HAWKINS INC (HWKN) FY 2024 MD&A

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 2024 and 2023. 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 2023, filed with the SEC on May 17, 2023. 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 2023 compared to fiscal 2022.

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 2024 include:

•Sales of $919.2 million, a 2% decrease from fiscal 2023;

•Gross profit of $193.6 million, an increase of $28.5 million, or 17% from fiscal 2023; and

•Diluted earnings per share (EPS) of $3.59, an increase of $0.73, or 26%, from fiscal 2023.

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.

Factors Affecting Comparability of Results

Business Acquisitions and Asset Sales

On March 8, 2024, we acquired substantially all the assets of Industrial Research Corporation ("Industrial Research") under the terms of a purchase agreement with Industrial Research and its shareholders. Industrial Research was a distributor of water treatment chemicals and equipment for its customers in central to northern Louisiana, eastern Texas and southern Arkansas. The results of operations since the acquisition and the assets are included in our Water Treatment segment.

On October 31, 2023, we acquired substantially all the assets of The Miami Products & Chemical Company ("Miami Products") under the terms of a purchase agreement with Miami Products and its shareholders. Miami Products was a bleach manufacturer and distributor serving customers primarily throughout Ohio and the surrounding region. The results of operations since the acquisition date and the assets are included in our Water Treatment segment.

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On October 27, 2023, we acquired substantially all the assets of Water Solutions Unlimited, Inc. ("Water Solutions") under the terms of a purchase agreement with Water Solutions and its shareholders. Water Solutions was a manufacturer and distributor of water treatment chemicals serving customers primarily throughout Indiana, Illinois and Michigan. The results of operations since the acquisition date and the assets are included in our Water Treatment segment.

On July 14, 2023, we acquired substantially all the assets of EcoTech Enterprises, Inc. ("EcoTech") under the terms of a purchase agreement with EcoTech and its shareholders. EcoTech was a water treatment chemical distribution company operating primarily in Arkansas. The results of operations since the acquisition date and the assets are included in our Water Treatment segment.

The aggregate annual revenue of these four businesses acquired in fiscal 2024 totaled approximately $70 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 has been recorded as a reduction to selling, general and administrative expenses.

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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 2024 and 2023:

Fiscal 2024 Compared to Fiscal 2023

Sales

Sales were $919.2 million for fiscal 2024, a decrease of $15.9 million, or 2%, from sales of $935.1 million for fiscal 2023. Increased sales in our Water Treatment segment were more than offset by decreased sales in our Industrial and Health & Nutrition segments.

Industrial Segment.  Industrial segment sales decreased $61.3 million, or 13%, to $409.5 million for fiscal 2024, as compared to $470.8 million for fiscal 2023. Sales of bulk commodity products in the Industrial segment were approximately 14% of sales dollars in fiscal 2024 and 16% of sales dollars in fiscal 2023. The sale of our consumer bleach packaging business at the end of fiscal 2023 resulted in $14.5 million lower sales in the current year. In addition, sales declined due to overall lower volumes.

Water Treatment Segment.  Water Treatment segment sales increased $58.4 million, or 19%, to $363.3 million for fiscal 2024, as compared to $304.9 million for fiscal 2023. Sales of bulk commodity products in the Water Treatment segment were approximately 9% of sales dollars in both fiscal 2024 and fiscal 2023. In addition to $23.9 million in sales from acquired businesses, 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.

Health and Nutrition Segment. Health and Nutrition segment sales decreased $13.0 million, or 8%, to $146.4 million for fiscal 2024, as compared to $159.4 million for fiscal 2023. Sales decreased primarily due to decreased sales of our manufactured products, which we believe was driven by customers destocking inventory in the first half of the current fiscal year.

Gross Profit

Gross profit increased $28.5 million, or 17%, to $193.6 million, or 21% of sales, for fiscal 2024, from $165.1 million, or 18% of sales, for fiscal 2023. During fiscal 2024, the LIFO reserve decreased, and gross profits increased, by $15.4 million, primarily due to decreased raw material costs. In fiscal 2023, the LIFO reserve increased, and gross profits decreased, by $18.5 million, primarily due to rising raw material costs. Included as a reduction to gross profit in the current year was a $7.7 million charge to operating expense for an environmental liability related to perchlorinated biphenyls (PCBs) discovered in the soil at our Rosemount, MN facility.

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Industrial Segment.  Gross profit for the Industrial segment decreased $0.6 million, or 1%, to $67.5 million, or 16% of sales, for fiscal 2024, from $68.1 million, or 14% of sales, for fiscal 2023. During fiscal 2024, the LIFO reserve decreased, and gross profits increased, by $12.1 million, primarily due to decreased raw material costs. In fiscal 2023, the LIFO reserve increased, and gross profits decreased, by $12.3 million, primarily due to rising raw material costs. Offsetting the impact of the favorable year-over-year LIFO change, gross profit decreased as a result of the $7.7 million charge to operating expense for an environmental liability related to PCBs discovered in the soil at our Rosemount, MN facility as well as lower sales.

Water Treatment Segment.  Gross profit for the Water Treatment segment increased $31.3 million, or 47%, to $98.5 million, or 27% of sales, for fiscal 2024, from $67.2 million, or 22% of sales, for fiscal 2023. During fiscal 2024, the LIFO reserve decreased, and gross profits increased, by $3.3 million, primarily due to decreased raw material costs. During fiscal 2023, the LIFO reserve increased, and gross profit decreased, by $6.2 million, primarily due to rising raw material costs. 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 acquired businesses.

