Item 7. Management’s Discussion and Analysis
ITEM 7. 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 fiscal 2021 and 2020. This discussion should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
We have omitted discussion of the earliest of the three years covered by our consolidated financial statements presented in this report because that disclosure was already included in our Annual Report on Form 10-K for fiscal 2020, filed with the SEC on May 20, 2020. You are encouraged to reference Part II, Item 7, within that report, for a discussion of our financial condition and result of operations for fiscal 2019 compared to fiscal 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 chemical products and specialty ingredients, including manufacturing, blending and repackaging certain products.
Financial Overview
An overview of our financial performance in fiscal 2021 is provided below:
• Sales of $596.9 million, a 10% increase from fiscal 2020;
• Gross profit of $123.8 million, an increase of $22.8 million, or 23% from fiscal 2020;
• Selling, general and administrative (“SG&A”) expenses increased $8.6 million year over year, and were relatively flat as a percentage of sales from fiscal 2020;
• Net cash provided by operating activities of $43.8 million, as compared to $58.9 million for fiscal 2020.
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 prices 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 last in, first out (“LIFO”) method of valuing the inventory in our Industrial and Water Treatment segments, which causes the most recent product costs to be recognized in our income statement. 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 our Health and Nutrition segment are valued using the first-in, first-out (“FIFO”) method.
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.
Business and Property Acquisitions
In the fourth quarter of fiscal 2021, we acquired substantially all the assets of C & L Aqua Professionals, Inc. and LC Blending, Inc. (together, “C&L Aqua”) under the terms of an asset purchase agreement among us, C&L Aqua and its shareholders. C&L Aqua was a water treatment chemical distribution company operating primarily in Louisiana. The results of operations since the acquisition date are included in our Water Treatment segment.
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In the third quarter of fiscal 2021, we acquired a manufacturing facility to allow further expansion and growth in both our Industrial and Water Treatment segments. This site is adjacent to our facility in Rosemount, Minnesota, adding 40,000 square feet of manufacturing and warehouse space on 28 acres of land to bring us to a total of 105,000 square feet of space on 56 acres of land, with rail access at both of the sites. The expansion will allow for future growth and provide supply chain flexibility on certain raw materials to better serve our customers.
In the second quarter of fiscal 2021, we acquired substantially all the assets of American Development Corporation of Tennessee, Inc. (“ADC”) under the terms of an asset purchase agreement among us, ADC and its shareholders. ADC was a water treatment chemical distribution company operating primarily in Tennessee, Georgia and Kentucky. The results of operations since the acquisition date are included in our Water Treatment segment.
The aggregate annual revenue from C&L Aqua and ADC in the twelve months prior to each acquisition date totaled approximately $25 million.
Stock Split
On March 1, 2021, we effected a two-for-one split of our common stock, and adjusted the par value from $.05 per share to $0.01 per share. At the same time, we increased the number of authorized shares from 30 million to 60 million. Our consolidated financial statements, related notes, and other financial data contained in this report have been adjusted to give retroactive effect to the stock split for all periods presented.
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, from time to time, quarantines, “shelter in place” and “stay at home” orders, travel restrictions or bans, business curtailments, school closures, and other protective measures. While many restrictions have eased since the start of the COVID-19 pandemic, certain restrictions remain in place or new restrictions may be implemented in the future. Certain restrictions may remain in place for some time.
All of our manufacturing facilities have qualified 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, with no significant impact to our output levels.
During this public health crisis, we have remained 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.
The financial impact of the COVID-19 pandemic 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. In addition, certain expenses, such as travel and entertainment and trade show expenses, were lower than historical levels during fiscal 2021. We expect mixed results to continue until conditions normalize following the end of the pandemic.
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Results of Operations
The following table sets forth certain items from our statement of income as a percentage of sales from period to period:
Fiscal 2021 Fiscal 2020
Sales 100.0 % 100.0 %
Cost of sales (79.3) % (81.3) %
Gross profit 20.7 % 18.7 %
Selling, general and administrative expenses (11.4) % (11.0) %
Operating income (loss) 9.4 % 7.7 %
Interest expense, net (0.2) % (0.4) %
Other income 0.2 % — %
Income (loss) before income taxes 9.4 % 7.3 %
Income tax provision (2.5) % (2.0) %
Net income (loss) 6.9 % 5.3 %
Fiscal 2021 Compared to Fiscal 2020
Sales
Sales were $596.9 million for fiscal 2021, an increase of $56.7 million, or 10%, from sales of $540.2 million for fiscal 2020.
