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 nine months ended January 1, 2023 as compared to the similar period ended December 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 . 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 2022, we acquired substantially all the assets of NAPCO Chemical Company, Inc. and its affiliates ("NAPCO") under the terms of an asset purchase agreement among us, NAPCO and certain other parties thereto. NAPCO manufactured and distributed water treatment chemicals from three locations in Texas. 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. Water and Waste Specialties was a water treatment chemical distribution company operating primarily in Alabama. The results of operations since the acquisition date are included in our Water Treatment segment. In the second quarter of fiscal 2022, we acquired substantially all the assets of Southeast Water Systems LLC, under the terms of an asset purchase agreement with Southeast Water Systems and its shareholders. Southeast Water Systems supplied and installed water treatment chemical equipment to its customers located primarily in Alabama, southern Georgia and the Florida panhandle. The results of operations since the acquisition date are included in our Water Treatment segment. The aggregate annual revenue of the three businesses acquired in fiscal 2022 totaled approximately $17 million, as determined using the applicable twelve-month period preceding each respective acquisition date. Share Repurchase Program 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. As of January 1, 2023, 1,129,348 shares remain available to be repurchased under this program. 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 Nine Months Ended January 1, 2023 December 26, 2021 January 1, 2023 December 26, 2021 Sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales (83.5) % (81.9) % (81.7) % (80.0) % Gross profit 16.5 % 18.1 % 18.3 % 20.0 % Selling, general and administrative expenses (9.6) % (10.5) % (8.4) % (9.8) % Operating income 6.9 % 7.6 % 9.9 % 10.2 % Interest expense, net (0.7) % (0.2) % (0.5) % (0.2) % Other (expense) income 0.2 % 0.1 % (0.1) % 0.1 % Income before income taxes 6.4 % 7.5 % 9.3 % 10.1 % Income tax expense (1.6) % (2.1) % (2.4) % (2.6) % Net income 4.8 % 5.4 % 6.9 % 7.5 % Three Months Ended January 1, 2023 Compared to Three Months Ended December 26, 2021 Sales Sales were $219.2 million for the three months ended January 1, 2023, an increase of $32.1 million, or 17%, from sales of $187.1 million in the same period a year ago, driven primarily by increased selling prices. Industrial Segment. Industrial segment sales increased $13.8 million or 14%, to $114.4 million for the three months ended January 1, 2023, from sales of $100.6 million in the same period a year ago. Sales of bulk commodity products in the Industrial segment were approximately 18% of sales dollars in the three months ended January 1, 2023 and 16% in 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. Water Treatment Segment. Water Treatment segment sales increased $18.7 million, or 38%, to $68.5 million for the three months ended January 1, 2023, from sales of $49.8 million in the same period a year ago. Sales of bulk commodity products in the Water Treatment segment were approximately 10% of sales dollars in the three months ended January 1, 2023 and 9% 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, added sales from acquired businesses and increased sales of our products. Health & Nutrition Segment. Health and Nutrition segment sales decreased $0.5 million, or 1%, to $36.2 million for the three months ended January 1, 2023, from sales of $36.7 million in the same period a year ago. Increased sales of our manufactured products were more than offset by a decrease in sales of our specialty distributed products. Gross Profit Gross profit increased $2.4 million, or 7%, to $36.3 million, or 17% of sales, for the three months ended January 1, 2023, from $33.9 million, or 18% of sales, in the same period a year ago. During the three months ended January 1, 2023, the LIFO reserve increased, and gross profit decreased, by $3.7 million due primarily to rising raw material costs. In the same quarter a year ago, the LIFO reserve increased, and gross profit decreased, by $2.9 million. Gross profit increased due to increased revenue, partially offset by the unfavorable year-over-year impact of the increased LIFO reserve. Industrial Segment. Gross profit for the Industrial segment increased $0.7 million, or 5%, to $16.0 million, or 14% of sales, for the three months ended January 1, 2023, from $15.3 million, or 15% of sales, in the same period a year ago. During the three months ended January 1, 2023, the LIFO reserve increased, and gross profit decreased, by $2.0 million, primarily due to rising raw material costs. In the same quarter a year ago, the LIFO reserve increased, and gross profit decreased, by $2.2 million. Gross profit increased as a result of increased sales as well as improved unit margins on many of our products. Water Treatment Segment. Gross profit for the Water Treatment segment increased $2.2 million, or 20%, to $13.3 million, or 19% of sales, for the three months ended January 1, 2023, from $11.1 million, or 22% of sales, in the same period a year ago. During the three months ended January 1, 2023, the LIFO reserve increased, and gross profit decreased, by $1.7 million due primarily to rising raw