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 December 31, 2023 as compared to the similar period ended January 1, 2023. 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 2, 2023 . 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 and Asset Sales On October 31, 2023, we acquired substantially all the assets of Miami Products & Chemical Company ("Miami Products") for $15.5 million, under the terms of an asset purchase agreement with Miami Products and its shareholders. Miami Products is a bleach manufacturer and distributor serving customers primarily throughout Ohio and the surrounding region. The results of operations and the assets, including goodwill associated with this acquisition, are included as part of our Water Treatment segment from the date of acquisition forward. On October 27, 2023, we acquired substantially all the assets of Water Solutions Unlimited, Inc. ("Water Solutions") for $60 million and an additional amount to be paid after three years based on achieving certain targets, under the terms of an asset purchase agreement with Water Solutions and its shareholders. The total purchase price was estimated to be $70.7 million, including the estimated potential earnout to be paid of $10.7 million. Water Solutions is a manufacturer and distributor of water treatment chemicals serving customers primarily throughout Indiana, Illinois and Michigan. The results of operations and the assets, including goodwill associated with this acquisition, are included as part of our Water Treatment segment from the date of acquisition forward. On July 14, 2023, we acquired substantially all the assets of EcoTech Enterprises, Inc. ("EcoTech") for $3.4 million, under the terms of an asset purchase agreement with EcoTech and its shareholders. EcoTech was a manufacturer and distributor of water treatment chemicals serving customers throughout Arkansas and surrounding states. The results of operations and the assets are included as part of our Water Treatment segment from the date of acquisition forward. The aggregate annual revenue of these three businesses acquired in fiscal 2024 totaled approximately $66 million, as determined using the applicable twelve-month period preceding each respective acquisition date. In the fourth quarter of fiscal 2023, we sold certain assets in our Industrial segment related to our consumer bleach packaging business for $7 million. These assets were not deemed core to our Industrial segment operations. The assets sold included plant equipment, inventory, and intangible assets, all related to the packaging of bleach. We realized a gain of $3 million on this sale, which was recorded as a reduction to selling, general and administrative expenses. Share Repurchase Program We have in place a share repurchase program for up to 2.6 million shares of our common shares. As of December 31, 2023, 937,487 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 as raw material prices rise and fall, particularly in our Industrial and Water Treatment segments. 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 majority of our 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. We disclose the percentage of our overall sales that consist of sales of bulk commodity products as these products are generally distributed and we do not add significant value to these products in comparison to our non-bulk products. Sales of these products are generally highly competitive and price sensitive. As a result, bulk commodity products generally have our lowest margins. 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 December 31, 2023 January 1, 2023 December 31, 2023 January 1, 2023 Sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales (79.7) % (83.5) % (78.7) % (81.7) % Gross profit 20.3 % 16.5 % 21.3 % 18.3 % Selling, general and administrative expenses (11.4) % (9.6) % (9.2) % (8.4) % Operating income 8.9 % 6.9 % 12.1 % 9.9 % Interest expense, net (0.6) % (0.7) % (0.4) % (0.5) % Other (expense) income 0.4 % 0.2 % 0.1 % (0.1) % Income before income taxes 8.7 % 6.4 % 11.8 % 9.3 % Income tax expense (1.6) % (1.6) % (2.9) % (2.4) % Net income 7.1 % 4.8 % 8.9 % 6.9 % Three Months Ended December 31, 2023 Compared to Three Months Ended January 1, 2023 Sales Sales were $208.5 million for the three months ended December 31, 2023, a decrease of $10.7 million, or 5%, from sales of $219.2 million in the same period a year ago. Increased sales in our Water Treatment segment were more than offset by decreased sales in our Industrial and Health and Nutrition segments. Industrial Segment. Industrial segment sales decreased $21.4 million or 19%, to $93.0 million for the three months ended December 31, 2023, from sales of $114.4 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 December 31, 2023 and 18% in the same period of the prior year. The sale of our consumer bleach packaging business at the end of fiscal 2023 resulted in a $2.7 million decrease in sales in the current quarter. In addition, sales declined due to overall lower volumes as well as lower selling prices on certain products driven by lower raw material costs and competitive pricing pressures. Water Treatment Segment. Water Treatment segment sales increased $13.5 million, or 20%, to $82.0 million for the three months ended December 31, 2023, from sales of $68.5 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 December 31, 2023 and 10% in the same period a year ago. Sales increased as a result of increased selling prices on many of our products as well as increased sales volumes of certain of our products, including $8.2 million of added sales from acquired businesses. Health & Nutrition Segment. Health and Nutrition segment sales decreased $2.7 million, or 7%, to $33.5 million for the three months ended December 31, 2023, from sales of $36.2 million in the same period a year ago. The decrease in sales was a result of lower sales of our manufactured products, offset somewhat by increased sales of our specialty distributed products. Gross Profit Gross profit increased $5.9 million, or 16%, to $42.2 million, or 20% of sales, for the three months ended December 31, 2023, from $36.3 million, or 17% of sales, in the same period a year ago. During