Industrial Segment. Industrial segment sales decreased $1.9 million, or 1%, to $273.4 million for fiscal 2021, as compared to $275.2 million for fiscal 2020. Sales of bulk commodity products in the Industrial segment were approximately 14% of sales dollars in fiscal 2021 and 18% of sales dollars in fiscal 2020. Increased sales resulting from a product mix shift to more sales of certain of our higher-priced manufactured, blended and repackaged products, in particular certain of our food ingredient and agricultural products, as well as increased sales of our bleach products, was more than offset by decreased sales into the ethanol industry in the first half of fiscal 2021, due largely to weakened economic conditions in that industry.
Water Treatment Segment. Water Treatment segment sales increased $10.1 million, or 6%, to $170.0 million for fiscal 2021, as compared to $159.9 million for fiscal 2020. Sales of bulk commodity products in the Water Treatment segment were approximately 9% of sales dollars in fiscal 2021 and 12% of sales dollars in fiscal 2020. The increase in sales dollars resulted from the added sales from the acquisition of ADC and C&L Aqua as well as increased sales of certain manufactured, blended and re-packaged products in our legacy business, partially offset by a first quarter sales decline as a result of COVID-19 which reduced sales to certain end markets, primarily swimming pools.
Health and Nutrition Segment. Sales for our Health and Nutrition segment increased $48.4 million, or 46%, to $153.5 million for fiscal 2021, as compared to $105.1 million for fiscal 2020. The increase in sales was driven by increased sales of both our manufactured and specialty distributed products largely as a result of increased demand for health and immunity products.
Gross Profit
Gross profit increased $22.8 million, or 23%, to $123.8 million, or 21% of sales, for fiscal 2021, from $100.9 million, or 19% of sales, for fiscal 2020. During fiscal 2021, the LIFO reserve decreased, and gross profits increased, by $0.1 million. In fiscal 2020, the LIFO reserve increased, and gross profits decreased, by $0.6 million.
Industrial Segment. Gross profit for the Industrial segment increased $4.4 million, or 11%, to $43.3 million, or 16% of sales, for fiscal 2021, from $38.9 million, or 14% of sales, for fiscal 2020. During fiscal 2021, the LIFO reserve decreased, and gross profits increased, by $0.2 million. In fiscal 2020, the LIFO reserve increased, and gross profits decreased, by $0.6 million. Total gross profit, and gross profit as a percentage of sales, increased due to a product mix shift to more sales of certain higher-margin manufactured, blended and re-packaged products, partially offset by higher operating costs.
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Water Treatment Segment. Gross profit for the Water Treatment segment increased $4.9 million, or 12%, to $46.8 million, or 28% of sales, for fiscal 2021, from $41.9 million, or 26% of sales, for fiscal 2020. During fiscal 2021, the LIFO reserve increased, and gross profits decreased, by $0.1 million. During fiscal 2020, the LIFO reserve had a nominal impact on gross profit. Gross profit increased as a result of the added gross profit from sales in the acquired businesses of ADC and C&L Aqua. Gross profit, and gross profit as a percentage of sales, also increased as a result of a product mix shift to more sales of certain of our manufactured, blended and repackaged products in our legacy business.
Health and Nutrition Segment. Gross profit for our Health and Nutrition segment increased $13.6 million, or 68% to $33.6 million, or 22% of sales, for fiscal 2021, from $20.1 million, or 19% of sales, for fiscal 2020. The increase in gross profit was a result of higher sales compared to the prior year. Gross profit as a percentage of sales increased primarily as a result of product mix changes.
Selling, General and Administrative Expenses
SG&A expenses increased $8.6 million to $67.9 million, or 11% of sales, for fiscal 2021, from $59.2 million, or 11% of sales, for fiscal 2020. Expenses increased primarily due to increased variable pay, the added costs from the acquired businesses of ADC and C&L Aqua, including $0.8 million expense for amortization of intangibles, and a year-over-year increase in compensation expense related to our non-qualified deferred compensation plan, with the expense offset in other income.
Operating Income
Operating income was $55.9 million, or 9% of sales, for fiscal 2021, as compared to $41.7 million, or 8% of sales, for fiscal 2020 due to the combined impact of the factors discussed above.
Interest Expense, Net
Interest expense was $1.5 million for fiscal 2021, a decrease of $1.0 million from interest expense of $2.5 million for fiscal 2020. The additional interest cost as a result of the increase in outstanding borrowings was more than offset by lower borrowing rates compared to the prior year.
