# HAWKINS INC (HWKN) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from HAWKINS INC's 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/46250/000004625022000016/hwkn-20220403.htm
Accession: 0000046250-22-000016
Filing date: 2022-05-18
Report date: 2022-04-03
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/HWKN/
All MD&A years: /company/HWKN/mda/
Next year: /company/HWKN/mda/fy2023/ (FY 2023)

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is a discussion and analysis of our financial condition and results of operations for fiscal 2022 and 2021. This discussion should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

We have omitted discussion of the earliest of the three years covered by our consolidated financial statements presented in this report because that disclosure was already included in our Annual Report on Form 10-K for fiscal 2021, filed with the SEC on June 2, 2021. You are encouraged to reference Part II, Item 7, within that report, for a discussion of our financial condition and results of operations for fiscal 2020 compared to fiscal 2021.

Overview

We derive substantially all of our revenues from the sale of specialty chemicals and ingredients that we formulate, distribute, blend and manufacture for our Industrial, Water Treatment and Health and Nutrition customers.

Financial Overview

Highlights of fiscal 2022 include:

•Sales of $774.5 million, a 30% increase from fiscal 2021;

•Gross profit of $146.5 million, an increase of $22.8 million, or 18% from fiscal 2021;

•An increase in selling, general and administrative (“SG&A”) expenses of $7.4 million year over year, but a decrease of 160 basis points as a percentage of sales when compared to fiscal 2021;

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.

Business and Property Acquisitions

On December 30, 2021, 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 manufactures and distributes water treatment chemicals from three locations in Texas. The results of operations are included as part of our Water Treatment segment from the date of acquisition forward.

On October 29, 2021, 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.

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On September 20, 2021, 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.

In the fourth quarter of fiscal 2021, we acquired substantially all the assets of C & L Aqua Professionals, Inc. and LC Blending, Inc. (together, “C&L Aqua”) under the terms of an asset purchase agreement among us, C&L Aqua and its shareholders. C&L Aqua was a water treatment chemical distribution company operating primarily in Louisiana. The results of operations since the acquisition date are included in our Water Treatment segment.

In the third quarter of fiscal 2021, we acquired a manufacturing facility to allow further expansion and growth in both our Industrial and Water Treatment segments. This site is adjacent to our facility in Rosemount, Minnesota, adding 40,000 square feet of manufacturing and warehouse space on 28 acres of land to bring us to a total of 105,000 square feet of space on 56 acres of land, with rail access at both of the sites. The expansion will allow for future growth and provide supply chain flexibility on certain raw materials to better serve our customers.

In the second quarter of fiscal 2021, we acquired substantially all the assets of American Development Corporation of Tennessee, Inc. (“ADC”) under the terms of an asset purchase agreement among us, ADC and its shareholders. ADC was a water treatment chemical distribution company operating primarily in Tennessee, Georgia and Kentucky. The results of operations since the acquisition date are included in our Water Treatment segment.

The aggregate annual revenue 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. The aggregate annual revenue from the fiscal 2021 acquisitions totaled approximately $25 million, as determined using the applicable twelve-month period preceding each respective acquisition date.

Stock Split

On March 1, 2021, we effected a two-for-one split of our common stock and adjusted the par value from $.05 per share to $0.01 per share. At the same time, we increased the number of authorized shares from 30 million to 60 million. Our consolidated financial statements, related notes, and other financial data contained in this report have been adjusted to give retroactive effect to the stock split for all periods presented.

Statement on COVID-19

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 the 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 country's critical infrastructure.

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Results of Operations

The following table sets forth certain items from our statement of income as a percentage of sales for fiscal 2022 and 2021: 

[[GREPCENT_TABLE]]
[["","","Fiscal 2022","","Fiscal 2021"],["Sales","","100.0","%","","100.0","%"],["Cost of sales","","(81.1)","%","","(79.3)","%"],["Gross profit","","18.9","%","","20.7","%"],["Selling, general and administrative expenses","","(9.7)","%","","(11.3)","%"],["Operating income","","9.2","%","","9.4","%"],["Interest expense, net","","(0.2)","%","","(0.2)","%"],["Other income","","\u2014","%","","0.2","%"],["Income before income taxes","","9.0","%","","9.4","%"],["Income tax provision","","(2.3)","%","","(2.5)","%"],["Net income","","6.7","%","","6.9","%"]]
[[/GREPCENT_TABLE]]

Fiscal 2022 Compared to Fiscal 2021

Sales

Sales were $774.5 million for fiscal 2022, an increase of $177.7 million, or 30%, from sales of $596.9 million for fiscal 2021. We estimated the impact of the 53rd week in fiscal 2022 to be approximately $17.5 million in additional sales.

