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Item 2. Management’s Discussion and Analysis

2022-11-02 compared with 2022-08-04 · 95 added, 52 removed, 105 unchanged (58% of the section changed)

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 July 3, 2022 as compared to the similar period ended June 27, 2021.

The following is a discussion and analysis of our financial condition and results of operations for the six months ended October 2, 2022 as compared to the similar period ended September 26, 2021.

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 April 3, 2022 .

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NAPCO manufactured and distributed water treatment chemicals from three locations in Texas.

The results of operations beginning at the date of acquisition will be included as part of our Water Treatment segment from the date of acquisition forward.

The results of operations since the acquisition date are included in our Water Treatment segment.

In the third quarter of fiscal 2022, we acquired substantially all the assets of Water and Waste Specialties, LLC, under the terms of an asset purchase agreement with Water and Waste Specialties and its shareholders.

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On August 4, 2022, our Board increased the number of shares authorized to be repurchased under our share repurchase program from 1.6 million to 2.6 million.

Accordingly, as of August 4, 2022, 1,129,348 shares remain available to be repurchased under this program.

As of October 2, 2022, 1,129,348 shares remain available to be repurchased under this program.

Financial Results

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The following table sets forth the percentage relationship of certain items to sales for the period indicated:

Three Months Ended

July 3, 2022 June 27, 2021

Three Months Ended Six Months Ended

October 2, 2022 September 26, 2021 October 2, 2022 September 26, 2021

Sales 100.0 % 100.0 % 100.0 % 100.0 %

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Net income 7.5 % 7.7 % 7.7 % 8.4 %

Three Months Ended July 3, 2022 Compared to Three Months Ended June 27, 2021

Sales were $246.5 million for the three months ended July 3, 2022, an increase of $65.3 million, or 36%, from sales of $181.2 million in the same period a year ago, driven primarily by price increases.

Three Months Ended October 2, 2022 Compared to Three Months Ended September 26, 2021

Sales were $241.2 million for the three months ended October 2, 2022, an increase of $57.9 million, or 32%, from sales of $183.3 million in the same period a year ago, driven primarily by price increases.

Industrial Segment.

Industrial segment sales increased $38.8 million, or 45%, to $124.7 million for the three months ended July 3, 2022, from sales of $85.9 million in the same period a year ago.

Sales of bulk commodity products in the Industrial segment were approximately 16% of sales dollars in the three months ended July 3, 2022 and 14% the same period of the prior year.

The growth in Industrial segment sales was driven by increased selling prices on many of our products driven by higher costs on many of our raw materials as well as a product mix shift to more sales of our food ingredient products, which typically have higher margins.

Industrial segment sales increased $30.7 million, or 37%, to $113.9 million for the three months ended October 2, 2022, from sales of $83.2 million in the same period a year ago.

Sales of bulk commodity products in the Industrial segment were approximately 16% of sales dollars in both the three months ended October 2, 2022 and the same period of the prior year.

The increase in sales was driven by increased selling prices on many of our products driven by higher costs on many of our raw materials as well as a product mix shift.

Water Treatment Segment.

Water Treatment segment sales increased $22.3 million, or 40%, to $78.5 million for the three months ended July 3, 2022, from sales of $56.2 million in the same period a year ago.

Sales of bulk commodity products in the Water Treatment segment were approximately 9% of sales dollars in the three months ended July 3, 2022 and 8% in the same period of the prior year.

The sales growth was a result of increased selling prices on many of our products driven by higher costs on many of our raw materials, increased demand for our products and the added sales from acquisitions.

Water Treatment segment sales increased $24.4 million, or 39%, to $86.5 million for the three months ended October 2, 2022, from sales of $62.1 million in the same period a year ago.

Sales of bulk commodity products in the Water Treatment segment were approximately 9% of sales dollars in the three months ended October 2, 2022 and 8% in the same period a year ago.

Sales increased as a result of increased selling prices on many of our products driven by higher costs on many of our raw materials, the added sales from acquisitions and increased demand for our products.

Health & Nutrition Segment.