Income Tax Provision
Our effective tax rate was approximately 27% for both fiscal 2021 and fiscal 2020. The effective tax rate is impacted by projected levels of annual taxable income, permanent items, and state taxes.
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Selected Quarterly Financial Data
(In thousands, except per share data) Fiscal 2021
First Second Third Fourth
Sales $ 143,172 $ 147,801 $ 142,927 $ 162,971
Gross profit 30,976 32,797 28,239 31,750
Selling, general, and administrative expenses 15,038 16,221 17,750 18,875
Operating income 15,938 16,576 10,489 12,875
Net income 11,788 12,190 7,921 9,081
Basic earnings per share $ 0.56 $ 0.58 $ 0.38 $ 0.43
Diluted earnings per share $ 0.55 $ 0.57 $ 0.37 $ 0.43
Fiscal 2020
First Second Third Fourth
Sales $ 147,336 $ 140,043 $ 120,406 $ 132,413
Gross profit 28,797 27,994 21,478 22,648
Selling, general, and administrative expenses 14,836 14,817 14,702 14,891
Operating income 13,961 13,177 6,776 7,757
Net income 9,807 9,250 4,547 4,763
Basic earnings per share $ 0.46 $ 0.44 $ 0.22 $ 0.23
Diluted earnings per share $ 0.46 $ 0.43 $ 0.21 $ 0.22
Fiscal 2019
First Second Third Fourth
Sales $ 149,800 $ 145,324 $ 128,151 $ 133,051
Gross profit 28,457 25,772 21,033 20,674
Selling, general, and administrative expenses 14,979 14,941 14,312 14,886
Operating income 13,478 10,831 6,721 5,788
Net income 9,123 7,409 4,130 3,771
Basic earnings per share $ 0.43 $ 0.35 $ 0.19 $ 0.18
Diluted earnings per share $ 0.43 $ 0.35 $ 0.19 $ 0.18
Earnings (loss) per share may not equal the face of the Consolidated Statements of Income (Loss) due to rounding.
Liquidity and Capital Resources
Cash provided by operating activities in fiscal 2021 was $43.8 million compared to $58.9 million in fiscal 2020. The decrease in cash provided by operating activities in fiscal 2021 as compared to fiscal 2020 was primarily driven by increases in customer receivables, resulting from higher sales, as well as higher inventory levels, partially offset by an increase in net income. Increased customer demand in our Health and Nutrition segment resulted in an increase in on-hand inventory due to increased stocking levels to fill the increased demand and to offset longer lead times from our suppliers for many products. Due to the nature of our operations, which includes purchases of large quantities of bulk chemicals, the timing of purchases can result in significant changes in working capital and the resulting operating cash flow. Historically, our cash requirements for working capital increase during the period from April through November as caustic soda inventory levels increase as most of our barges are received during this period.
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Cash used in investing activities was $71.4 million in fiscal 2021 compared to $24.2 million in fiscal 2020. Capital expenditures were $20.8 million in fiscal 2021 and $24.5 million in fiscal 2020. Total cash used in investing activities in fiscal 2021 included an aggregate of $51.0 million for the acquisitions of ADC, C&L Aqua and the purchase of the manufacturing facility in Rosemount, Minnesota. Capital expenditures in fiscal 2021 included $7.8 million of facility improvements, including $4.3 million to expand our pharmaceutical product manufacturing capabilities, vehicles and trucks of $4.7 million, the purchase of a previously leased Water Treatment branch facility for $0.9 million, along with other new and replacement equipment. Capital expenditures in fiscal 2020 included $9.5 million in the aggregate for the purchase of our previously leased corporate headquarters and a previously leased Water Treatment branch facility as well as the purchase of a facility for a Water Treatment branch expansion.
Cash provided by financing activities was $26.4 million in fiscal 2021, as compared to cash used in financing activities of $39.6 million in fiscal 2020. Cash provided by financing activities included net debt borrowings of $39.0 million in fiscal 2021 to partially fund the acquisitions in fiscal 2021, compared to net debt repayments of $25.0 million in fiscal 2020. We also paid out cash dividends of $10.0 million in fiscal 2021 and $9.8 million in fiscal 2020. In fiscal 2021, we used $4.1 million to repurchase shares under our board-authorized share repurchase program, and in fiscal 2020, we used $5.9 million to repurchase shares under the program.