material costs. In the same quarter a year ago, the LIFO reserve increased, and gross profit decreased, by $0.6 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 decreased $0.5 million, or 7.0%, to $7.0 million, or 19% of sales, for the three months ended January 1, 2023, from $7.5 million, or 21% of sales, in the same period a year ago. Gross profit decreased as a result of decreased sales. Selling, General and Administrative Expenses Selling, general and administrative (“SG&A”) expenses increased $1.3 million to $21.0 million, or 10% of sales, for the three months ended January 1, 2023, from $19.7 million, or 11% of sales, in the same period a year ago. Expenses increased primarily due to the added costs from the acquired business in our Water Treatment segment. Operating Income Operating income increased $1.0 million, or 7%, to $15.3 million, or 7% of sales, for the three months ended January 1, 2023, from $14.3 million, or 8% 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 $1.5 million for the three months ended January 1, 2023 and $0.3 million the same period a year ago. 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 income was $0.5 million for the three months ended January 1, 2023 and $0.1 million in the same period a year ago. The income represents gains recorded on investments held for our non-qualified deferred compensation plan. The amounts recorded as a gain were offset by similar amounts recorded as a decrease to compensation expense within SG&A expenses. Income Tax Provision Our effective income tax rate was 24% for the three months ended January 1, 2023 and 27% the three months ended December 26, 2021. The effective tax rate decreased from the prior year due to favorable tax provision adjustments recorded in the third quarter of fiscal 2023. 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%. Nine Months Ended January 1, 2023 Compared to Nine Months Ended December 26, 2021 Sales Sales were $707.0 million for the nine months ended January 1, 2023, an increase of $155.4 million, or 28%, from sales of $551.6 million in the same period a year ago, driven primarily by increased selling prices. Industrial Segment. Industrial segment sales increased $83.5 million, or 31%, to $353.1 million for the nine months ended January 1, 2023, from sales of $269.6 million in the same period a year ago. Sales of bulk commodity products in the Industrial segment were approximately 17% of sales dollars in the nine months ended January 1, 2023 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. Water Treatment Segment. Water Treatment segment sales increased $65.4 million, or 39%, to $233.5 million for the nine months ended January 1, 2023, from sales of $168.1 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 both the nine months ended January 1, 2023 and 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, added sales from acquired businesses and increased sales of our products. Health & Nutrition Segment. Health and Nutrition segment sales increased $6.4 million, or 6%, to $120.3 million for the nine months ended January 1, 2023, from sales of $113.9 million in the same period a year ago. Increased sales of our manufactured products more than offset a decrease in sales of our specialty distributed products. Gross Profit Gross profit increased $19.2 million or 17%, to $129.4 million, or 18% of sales, for the nine months ended January 1, 2023, from $110.2 million, or 20% of sales, in the same period a year ago. During the nine months ended January 1, 2023, the LIFO reserve increased, and gross profit decreased, by $12.7 million, due primarily to rising raw material costs. In the same period a year ago, the LIFO reserve increased, and gross profit decreased, by $7.6 million. Gross profit increased due to increased revenue, partially offset by the unfavorable year-over-year impact of the increased LIFO reserve. Industrial Segment. Gross profit for the Industrial segment increased $11.6 million, or 28%, to $53.7 million, or 15% of sales, for the nine months ended January 1, 2023, from $42.1 million, or 16% of sales, in the same period a year ago. During the nine months ended January 1, 2023, the LIFO reserve increased, and gross profit decreased, by $8.5 million, due primarily to rising raw material costs. In the same period a year ago, the LIFO reserve increased, and gross profit decreased, by $5.9 million. Gross profit increased as a result of increased sales as well as improved unit margins on many of our products, 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 $7.8 million, or 17%, to $52.7 million, or 23% of sales, for the nine months ended January 1, 2023, from $44.9 million, or 27% of sales, in the same period a year ago. During the nine months ended January 1, 2023, the LIFO reserve increased, and gross profit decreased, by $4.2 million due primarily to rising raw material costs. In the same period a year ago, the LIFO reserve increased and gross profit decreased by $1.7 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 decreased $0.2 million, to $23.0 million, or 19% of sales, for the nine months ended January 1, 2023, from $23.2 million, or 20% of sales, in the same period a year ago. In spite of an increase in overall sales dollars, gross profit decreased as a result of a product mix shift. Selling, General and Administrative Expenses SG&A expenses increased $5.5 million to $59.7 million, or 8% of sales, for the nine months ended January 1, 2023, from $54.2 million, or 10% of sales, in the same period a year ago. Expenses increased primarily due to the added costs from the acquired businesses in our Water Treatment segment and increased wages, partially offset by and a $1.3 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 $13.7 million, or 24%, to $69.7 million, or 10% of sales, for the nine months ended January 1, 2023, from $56.0 million, or 10% 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 $3.9 million for the nine months ended January 1, 2023 and $1.0 million for the same period a year ago. 