Health and Nutrition segment sales increased $4.1 million, or 10%, to $43.3 million for the three months ended July 3, 2022, from sales of $39.2 million in the same period a year ago.

Sales growth of our manufactured products was partially offset by a decrease in sales of our specialty distributed products.

Gross profit increased $7.7 million, or 20%, to $46.7 million, or 19% of sales, for the three months ended July 3, 2022, from $39.0 million, or 22% of sales, for the same period a year ago.

During the three months ended July 3, 2022, the LIFO reserve increased, and gross profit decreased, by $3.8 million, primarily due to rising raw material prices.

Health and Nutrition segment sales increased $2.8 million, or 7%, to $40.8 million for the three months ended October 2, 2022, from sales of $38.0 million in the same period a year ago.

Sales Increased due to increased sales of our manufactured products.

Gross profit increased $9.1 million, or 24%, to $46.4 million, or 19% of sales, for the three months ended October 2, 2022, from $37.3 million, or 20% of sales, in the same period a year ago.

During the three months ended October 2, 2022, the LIFO reserve increased, and gross profit decreased, by $5.3 million due primarily to rising raw material prices.

In the same quarter a year ago, the LIFO reserve increased, and gross profit decreased, by $3.0 million.

Industrial Segment.

Gross profit for the Industrial segment increased $5.7 million, or 40%, to $20.0 million, or 16% of sales, for the three months ended July 3, 2022, from $14.3 million, or 17% of sales, in the same period a year ago.

During the three months ended July 3, 2022, the LIFO reserve increased, and gross profit decreased, by $2.7 million, primarily due to rising raw material prices.

Gross profit for the Industrial segment increased $5.1 million, or 40%, to $17.7 million, or 16% of sales, for the three months ended October 2, 2022, from $12.6 million, or 15% of sales, in the same period a year ago.

During the three months ended October 2, 2022, the LIFO reserve increased, and gross profit decreased, by $3.9 million, primarily due to rising raw material prices.

In the same quarter a year ago, the LIFO reserve increased, and gross profit decreased, by $2.3 million.

Gross profit increased as a result of sales growth and product mix shift, partially offset by the decrease in gross profits as a result of the increased LIFO reserve.

Gross profit increased as a result of increased sales and a product mix shift, partially offset by the unfavorable year-over-year impact of the increased LIFO reserve.

Water Treatment Segment.

Gross profit for the Water Treatment segment increased $2.8 million, or 17%, to $19.0 million, or 24% of sales, for the three months ended July 3, 2022, from $16.2 million, or 29% of sales, in the same period a year ago.

During the three months ended July 3, 2022, the LIFO reserve increased, and gross profit decreased, by $1.1 million due primarily to rising raw material costs.

Gross profit for the Water Treatment segment increased $3.0 million, or 17%, to $20.5 million, or 24% of sales, for the three months ended October 2, 2022, from $17.5 million, or 28% of sales, in the same period a year ago.

During the three months ended October 2, 2022, the LIFO reserve increased, and gross profit decreased, by $1.4 million due primarily to rising raw material prices.

In the same quarter a year ago, the LIFO reserve increased, and gross profit decreased, by $0.7 million.

Gross profit increased as a result of sales growth, partially offset by the decrease in gross profits as a result of the increased LIFO reserve.

Gross profit increased as a result of increased sales, partially offset by the unfavorable year-over-year impact of the increased LIFO reserve.

Health and Nutrition Segment .

Gross profit for our Health and Nutrition segment decreased $0.7 million, or 8%, to $7.8 million, or 18% of sales, for the three months ended July 3, 2022, from $8.5 million, or 22% of sales, for the same period a year ago.

While sales increased year over year, the decrease in gross profit was a result of inventory adjustments made to increase reserves for excess product on hand.

Gross profit for our Health and Nutrition segment increased $1.0 million, or 14%, to $8.2 million, or 20% of sales, for the three months ended October 2, 2022, from $7.2 million, or 19% of sales, in the same period a year ago.

Gross profit increased as a result of increased sales as well as decreased inventory adjustments in the current quarter as compared to the same quarter a year ago.