the three months ended December 31, 2023, the LIFO reserve decreased, and gross profit increased, by $2.5 million due primarily to decreasing raw material prices. In the same quarter a year ago, the LIFO reserve increased, and gross profit decreased, by $3.7 million due primarily to rising raw material prices. Industrial Segment. Gross profit for the Industrial segment increased $0.5 million, or 3%, to $16.5 million, or 18% of sales, for the three months ended December 31, 2023, from $16.0 million, or 14% of sales, in the same period a year ago. During the three months ended December 31, 2023, the LIFO reserve decreased, and gross profit increased, by $2.1 million due primarily to decreasing raw material costs. In the same quarter a year ago, the LIFO reserve increased, and gross profit decreased, by $2.0 million due primarily to rising raw material prices. Gross profit increased as the LIFO benefit offset lower unit margins on certain products. Water Treatment Segment. Gross profit for the Water Treatment segment increased $6.9 million, or 52%, to $20.2 million, or 25% of sales, for the three months ended December 31, 2023, from $13.3 million, or 19% of sales, in the same period a year ago. During the three months ended December 31, 2023, the LIFO reserve decreased, and gross profit increased, by $0.4 million due primarily to decreasing raw material costs. In the same quarter a year ago, the LIFO reserve increased, and gross profit decreased, by $1.7 million due primarily to rising raw material prices. Gross profit increased as a result of higher per-unit margins on many of our products as well as increased sales, including the added sales from our acquired businesses. Health and Nutrition Segment . Gross profit for our Health and Nutrition segment decreased $1.5 million, or 21%, to $5.5 million, or 16% of sales, for the three months ended December 31, 2023, from $7.0 million, or 19% 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 $2.8 million, or 13%, to $23.8 million, or 11% of sales, for the three months ended December 31, 2023, from $21.0 million, or 10% of sales, in the same period a year ago. Expenses increased due to acquisition costs of $0.7 million as well as added costs from the acquired businesses in our Water Treatment segment of $2.2 million, including $0.7 million of amortization of intangibles. Operating Income Operating income increased $3.2 million, or 21%, to $18.5 million, or 9% of sales, for the three months ended December 31, 2023, from $15.3 million, or 7% 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 $1.2 million for the three months ended December 31, 2023 and $1.5 million the same period a year ago. The decrease was due to a decrease in outstanding borrowings. Other (Expense) Income Other income was $0.9 million for the three months ended December 31, 2023 compared to $0.5 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 an increase to compensation expense within SG&A expenses. Income Tax Provision Our effective income tax rate was 18% for the three months ended December 31, 2023 and 24% for the three months ended January 1, 2023. The effective tax rate in the third quarter of both years was impacted by favorable tax provision adjustments recorded. 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 expected to be approximately 25 to 26%. Nine Months Ended December 31, 2023 Compared to Nine Months Ended January 1, 2023 Sales Sales were $696.1 million for the nine months ended December 31, 2023, a decrease of $10.9 million, or 2%, from sales of $707.0 million in the same period a year ago. Increased sales in our Water Treatment segment were more than offset by decreased sales in our Industrial and Health and Nutrition segments. Industrial Segment. Industrial segment sales decreased $40.7 million or 12%, to $312.4 million for the nine months ended December 31, 2023, from sales of $353.1 million in the same period a year ago. Sales of bulk commodity products in the Industrial segment were approximately 13% of sales dollars in the nine months ended December 31, 2023 and 17% in the same period of the prior year.The sale of our consumer bleach packaging business at the end of fiscal 2023 resulted in and $11.4 million decrease in sales in the nine months ended December 31, 2023. In addition, sales declined due to overall lower sales volumes. Water Treatment Segment. Water Treatment segment sales increased $43.1 million, or 18%, to $276.6 million for the nine months ended December 31, 2023, from sales of $233.5 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 December 31, 2023 and in the same period a year ago. Sales increased as a result of increased selling prices on many of our products as well as increased sales volumes of certain of our products, including $9.8 million of added sales from acquired businesses. Health & Nutrition Segment. Health and Nutrition segment sales decreased $13.2 million, or 11%, to $107.1 million for the nine months ended December 31, 2023, from sales of $120.3 million in the same period a year ago. The decrease in sales was a result of lower sales volumes of both our manufactured products and our specialty distributed products. Gross Profit Gross profit increased $18.7 million, or 14%, to $148.1 million, or 21% of sales, for the nine months ended December 31, 2023, from $129.4 million, or 18% of sales, in the same period a year ago. During the nine months ended December 31, 2023, the LIFO reserve decreased, and gross profit increased, by $6.0 million due primarily to decreasing raw material prices. In the same quarter a year ago, the LIFO reserve increased, and gross profit decreased, by $12.7 million due primarily to rising raw material prices. Industrial Segment. Gross profit for the Industrial segment was relatively flat at $53.6 million, or 17% of sales, for the nine months ended December 31, 2023, and $53.7 million, or 15% of sales, in the same period a year ago. During the nine months ended December 31, 2023, the LIFO reserve decreased, and gross profit increased, by $5.0 million due primarily to decreasing raw material costs. In the same quarter a year ago, the LIFO reserve increased, and gross profit decreased, by $8.5 million due