million for the three months ended June 28, 2020, compared to cash provided by operating activities of $10.1 million for the same period of the prior year. The year-over-year decrease in cash provided by operating activities was primarily driven by an increase in inventory and decreased payables, partially offset by an increase in customer receivables and improvement in net income for the first three months of fiscal 2020 compared to the same period a year ago. Due to the nature of our operations, which includes purchases of large quantities of bulk chemicals, timing of purchases can result in significant changes in working capital investment and the resulting operating cash flow. Due to flooding in the first quarter of the prior year, we were not able to receive any barges of bulk chemicals into inventory and as a result our inventory levels were unusually low at that time. Typically, our cash requirements increase during the period from April through November as caustic soda inventory levels increase because we receive the majority of barges during this period. Cash used in investing activities was $4.8 million for the three months ended June 28, 2020, compared to $9.1 million for the same period of the prior year. Capital expenditures were $4.8 million for the three months ended June 28, 2020, compared to $9.2 million in the same period of the prior year. In the first three months of the prior year, we purchased our previously leased corporate headquarters facility for $6.4 million, which was partially offset by increased investments in facility improvements and new and replacement equipment during the first three months of the current year. 15 Cash provided by financing activities was $3.5 million for the three months ended June 28, 2020, compared to $4.6 million of cash used in financing activities in the same period of the prior year. Included in financing activities in the first three months of the current year were net debt proceeds of $6.0 million, compared to no borrowings in the first three months of the prior year, as our working capital needs were lower at that time because we did not receive any barges of bulk chemicals into inventory in that quarter. In addition, we repurchased no shares of our common stock in the first quarter of the current fiscal year, compared to $1.8 million in the same quarter in the prior year. We expect our cash balances and funds available under our credit facility, discussed below, along with cash flows generated from operations, will be sufficient to fund the cash requirements of our ongoing operations for the foreseeable future. Our Board has authorized the repurchase of up to 800,000 shares of our outstanding common stock. The shares may be purchased on the open market or in privately negotiated transactions subject to applicable securities laws and regulations. The primary objective of the share repurchase program is to offset the impact of dilution from issuances relating to employee and director equity grants and our employee stock purchase program. During the first three months of fiscal 2021, we did not repurchase any shares of common stock. In the first three months of the prior fiscal year, we repurchased 47,136 shares of common stock with an aggregate purchase price of $1.8 million. As of June 28, 2020, 358,797 shares remained available for purchase under the program We are party to an amended and restated credit agreement (the “Credit Agreement”) with U.S. Bank National Association (“U.S. Bank”) as Sole Lead Arranger and Sole Book Runner, and other lenders from time to time party thereto (collectively, the “Lenders”), whereby U.S. Bank is also serving as Administrative Agent. The Credit Agreement provides us with senior secured revolving credit facilities (the “Revolving Loan Facility”) totaling $150.0 million. The Revolving Loan Facility includes a $5.0 million letter of credit subfacility and $15.0 million swingline subfacility. The Revolving Loan Facility has a five-year maturity date, maturing on November 30, 2023. The Revolving Loan Facility is secured by substantially all of our personal property assets and those of our subsidiaries. Borrowings under the Revolving Loan Facility bear interest at a rate per annum equal to one of the following, plus, in both cases, an applicable margin based upon our leverage ratio: (a) LIBOR for an interest period of one, two, three or six months as selected by us, reset at the end of the selected interest period, or (b) a base rate determined by reference to the highest of (1) U. S. Bank’s prime rate, (2) the Federal Funds Effective Rate plus 0.5%, or (3) one-month LIBOR for U.S. dollars plus 1.0%. The LIBOR margin is between 0.85% - 1.35%, depending on our leverage ratio. The base rate margin is between 0.00% - 0.35%, depending on our leverage ratio. In the event that the ICE Benchmark Administration (or any person that takes over administration of such rate) determines that LIBOR is no longer available, including as a result of the intended phase out of LIBOR by the end of 2021, our Revolving Loan Facility provides for an alternative rate of interest to be jointly determined by us and U.S. Bank, as administrative agent, that gives due consideration to the then prevailing market convention for determining a rate of interest for syndicated loans in the United States. Once such successor rate has been approved by us and U.S. Bank, the Revolving Credit Loan Facility would be amended to use such successor rate without any further action or consent of any other lender, so long as the administrative agent does not receive any objection from any other lender. At June 28, 2020, the effective interest rate on our borrowing was 1.5% . In addition to paying interest on the outstanding principal under the Revolving Loan Facility, we are required to pay a commitment fee on the unutilized commitments thereunder. The commitment fee is between 0.15% - 0.25%, depending on our leverage ratio. Debt issuance costs paid to the Lenders are being amortized as interest expense over the term of the Credit Agreement. As of June 28, 2020, the unamortized balance of these costs was $0.3 million, and is reflected as a reduction of debt on our balance sheet. The Credit Agreement requires us to maintain (a) a minimum fixed charge coverage ratio of 1.15 to 1.00 and (b) a maximum total cash flow leverage ratio of 3.0 to 1.0. The Credit Agreement also contains other customary affirmative and negative covenants, including covenants that restrict our ability to incur additional indebtedness, dispose of significant assets, make certain investments, including any acquisitions other than permitted acquisitions, make certain payments, enter into sale and leaseback transactions, grant liens on our assets or rate management transactions, subject to certain limitations. We are permitted to make distributions, pay dividends and repurchase shares so long as no default or event of default exists or would exist as a result thereof. We were in compliance with all covenants of the Credit Agreement as of June 28, 2020. The Credit Agreement contains customary events of default, including failure to comply with covenants in the Credit Agreement and other loan documents, cross default to other material indebtedness, failure by us to pay or discharge material judgments, bankruptcy, and change of control. The occurrence of an event of default would permit the Lenders to terminate their commitments and accelerate loans under the Revolving Loan Facility. 16 As part of our growth strategy, we have acquired businesses and may pursue acquisitions or other strategic relationships in the future that we believe will complement or expand our existing businesses or increase our customer base. We believe we could borrow additional funds under our current or new credit facilities or sell equity for strategic reasons or to further strengthen our financial position. Critical Accounting Estimates There were no material changes in our critical accounting estimates since the filing of our Annual Report on Form 10-K for the fiscal year ended March 29, 2020 . Forward-Looking Statements The information presented in this Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These statements are not historical facts, but rather are based on our current expectations, estimates and projections, and our beliefs and assumptions. Words such as “anticipate,” “believe,” “estimate,”, “expect,” “intend,” “plan,” “will” and similar expressions to identify forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and other factors, some of which are beyond our control and are difficult to predict. These factors could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. Additional information concerning potential factors that could affect future financial results is included in our Annual Report on Form 10-K for the fiscal year ended March 29, 2020 . We caution you not to place undue reliance on these forward-looking statements, which reflect our management’s view only as of the date of this Quarterly Report on Form 10-Q. We are not obligated to update these statements or publicly release the result of any revisions to them to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect the occurrence of unanticipated events. 17