Selling, General and Administrative Expenses

Selling, general and administrative (“SG&A”) expenses increased $2.0 million to $18.9 million, or 8% of sales, for the three months ended July 3, 2022, from $16.9 million, or 9% of sales, for the same period a year ago.

The increase was mainly a result of added costs associated with the acquired businesses in our Water Treatment segment, as well as increased variable expenses.

Partially offsetting the increase was a reduction of $0.8 million to compensation expense as a result of losses incurred on investments held for our non-qualified deferred compensation plan, as compared to $0.2 million increase in compensation expense in the same quarter a year ago as a result of gains incurred.

These amounts were offset by similar amounts recorded in other (expense) income.

Selling, general and administrative (“SG&A”) expenses increased $2.1 million to $19.8 million, or 8% of sales, for the three months ended October 2, 2022, from $17.7 million, or 10% of sales, in the same period a year ago.

Expenses increased due to the added costs from the acquired business in our Water Treatment segment, as well as increased variable expenses.

Operating Income

Operating income increased $5.8 million, or 26%, to $27.9 million, or 11% of sales, for the three months ended July 3, 2022, from $22.1 million, or 12% of sales, for the same period a year ago due to the combined impact of the factors discussed above.

Operating income increased $6.9 million, or 35%, to $26.5 million, or 11% of sales, for the three months ended October 2, 2022, from $19.6 million, or 11% of sales, in the same period a year ago due to the combined impact of the factors discussed above.

Interest Expense, Net

Interest expense was $0.9 million for the three months ended July 3, 2022 and $0.3 million the three months ended June 27, 2021.

The increase was due an increase in outstanding borrowings due to increased working capital needs as well as an increase in borrowing rates.

Interest expense was $1.4 million for the three months ended October 2, 2022 and $0.3 million the three months ended September 26, 2021.

The increase was due to an increase in borrowing interest rates as well as an increase in outstanding borrowings due to increased working capital needs.

Other (Expense) Income

Other expense was $0.8 million for the three months ended July 3, 2022 compared to other income of $0.2 million in the same period a year ago.

Other expense was $0.4 million for the three months ended October 2, 2022 compared to other income of $0.2 million in the same period a year ago.

The current year expense represents losses recorded on investments held for our non-qualified deferred compensation plan, whereas the income in the prior represented gains recorded on those investments.

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Income Tax Provision

Our effective income tax rate was 25% for the three months ended July 3, 2022, compared to 24% in the same period a year ago.

Our effective income tax rate was 27% for both the three months ended October 2, 2022 and the three months ended September 26, 2021.

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%.

Our effective tax rate for the full year is currently expected to be approximately 26 to 27%.

Six Months Ended October 2, 2022 Compared to Six Months Ended September 26, 2021

Sales were $487.7 million for the six months ended October 2, 2022, an increase of $123.2 million, or 34%, from sales of $364.5 million in the same period a year ago, driven primarily by price increases.

Industrial Segment.

Industrial segment sales increased $69.6 million, or 41%, to $238.6 million for the six months ended October 2, 2022, from sales of $169.0 million in the same period a year ago.

Sales of bulk commodity products in the Industrial segment were approximately 16% of sales dollars in the six months ended October 2, 2022 and 15% in the same period of the prior year.

Sales increased as a result of increased selling prices on many of our products driven by higher costs on many of our raw materials as well as a product mix shift.

Water Treatment Segment.

Water Treatment segment sales increased $46.7 million, or 39%, to $165.0 million for the six months ended October 2, 2022, from sales of $118.3 million in the same period a year ago.

Sales of bulk commodity products in the Water Treatment segment were approximately 9% of sales dollars in the six months ended October 2, 2022 and 8% in the same period of the prior year.

Health & Nutrition Segment.

Health and Nutrition segment sales increased $6.9 million, or 9%, to $84.1 million for the six months ended October 2, 2022, from sales of $77.2 million in the same period a year ago.

Sales increased due to increased sales of our manufactured products.

Gross profit increased $16.8 million, or 22%, to $93.1 million, or 19% of sales, for the six months ended October 2, 2022, from $76.3 million, or 21% of sales, in the same period a year ago.