primarily to rising raw material prices. Gross profit was relatively unchanged as the decreased margins as a result of the sales decline was offset by improved per-unit margins on certain products. Water Treatment Segment. Gross profit for the Water Treatment segment increased $23.3 million, or 44%, to $76.0 million, or 27% of sales, for the nine months ended December 31, 2023, from $52.7 million, or 23% of sales, in the same period a year ago. During the nine months ended December 31, 2023, the LIFO reserve decreased, and gross profit increased, by $0.9 million due primarily to decreasing raw material costs. In the same quarter a year ago, the LIFO reserve increased, and gross profit decreased, by $4.2 million due primarily to rising raw material prices. Gross profit increased as a result of improved per-unit margins on many of our products as well as increased sales, including the added sales from our acquired businesses. Health and Nutrition Segment . Gross profit for our Health and Nutrition segment decreased $4.4 million, or 19%, to $18.5 million, or 17% of sales, for the nine months ended December 31, 2023, from $23.0 million, or 19% of sales, in the same period a year ago. Gross profit decreased as a result of the decreased sales. Selling, General and Administrative Expenses Selling, general and administrative (“SG&A”) expenses increased $4.5 million, or 7%, to $64.2 million, or 9% of sales, for the nine months ended December 31, 2023, from $59.7 million, or 8% of sales, in the same period a year ago. In the current period, we recorded compensation expense of $0.9 million as a result of gains recorded on investments held for our non-qualified deferred compensation plan, as compared to a $0.7 million decrease in compensation expense in the same period a year ago as a result of losses incurred. These amounts were offset by similar amounts recorded in other income (expense). SG&A expenses also increased due to added costs from the acquired businesses in our Water Treatment segment of $2.4 million, including $0.8 million of amortization of intangibles, increased variable pay of $1.7 million, and acquisition costs of $0.8 million, offset somewhat by decreases in other variable expenses. Operating Income Operating income increased $14.3 million, or 21%, to $84.0 million, or 12% of sales, for the nine months ended December 31, 2023, from $69.7 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 $3.0 million for the nine months ended December 31, 2023 and $3.9 million the same period a year ago. The decrease was primarily due to a decrease in outstanding borrowings. Other (Expense) Income Other income was $0.9 million for the nine months ended December 31, 2023 compared to other expense of $0.7 million in the same period a year ago. The current year income represents gains recorded on investments held for our non-qualified deferred compensation plan, whereas the prior year expense represented losses recorded on those investments. The amounts recorded as a gain or loss were offset by similar amounts recorded as an increase or decrease to compensation expense within SG&A expenses. Income Tax Provision Our effective income tax rate was 25% for the nine months ended December 31, 2023 and 26% the nine months ended January 1, 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 25 to 26%. Liquidity and Capital Resources Cash was $5.7 million at December 31, 2023, a decrease of $1.8 million as compared with the $7.6 million available as of April 2, 2023. Cash provided by operating activities was $117.6 million for the nine months ended December 31, 2023, compared to cash provided by operating activities of $44.5 million in the same period a year ago. The year-over-year increase in cash provided by operating activities in the first nine months of the current year was primarily driven by decreased cash expended for inventory, along with increased customer collections and increased net income 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. Cash u sed in investing activities was $106.4 million for the nine months ended December 31, 2023, compared to $32.0 million in the same period a year ago. Capital expenditures were $28.2 million for the nine months ended December 31, 2023, compared to $32.3 million in the same period a year ago. In the first nine months of the current year, we invested $5.1 million to complete an expansion of one of our Minnesota manufacturing facilities. In the prior 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 safety equipment resulting in larger overall capital investments compared to the current year. In addition, we acquired substantially all the assets of Water Solutions Unlimited for $60.0 million, Miami Products & Ch emical for $15.5 million and EcoTech for $3.4 million in the first nine months of the current year. Cash used in financing activities was $13.1 million for the nine months ended December 31, 2023, compared to $9.9 million of cash provided by 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 $8.0 million, compared to net debt proceeds of $5.0 million in the first nine months of the prior year. In addition, we repurchased $11.3 million of our common stock in the first nine months of the current year, compared to $6.6 million in the same period of 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 2.6 million shares of our outstanding common shares. 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 December 31, 2023, we repurchased 191,861 shares of common stock with an aggregate purchase price of $11.3 million. During the nine months ended January 1, 2023, we repurchased 181,657 shares at an aggregate purchase price of $6.6 million. As of December 31, 2023, 937,487 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 December 31, 2023, the effective interest rate on our borrowings was 4.6%. 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 December 31, 2023, 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 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 December 31, 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 2, 2023 . 14 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 2, 2023 . 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. 15