Industrial Segment.  Industrial segment sales increased $113.6 million, or 42%, to $386.9 million for fiscal 2022, as compared to $273.4 million for fiscal 2021. Sales of bulk commodity products in the Industrial segment were approximately 16% of sales dollars in fiscal 2022 and 14% of sales dollars in fiscal 2021. We estimated the impact of the 53rd week in fiscal 2022 to be approximately $10.0 million in additional sales in our Industrial segment. In addition, 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 increased sales of our bulk and our manufactured, blended and repackaged products.

Water Treatment Segment.  Water Treatment segment sales increased $58.1 million, or 34%, to $228.1 million for fiscal 2022, as compared to $170.0 million for fiscal 2021. Sales of bulk commodity products in the Water Treatment segment were approximately 9% of sales dollars in both fiscal 2022 and fiscal 2021. We estimated the impact of the 53rd week in fiscal 2022 to be approximately $3.9 million in additional sales in our Water Treatment segment. In addition, sales increased as a result of increased demand for our products as well as the added sales from acquisitions.

Health and Nutrition Segment. Health and Nutrition segment sales increased $6.0 million, or 4%, to $159.5 million for fiscal 2022, as compared to $153.5 million for fiscal 2021. We estimated the impact of the 53rd week in fiscal 2022 to be approximately $3.6 million in additional sales in our Health and Nutrition segment. In addition, sales increased as a result of an increase in sales of our specialty distributed products, which was partially offset by the normalizing of demand for our manufactured products when compared to the temporary COVID-driven increase in demand these products experienced in the prior year.

Gross Profit

Gross profit increased $22.8 million, or 18%, to $146.5 million, or 19% of sales, for fiscal 2022, from $123.8 million, or 21% of sales, for fiscal 2021. During fiscal 2022, the LIFO reserve increased, and gross profits decreased, by $15.8 million, primarily due to rising input costs. In fiscal 2021, the LIFO reserve decreased, and gross profits increased, by $0.1 million. We estimated the impact of the 53rd week in fiscal 2022 to be approximately $3.6 million in additional gross profit.

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Industrial Segment.  Gross profit for the Industrial segment increased $16.3 million, or 38%, to $59.6 million, or 15% of sales, for fiscal 2022, from $43.3 million, or 16% of sales, for fiscal 2021. During fiscal 2022, the LIFO reserve increased, and gross profits decreased, by $10.4 million, primarily due to rising raw material costs. In fiscal 2021, the LIFO reserve decreased, and gross profits increased, by $0.2 million. We estimated the impact of the 53rd week in fiscal 2022 to be approximately $1.9 million in additional gross profit in our Industrial segment. In addition, gross profit increased as a result of the increase in sales, partially offset by the negative impact resulting from the increase in the LIFO reserve.

Water Treatment Segment.  Gross profit for the Water Treatment segment increased $7.8 million, or 17%, to $54.6 million, or 24% of sales, for fiscal 2022, from $46.8 million, or 28% of sales, for fiscal 2021. During fiscal 2022, the LIFO reserve increased, and gross profits decreased, by $5.4 million, primarily due to rising raw material costs. During fiscal 2021, the LIFO reserve increased, and gross profit decreased, by $0.1 million. We estimated the impact of the 53rd week in fiscal 2022 to be approximately $1.0 million in additional gross profit in our Water Treatment segment. In addition, gross profit increased as a result of the increase in sales.

Health and Nutrition Segment. Gross profit for our Health and Nutrition segment decreased $1.3 million, or 4%, to $32.3 million, or 20% of sales, for fiscal 2022, from $33.6 million, or 22% of sales, for fiscal 2021. We estimated the impact of the 53rd week in fiscal 2022 to be approximately $0.7 million in additional gross profit in our Health and Nutrition segment. This increase from the 53rd week was more than offset by a decrease in gross profit resulting from a decline in sales of our manufactured products which generally have higher per-unit margins than our specialty distributed products.

Selling, General and Administrative Expenses

SG&A expenses increased $7.4 million to $75.3 million, or 10% of sales, for fiscal 2022, from $67.9 million, or 11% of sales, for fiscal 2021. We estimated the impact of the 53rd week in fiscal 2022 to be approximately $1.0 million in additional SG&A expense. In addition, expenses increased in part due to the added costs from the acquired businesses in the Water Treatment segment, an increase in variable incentive compensation, increased costs due to added personnel and other resources as we invest to grow the business, and normalization of travel and other variable expenses to pre-COVID levels.