During the six months ended October 2, 2022, the LIFO reserve increased, and gross profit decreased, by $9.0 million, due primarily to rising raw material costs.

In the same period a year ago, the LIFO reserve increased, and gross profit decreased, by $4.8 million.

Industrial Segment.

Gross profit for the Industrial segment increased $10.9 million, or 41%, to $37.7 million, or 16% of sales, for the six months ended October 2, 2022, from $26.8 million, or 16% of sales, in the same period a year ago.

During the six months ended October 2, 2022, the LIFO reserve increased, and gross profit decreased, by $6.6 million, due primarily to rising raw material costs.

In the same period a year ago, the LIFO reserve increased, and gross profit decreased, by $3.7 million.

Gross profit increased as a result of increased sales and a product mix shift, partially offset by the unfavorable year-over-year impact of the increase in the LIFO reserve.

Water Treatment Segment .

Gross profit for the Water Treatment segment increased $5.7 million, or 17%, to $39.5 million, or 24% of sales, for the six months ended October 2, 2022, from $33.8 million, or 29% of sales, in the same period a year ago.

During the six months ended October 2, 2022, the LIFO reserve increased, and gross profit decreased, by $2.4 million due primarily to rising raw material costs.

In the same period a year ago, the LIFO reserve increased and gross profit decreased by $1.1 million.

Gross profit increased as a result of increased sales, partially offset by the unfavorable year-over-year impact of the increased LIFO reserve.

Health and Nutrition Segment .

Gross profit for our Health and Nutrition segment increased $0.2 million, to $15.9 million, or 19% of sales, for the six months ended October 2, 2022, from $15.7 million, or 20% of sales, in the same period a year ago.

Gross profit increased as a result of increased sales.

Selling, General and Administrative Expenses

SG&A expenses increased $4.2 million to $38.7 million, or 8% of sales, for the six months ended October 2, 2022, from $34.5 million, or 9% of sales, in the same period a year ago.

Expenses increased due to the added costs from the acquired businesses in our Water Treatment segment, as well as increased variable expenses, partially offset by a $1.6 million decrease in compensation expense relating to the non-qualified deferred compensation plan liability which is offset in "Other (Expense) Income" as described below.

Operating Income

Operating income increased $12.7 million, or 30%, to $54.4 million, or 11% of sales, for the six months ended October 2, 2022, from $41.7 million, or 11% of sales, in the same period a year ago due to the combined impact of the factors discussed above.

Interest Expense, Net

Interest expense was $2.3 million for the six months ended October 2, 2022 and $0.7 million for the six months ended September 26, 2021.

The increase was due to an increase in borrowing interest rates as well as an increase in outstanding borrowings due to increased working capital needs.

Other (Expense) Income

Other expense was $1.2 million for the six months ended October 2, 2022 compared to other income of $0.4 million in the same period a year ago.

The current year expense represents losses recorded on investments held for our non-qualified deferred compensation plan, whereas the income in the prior year represented gains recorded on those investments.

The amounts recorded as a gain or loss were offset by a similar amounts recorded as a decrease or increase to compensation expense within SG&A expenses .

Income Tax Provision

Our effective income tax rate was 26% for both the six months ended October 2, 2022 and in the same period a year ago.

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 to 27%.

Liquidity and Capital Resources

Cash was $6.0 million at July 3, 2022, an increase of $2.5 million as compared with the $3.5 million available as of April 3, 2022.

Cash used in operating activities was $9.4 million for the three months ended July 3, 2022, compared to cash provided by operating activities of $14.8 million in the same period a year ago.

The year-over-year decrease in cash provided by operating activities was primarily driven by an increase in year-over-year changes in uses of working capital, including more cash expended in the first three months of the current year for accounts payable, inventory, and customer receivables, partially offset by increased net income for the three months ended July 3, 2022 compared to the same period a year ago.

The current year increase in accounts receivable and inventory was largely due to increased sales and increased raw material prices.

Cash was $3.9 million at October 2, 2022, an increase of $0.4 million as compared with the $3.5 million available as of April 3, 2022.