Our cash balance was $3.0 million at March 28, 2021, a decrease of $1.3 million as compared with March 29, 2020. Cash flows generated by operations and financing activities during fiscal 2021 were offset by the cash expended for acquisitions in fiscal 2021, capital expenditures and dividend payments.
We are party to an amended and restated credit agreement (the “Credit Agreement”) with 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 refinanced the term and revolving loans under the Prior Credit Agreement and 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% and 1.35%, depending on our leverage ratio. The base rate margin is between 0.00% and 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 March 28, 2021, the effective interest rate on our borrowings was 1.1%.
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% and 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 March 28, 2021, 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 March 28, 2021 and expect to remain in compliance with all covenants for the next 12 months.
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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 Credit Facility.
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.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
Contractual Obligations and Commercial Commitments
The following table provides aggregate information about our contractual payment obligations and the periods in which payments are due:
Payments Due by Fiscal Period
Contractual Obligation 2022 2023 2024 2025 2026 More than
5 Years Total
(In thousands)
Senior secured revolver (1) $ — $ — $ 99,000 $ — $ — $ — $ 99,000
Interest payments (2) $ 1,256 $ 1,256 $ 1,256 $ — $ — $ — $ 3,768
Operating lease obligations (3) $ 1,831 $ 1,707 $ 1,355 $ 1,304 $ 1,251 $ 6,280 $ 13,728
Pension withdrawal liability (4) $ 467 $ 467 $ 467 $ 467 $ 467 $ 3,505 $ 5,840
(1) Represents balance outstanding as of March 28, 2021, and assumes such amount remains outstanding until its maturity date, as periodic payments are not required under the terms of our Credit Agreement. However, it is our intention to pay down our debt with available excess cash flow. See Note 9 of our consolidated Financial Statements for further information.
(2) Represents interest payments and commitment fees payable on outstanding balances under our revolver, and assumes interest rates remain unchanged from the rate as of March 28, 2021.
(3) As reported under ASC Topic 842
(4) This relates to our withdrawal from a multiemployer pension plan. Payments on this obligation will continue through 2034.
Critical Accounting Policies
In preparing the financial statements, we follow U.S. generally accepted accounting principles (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. We re-evaluate our estimates on an on-going basis. Our estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions and conditions. We consider the following policies to involve the most judgment in the preparation of our financial statements.
Goodwill and Infinite-life Intangible Assets - Goodwill represents the excess of the cost of acquired businesses over the fair value of identifiable tangible net assets and identifiable intangible assets purchased. Goodwill is tested at least annually for impairment, and is tested for impairment more frequently if events or changes in circumstances indicate that the asset might be impaired. Our annual test for impairment is as of the first day of our fourth fiscal quarter, or December 28, 2020 for fiscal 2021. For each of our reporting units, we performed an analysis of qualitative factors to determine whether it is more likely than not that the fair value of any of our reporting units is less than its carrying amount as a basis for determining whether it is necessary to perform a quantitative goodwill impairment test. Based on management’s analysis of qualitative factors, we determined that it was not necessary to perform a quantitative goodwill impairment test for any of our reporting units.
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Business Acquisitions - We account for acquired businesses using the acquisition method of accounting which requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective fair values. The judgments made in determining the estimated fair value assigned to each class of assets acquired and liabilities assumed, as well as asset lives, can materially impact net income.
There are several methods that can be used to determine the fair value of assets acquired and liabilities assumed in a business combination. For intangible assets, we normally utilize one or more forms of the “income method.” This method starts with a forecast of all of the expected future net cash flows attributable to the subject intangible asset. These cash flows are then adjusted to present value by applying an appropriate discount rate that reflects the risk factors associated with the cash flow streams. Some of the more significant estimates and assumptions inherent in the income method (or other methods) include the projected future cash flows (including timing) and the discount rate reflecting the risks inherent in the future cash flows.
Estimating the useful life of an intangible asset also requires judgment. For example, different types of intangible assets will have different useful lives, influenced by the nature of the asset, competitive environment, and rate of change in the industry. Certain assets may even be considered to have indefinite useful lives. All of these judgments and estimates can significantly impact the determination of the amortization period of the intangible asset, and thus net income.
Recent Accounting Pronouncements
See Note 1 to the consolidated financial statements included in Item 8 of this Form 10-K for a full description of recent accounting pronouncements, including expected dates of adoption and estimated effects on results of operations and financial condition.