Operating Income

Operating income was $71.2 million, or 9% of sales, for fiscal 2022, as compared to $55.9 million, or 9% of sales, for fiscal 2021 due to the combined impact of the factors discussed above. We estimated the impact of the 53rd week in fiscal 2022 to be approximately $3 million in additional operating income.

Interest Expense, Net

Interest expense was $1.4 million for fiscal 2022, a decrease of $0.1 million from interest expense of $1.5 million for fiscal 2021. Lower borrowing rates compared to the prior year more than offset the increase in outstanding borrowings in the current year.

Income Tax Provision

Our effective tax rate was approximately 26.5% for both fiscal 2022 and fiscal 2021. The effective tax rate is impacted by projected levels of annual taxable income, permanent items, and state taxes.

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Selected Quarterly Financial Data

Selected financial data for our fiscal quarters is shown below. No changes have been made to previously reported information.

[[GREPCENT_TABLE]]
[["(In thousands, except per share data)","","Fiscal 2022"],["","","First","","Second","","Third","","Fourth","","Total"],["Sales","","$","181,241","","","$","183,277","","","$","187,050","","","$","222,973","","","$","774,541"],["Gross profit","","38,974","","","37,287","","","33,940","","","36,319","","","146,520"],["Selling, general, and administrative expenses","","16,856","","","17,679","","","19,681","","","21,110","","","75,326"],["Operating income","","22,118","","","19,608","","","14,259","","","15,209","","","71,194"],["Net income","","16,628","","","14,133","","","10,204","","","10,577","","","51,542"],["Basic earnings per share","","$","0.79","","","$","0.67","","","$","0.49","","","$","0.51","","","$","2.46"],["Diluted earnings per share","","$","0.79","","","$","0.67","","","$","0.48","","","$","0.50","","","$","2.44"],["","","Fiscal 2021"],["","","First","","Second","","Third","","Fourth"],["Sales","","$","143,172","","","$","147,801","","","$","142,927","","","$","162,971","","","$","596,871"],["Gross profit","","30,976","","","32,797","","","28,239","","","31,750","","","123,762"],["Selling, general, and administrative expenses","","15,038","","","16,221","","","17,750","","","18,875","","","67,884"],["Operating income","","15,938","","","16,576","","","10,489","","","12,875","","","55,878"],["Net income","","11,788","","","12,190","","","7,921","","","9,081","","","40,980"],["Basic earnings per share","","$","0.56","","","$","0.58","","","$","0.38","","","$","0.43","","","$","1.95"],["Diluted earnings per share","","$","0.55","","","$","0.57","","","$","0.37","","","$","0.43","","","$","1.93"],["","","Fiscal 2020"],["","","First","","Second","","Third","","Fourth"],["Sales","","$","147,336","","","$","140,043","","","$","120,406","","","$","132,413","","","$","540,198"],["Gross profit","","28,797","","","27,994","","","21,478","","","22,648","","","100,917"],["Selling, general, and administrative expenses","","14,836","","","14,817","","","14,702","","","14,891","","","59,246"],["Operating income","","13,961","","","13,177","","","6,776","","","7,757","","","41,671"],["Net income","","9,807","","","9,250","","","4,547","","","4,763","","","28,367"],["Basic earnings per share","","$","0.46","","","$","0.44","","","$","0.22","","","$","0.23","","","$","1.34"],["Diluted earnings per share","","$","0.46","","","$","0.43","","","$","0.21","","","$","0.22","","","$","1.33"]]
[[/GREPCENT_TABLE]]

Earnings per share may not equal the face of the Consolidated Statements of Income due to rounding.

Liquidity and Capital Resources

Cash provided by operating activities in fiscal 2022 was $42.8 million compared to $43.8 million in fiscal 2021. The decrease in cash provided by operating activities in fiscal 2022 as compared to fiscal 2021 was driven by higher inventory levels and increases in customer receivables resulting from higher sales, mostly offset by an increase in net income and accounts payable. The inventory increase was driven by increased raw material costs as well as a conscious management decision to increase inventory levels due to increased customer demand and supply chain issues. Due to the nature of our operations, which includes purchases of large quantities of bulk chemicals, the timing of purchases can result in significant changes in working capital and the resulting operating cash flow. Historically, our cash requirements for working capital increase during the period from March through November as caustic soda inventory levels increase as most of our barges are received during this period.