Cash provided by operating activities was $18.8 million for the six months ended October 2, 2022, compared to cash provided by operating activities of $40.1 million in the same period a year ago.

The year-over-year decrease in cash provided by operating activities was primarily driven by an increase in year-over-year changes in uses of working capital, including more cash expended in the first six months of the current year for inventory, customer receivables, and accounts payable, partially offset by increased net income for the six months ended October 2, 2022 compared to the same period a year ago.

The current year increase in inventory and accounts receivable was largely due to increased raw material prices and increased sales.

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.

Cash used in investing activities was $11.5 million for the three months ended July 3, 2022, compared to $2.1 million in the same period a year ago.

Capital expenditures were $11.6 million for the three months ended July 3, 2022, compared to $2.2 million in the same period a year ago.

In the first three months of the current year, we invested $1.1 million to expand one of our facilities, purchased a previously leased facility for $0.9 million, and had larger investments in trucks, containers and new and replacement equipment compared to the first three months of the prior year.

Cash provided by financing activities was $23.4 million for the three months ended July 3, 2022, compared to $10.5 million of cash used in financing activities in the same period a year ago.

Included in financing activities in the first three months of the current year were net debt proceeds of $33.5 million, compared to net debt payments of $3.0 million in the first three months of the prior year.

Cash used in investing activities was $20.4 million for the six months ended October 2, 2022, compared to $7.9 million in the same period a year ago.

Capital expenditures were $20.7 million for the six months ended October 2, 2022, compared to $6.9 million in the same period a year ago.

In the first six months of the current year, we invested an additional $1.1 million to complete the expansion of our Illinois manufacturing facility, purchased a previously leased facility for $0.9 million, and had

significantly larger investments in trucks, containers and new and replacement equipment compared to the first six months of the prior year.

Cash provided by financing activities was $2.0 million for the six months ended October 2, 2022, compared to $28.4 million of cash used in financing activities in the same period a year ago.

Included in financing activities in the first six months of the current year were net debt proceeds of $15.0 million, compared to net debt payments of $15.0 million in the first six months of the prior year.

The large increase in our working capital needs in the current year, as discussed above, required us to increase our borrowings.

In addition, we repurchased $6.6 million of shares of our common stock in the first three months of the current fiscal year, compared to $3.4 million of shares repurchased in the same period a year ago.

In addition, we repurchased $6.6 million of shares of our common stock in the first six months of the current fiscal year, compared to $7.4 million of shares repurchased in the same period a year ago.

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.

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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 July 3, 2022, we repurchased 181,657 shares of common stock with an aggregate purchase price of $6.6 million.

During the three months

ended June 27, 2021, 100,954 shares were repurchased with an aggregate purchase price of $3.4 million.

As of July 3, 2022, 129,348 shares remained available to be repurchased under the share repurchase program.

During the six months ended October 2, 2022, we repurchased 181,657 shares of common stock with an aggregate purchase price of $6.6 million.

During the six months ended September 26, 2021, 209,963 shares were repurchased with an aggregate purchase price of $7.4 million.

As of October 2, 2022, 1,129,348 shares remained available to be repurchased under the share repurchase program.

We are party to a second amended and restated credit agreement (the “Credit Agreement”) with U.S.

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The base rate margin is between 0.00% and 0.35%, depending on our leverage ratio.

At July 3, 2022, the effective interest rate on our borrowings was 2.8%.

At October 2, 2022, the effective interest rate on our borrowings was 3.4%.

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.

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Debt issuance costs paid to the Lenders are being amortized as interest expense over the term of the Credit Agreement.

As of July 3, 2022, the unamortized balance of these costs was $0.4 million, and is reflected as a reduction of debt on our balance sheet.

As of October 2, 2022, the unamortized balance of these costs was $0.4 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.

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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 July 3, 2022 and expect to remain in compliance with all covenants for the next 12 months.

We were in compliance with all covenants of the Credit Agreement as of October 2, 2022 and expect to remain in compliance with all covenants for the next 12 months.

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.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis