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 27, 2021 as compared to the similar period ended June 28, 2020. 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 28, 2021 . 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. Business 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 and the assets are included as part of our Water Treatment segment. 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 our acquisitions totaled approximately $25 million. Stock Split In the fourth quarter of fiscal 2021, we effected a two-for-one split of our common stock, and adjusted the par value from $0.05 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 During the pandemic caused by COVID-19, federal, state and local governments around the world implemented 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 most 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. 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 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. 12 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. 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 27, 2021 June 28, 2020 Sales 100.0 % 100.0 % Cost of sales (78.5) % (78.4) % Gross profit 21.5 % 21.6 % Selling, general and administrative expenses (9.3) % (10.5) % Operating income 12.2 % 11.1 % Interest expense, net (0.2) % (0.3) % Other income 0.1 % 0.3 % Income before income taxes 12.1 % 11.1 % Income tax expense (3.0) % (3.0) % Net income 9.1 % 8.1 % Three Months Ended June 27, 2021 Compared to Three Months Ended June 28, 2020 Sales Sales were $181.2 million for the three months ended June 27, 2021, an increase of $38.0 million, or 27%, from sales of $143.2 million a year ago. Industrial Segment. Industrial segment sales increased $14.3 million, or 20%, to $85.9 million for the three months ended June 27, 2021, as compared to $71.5 million in the same period a year ago. Sales of bulk commodity products in the Industrial segment were approximately 14% of sales dollars in the three months ended June 27, 2021 and 12% in the same period of the prior year. Sales of our bleach products decreased from the prior year, as prior year sales were high due to increased customer demand as a result of the pandemic. However, this decrease was more than offset by increased sales of both our bulk and our other manufactured, blended and repackaged products, in particular certain of our agricultural and food ingredient products. Water Treatment Segment. Water Treatment segment sales increased $16.5 million, or 42%, to $56.2 million for the three months ended June 27, 2021, as compared to $39.7 million in the same period a year ago. Sales of bulk commodity products in the Water Treatment segment were approximately 8% of sales dollars in the three months ended June 27, 2021 and 10% in the same period of the prior year. Sales increased over the prior year due to increased demand for many of our products. Sales also increased as a result of the added sales from the acquisitions of ADC and C&L Aqua in fiscal 2021. Health & Nutrition Segment. Health and Nutrition segment sales increased $7.2 million, or 23%, to $39.2 million for the three months ended June 27, 2021, as compared to $32.0 million in the same period a year ago. The increase in sales was driven by increased sales of both our manufactured and specialty distributed products largely as a result of increased consumer demand for health and immunity products. 13 Gross Profit Gross profit increased $8.0 million, or 26%, to $39.0 million, or 22% of sales, for the three months ended June 27, 2021, from $31.0 million, or 22% of sales, for the same period a year ago. During the three months ended June 27, 2021, the LIFO reserve increased, and gross profit decreased, by $1.8 million. In the same quarter a year ago, the LIFO reserve increased, and gross profit decreased, by $0.1 million. Industrial Segment. Gross profit for the Industrial segment increased $1.8 million, or 14%, to $14.3 million, or 17% of sales, for the three months ended June 27, 2021, from $12.5 million, or 17% of sales, in the same period of the prior year. During the three months ended June 27, 2021, the LIFO reserve increased, and gross profit decreased, by $1.4 million. In the same quarter a year ago, the change in the LIFO reserve had a nominal impact on gross profit. Gross profit increased as a result of the increase in sales, partially offset by the negative impact to gross profit as a result of the increase in the LIFO reserve. Water Treatment Segment. Gross profit for the Water Treatment segment increased $4.9 million, or 43%, to $16.2 million, or 29% of sales, for the three months ended June 27, 2021, from $11.3 million, or 29% of sales, in the same period of the prior year. During the three months ended June 27, 2021, the LIFO reserve increased, and gross profit decreased, by $0.4 million. In the same quarter a year ago, the change in the LIFO reserve had a nominal impact on gross profit. Gross profit increased as a result of the increased sales as well as the added gross profit from the sales in the acquired businesses of ADC and C&L Aqua. Health and Nutrition Segment . Gross profit for our Health and Nutrition segment increased $1.3 million, or 18%, to $8.5 million, or 22% of sales, for the three months ended June 27, 2021, from $7.2 million, or 23% 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 $1.8 million to $16.9 million, or 9% of sales, for the three months ended June 27, 2021, from $15.0 million, or 11% of sales, for the same period of the prior year. Expenses increased primarily due to the added costs from the acquired businesses of ADC and C&L Aqua, including $0.4 million of expense for amortization of intangibles. Operating Income Operating income increased $6.2 million, or 39%, to $22.1 million, or 12% of sales, for the three months ended June 27, 2021, from $15.9 million, or 11% 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 was $0.3 million for the three months ended June 27, 2021, a decrease of $0.1 million from interest expense of $0.4 million for the same period a year ago. 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. Other Income Other income of $0.2 million was $0.3 million lower than other income of $0.5 million a year ago. This represents gains recorded on investments held for our non-qualified deferred compensation plan. The amount recorded as a gain was offset by a similar amount recorded as an increase to compensation expense within SG&A expenses . Income Tax Provision Our effective income tax rate was 24.4% for the three months ended June 27, 2021, compared to 26.5% 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. Our effective tax rate for the full year is currently expected to be approximately 26-27%. 14 Liquidity and Capital Resources Cash was $5.2 million at June 27, 2021, an increase of $2.2 million as compared with the $3.0 million available as of March 28, 2021. Cash provided by operating activities was $14.8 million for the three months ended June 27, 2021, compared to cash provided by operating activities of $1.6 million for the same period of the prior year. The year-over-year increase in cash provided by operating activities was primarily driven by year-over-year changes in uses of working capital, including less cash expended in the current quarter for inventory, combined with an increase in net income for the three months ended June 27, 2021 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. 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 $2.1 million for the three months ended June 27, 2021, compared to $4.8 million for the same period of the prior year. Capital expenditures were $2.2 million for the three months ended June 27, 2021, compared to $4.8 million in the same period of the prior year. In the first three months of the prior year, we had larger investments in facility improvements and new and replacement equipment compared to the first three months of the current year. Cash used in financing activities was $10.5 million for the three months ended June 27, 2021, compared to $3.5 million of cash provided by 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 repayments of $3.0 million, compared to net debt borrowings of $6.0 million in the first three months of the prior year. In addition, we repurchased $3.4 million of shares of our common stock in the first three months of the current fiscal year, compared to no shares repurchased in the same period 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 1.6 million 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 three months ended June 27, 2021, we repurchased 100,954 shares of common stock with an aggregate purchase price of $3.4 million. During the three months ended June 28, 2020, no shares were repurchased. As of June 27, 2021, 450,552 shares remained available to be repurchased under the share repurchase 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 nine 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 27, 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% - 0.25%, depending on our leverage ratio. 15 Debt issuance costs paid to the Lenders are being amortized as interest expense over the term of the Credit Agreement. As of June 27, 2021, the unamortized balance of these costs was $0.2 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 27, 2021. 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. 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 28, 2021 . 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 28, 2021 . 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. 16