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Cash used in investing activities was $49.8 million in fiscal 2022 compared to $71.4 million in fiscal 2021. Capital expenditures were $28.5 million in fiscal 2022 and $20.8 million in fiscal 2021. Total cash used in investing activities in fiscal 2022 included an aggregate of $21.5 million for Water Treatment group acquisitions compared to $51.0 million in Water Treatment group acquisition spending in fiscal 2021. Capital expenditures in fiscal 2022 included vehicles and trucks, facility improvements, and pharmaceutical ingredient manufacturing capabilities, along with other new and replacement equipment. Capital expenditures in fiscal 2021 included pharmaceutical ingredient manufacturing capabilities, vehicles and trucks, and the purchase of a previously leased Water Treatment branch facility, along with other new and replacement equipment.

Cash provided by financing activities was $7.4 million in fiscal 2022, as compared to $26.4 million in fiscal 2021. Cash provided by financing activities included net debt borrowings of $27.0 million in fiscal 2022, compared to net debt borrowings of $39.0 million in fiscal 2021, which was used primarily to fund our acquisitions in both fiscal years. We paid out cash dividends of $11.1 million in fiscal 2022 and $10.0 million in fiscal 2021. In fiscal 2022, we used $8.5 million to repurchase shares under our board-authorized share repurchase program, and in fiscal 2021, we used $4.1 million to repurchase shares under the program.

Our cash balance was $3.5 million at April 3, 2022, an increase of $0.5 million as compared with March 28, 2021. Cash flows generated by operations and financing activities during fiscal 2022 were offset by the cash expended for acquisitions in fiscal 2022, capital expenditures and dividend payments.

We were party to an amended and restated credit agreement (the “Prior Credit Agreement”) with U.S. Bank as Sole Lead Arranger and Sole Book Runner, and other lenders from time to time party thereto (collectively, the “Lenders”), whereby U.S. Bank was also serving as Administrative Agent. The Prior Credit Agreement provided us with senior secured revolving credit facilities (the “Prior Revolving Loan Facility”) totaling $150.0 million. The Prior Revolving Loan Facility included a $5.0 million letter of credit subfacility and $15.0 million swingline subfacility. The Prior Revolving Loan Facility was scheduled to terminate on November 30, 2023, and was secured by substantially all of our personal property assets and those of our subsidiaries.

On March 31, 2022, we entered into 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 used $126.0 million of the proceeds from the Revolving Loan Facility to refinance the obligations under the previous credit facility. We may use the remaining amount of 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 April 3, 2022, the effective interest rate on our borrowings was 1.2%.

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

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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 April 3, 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. 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.

Contractual Obligations and Commercial Commitments

The following table provides aggregate information about our contractual payment obligations and the periods in which payments are due: 

[[GREPCENT_TABLE]]
[["","","Payments Due by Fiscal Period"],["Contractual Obligation","","2023","","2024","","2025","","2026","","2027","","More than 5 Years","","Total"],["","","(In thousands)"],["Senior secured revolver (1)","","$","\u2014","","","$","\u2014","","","$","\u2014","","","$","\u2014","","","$","\u2014","","","$","126,000","","","$","126,000"],["Interest payments (2)","","$","1,833","","","$","1,833","","","$","1,833","","","$","1,833","","","$","1,833","","","$","152","","","$","9,317"],["Operating lease obligations (3)","","$","1,889","","","$","1,515","","","$","1,450","","","$","1,388","","","$","1,359","","","$","5,171","","","$","12,772"],["Pension withdrawal liability (4)","","$","467","","","$","467","","","$","467","","","$","467","","","$","467","","","$","3,037","","","$","5,372"]]
[[/GREPCENT_TABLE]]

(1)    Represents balance outstanding as of April 3, 2022, and assumes such amount remains outstanding until its maturity date, as periodic payments are not required under the terms of our Credit Agreement. However, it is our intention to pay down our debt with available excess cash flow. See Note 9 of our consolidated Financial Statements for further information.

(2)    Represents interest payments and commitment fees payable on outstanding balances under our revolver, and assumes interest rates remain unchanged from the rate as of April 3, 2022.

(3)    As reported under ASC Topic 842

(4)    This relates to our withdrawal from a multiemployer pension plan. Payments on this obligation will continue through 2034.

Critical Accounting Estimates

In preparing the financial statements, we follow U.S. generally accepted accounting principles (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. We re-evaluate our estimates on an on-going basis. Our estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions and conditions. We have determined we have no critical accounting estimates material to our consolidated financial position, results of operations or cash flow.

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