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 $0.7 million for the nine months ended January 1, 2023 compared to other income of $0.5 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 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 nine months ended January 1, 2023 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 $6.1 million at January 1, 2023, an increase of $2.7 million as compared with the $3.5 million available as of April 3, 2022. Cash provided by operating activities was $44.5 million for the nine months ended January 1, 2023, compared to cash provided by operating activities of $38.7 million in the same period a year ago. The year-over-year increase in cash provided by operating activities was primarily driven by increased net income. 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 $32.0 million for the nine months ended January 1, 2023, compared to $18.0 million in the same period a year ago. Capital expenditures were $32.3 million for the nine months ended January 1, 2023, compared to $15.7 million in the same period a year ago. In the first nine months of the current year, we invested nearly $4 million on rail expansion projects at three of our facilities, an additional $1.1 million to complete an expansion of our Illinois manufacturing facility, purchased a previously leased facility for $0.9 million, and had larger investments in trucks, safety equipment and new and replacement equipment compared to the first nine months of the prior year. Cash provided by financing activities was $9.9 million for the nine months ended January 1, 2023, compared to $0.2 million of cash used in financing activities in the same period a year ago. Included in financing activities in the first nine months of the current year were net debt proceeds of $5.0 million, compared to net debt proceeds of $17.0 million in the first nine months of the prior year. In addition, we repurchased $6.6 million of shares of our common stock in the first nine months of the current fiscal year, compared to $8.5 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. Our Board has authorized the repurchase of up to 2.6 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 nine months ended January 1, 2023, we repurchased 181,657 shares of common stock with an aggregate purchase price of $6.6 million. During the nine months ended December 26, 2021, 240,501 shares were repurchased with an aggregate purchase price of $8.5 million. As of January 1, 2023, 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. 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 refinanced the revolving loan under our previous credit agreement with U.S. Bank and provides us with senior secured revolving credit facilities (the “Revolving Loan Facility”) totaling $250 million. The Revolving Loan Facility includes a $10 million letter of credit subfacility and $25 million swingline subfacility. The Revolving Loan Facility has a five-year maturity date, maturing on April 30, 2027. The Revolving Loan Facility is secured by substantially all of our personal property assets and those of our subsidiaries. We may use the amount available under the Revolving Loan Facility for working capital, capital expenditures, share repurchases, restricted payments and acquisitions permitted under the Credit Agreement, and other general corporate purposes. 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) Term SOFR, which includes a credit spread adjustment of 0.10%, for an interest period of one, 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 Term SOFR for U.S. dollars plus 1.0%. The Term SOFR 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. At January 1, 2023, the effective interest rate on our borrowings was 4.2%. 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 January 1, 2023, 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. 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 enter into 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 January 1, 2023 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. The occurrence of an event of default would permit the lenders to terminate their commitments and accelerate loans under the Credit Facility. We have in place an interest rate swap agreement to manage the risk associated with a portion of our variable-rate long-term debt. We do not utilize derivative instruments for speculative purposes. The interest rate swap involves the exchange of fixed-rate and variable-rate payments without the exchange of the underlying notional amount on which the interest payments are calculated. The notional amount of the swap agreement is $60 million and it will terminate on May 1, 2027. 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 April 3, 2022 . 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 April 3, 2022 . 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. 13