Health and Nutrition Segment. Gross profit for our Health and Nutrition segment decreased $2.2 million, or 7%, to $27.6 million, or 19% of sales, for fiscal 2024, from $29.8 million, or 19% of sales, for fiscal 2023. Gross profit decreased due to lower sales.

Selling, General and Administrative Expenses

SG&A expenses increased $12.6 million, or 16% to $89.6 million, or 10% of sales, for fiscal 2024, from $77.0 million, or 8% of sales, for fiscal 2023. Included in SG&A expenses for the prior year was a gain of approximately $3.0 million related to the sale of certain assets related to our consumer bleach packaging business. In addition, a year-over-year increase in compensation expense of $1.4 million related to our non-qualified deferred compensation plan reduced SG&A expenses, with the offset in Other Expense. Additionally, expenses increased due to the added costs from the acquired businesses in our Water Treatment segment of $5.8 million, including $1.8 million of amortization of intangibles, as well as increased variable expenses, most notably variable pay.

Operating Income

Operating income increased $15.8 million, or 18%, to $104.0 million, or 11% of sales, for fiscal 2024, as compared to $88.2 million, or 9% of sales, for fiscal 2023 due to the combined impact of the factors discussed above.

Interest Expense, Net

Interest expense was $4.3 million for fiscal 2024, a decrease of $0.9 million from interest expense of $5.2 million for fiscal 2023. Interest expense decreased due to lower outstanding borrowings in the current year as compared to the prior year, offset slightly by higher borrowing rates.

Income Tax Provision

Our effective tax rate was approximately 26% for fiscal 2024 and 27% for fiscal 2023. The current year decrease in the effective tax rate was primarily driven by favorable tax provision adjustments recorded. 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.

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 2024 was $159.5 million compared to $77.4 million in fiscal 2023. Our net cash provided by operating activities increased $82.1 million compared to fiscal 2023. In fiscal 2024, our operating cash flow was improved by $47 million in the aggregate due primarily to favorable year-over-year changes in trade receivables and inventory. In the prior fiscal year, we expended a net of $13 million in the aggregate for working capital primarily as a result of lower year-over-year payables. This, combined with improved net income, resulted in the year-over-year increase in net cash provided by operating activities. 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.

Cash used in investing activities was $122.5 million in fiscal 2024 compared to $41.2 million in fiscal 2023. Capital expenditures for property, plant and equipment were $40.2 million in fiscal 2024 and $48.3 million in fiscal 2023. The current year decrease in capital expenditures was primarily driven by decreased expenditures for facility improvements and expansions. Cash used in investing activities included Water Treatment group acquisition spending of $83.5 in fiscal 2024 compared to no acquisition spending for acquisitions in fiscal 2023. Cash used in investing activities also included proceeds from asset disposals of $1.1 million in fiscal 2024 compared to $7.1 million in fiscal 2023. The proceeds received in fiscal 2023 related primarily to our sale of certain assets related to our consumer bleach packaging business.

Cash used in financing activities was $37.4 million in fiscal 2024 compared to $32.1 million in fiscal 2023. Cash used in financing activities included net debt repayments of $13.0 million in fiscal 2024 and $14.0 million in fiscal 2023. We paid out cash dividends of $13.2 million in fiscal 2024 and $12.0 million in fiscal 2023. In fiscal 2024, we used $11.3 million to repurchase shares under our board-authorized share repurchase program, and in fiscal 2023, we used $6.6 million to repurchase shares under the program.

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Our cash balance was $7.2 million at March 31, 2024, a decrease of $0.4 million as compared with April 2, 2023. Cash flows generated by operations during fiscal 2024 were offset by the cash expended for acquisitions, capital expenditures, repayments of debt, dividend payments and share repurchases in fiscal 2024.

We are party to a Credit Agreement with U.S. Bank as Sole Lead Arranger and Sole Book Runner, and other lenders from time to time party thereto, whereby U.S. Bank is also serving as Administrative Agent. The Credit Agreement provides us with a Revolving Loan Facility totaling $250.0 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.

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 March 31, 2024, the effective interest rate on our borrowings was 4.3%.

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 March 31, 2024, 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 March 31, 2024 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.

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Material Cash Requirements

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

(1)    Represents balance outstanding as of March 31, 2024, 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 8 of our consolidated Financial Statements for further information.

(2)    Represents interest payments and commitment fees payable on outstanding balances under our revolver, net of the expected receivable from our interest rate swap agreement, and assumes interest rates remain unchanged from the rate as of March 31, 2024.

(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.

In addition to the above contractual obligations, in the ordinary course of business we have routine cash requirements related to capital expenditures for new trucks, facility improvements and expansions, safety equipment and other additions of property, plant and equipment. Our capital expenditures in fiscal 2024 were $40.2 million and in fiscal 2023 were $48.3 million. We anticipate total capital expenditures to be in the range of $40 to $45 million for fiscal 2025.

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 ongoing 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 the following is a critical accounting estimate material to our consolidated financial position, results of operations or cash flow.

Acquisition accounting. The fair value of the consideration we pay for each new acquisition is allocated to tangible assets and identifiable intangible assets and liabilities assumed. The accounting for acquisitions involves a considerable amount of judgment and estimate, including the fair value of certain forms of consideration; fair value of acquired intangible assets involving projections of future revenues and cash flows that are then either discounted at an estimated discount rate or measured at an estimated royalty rate; fair value of other acquired assets and assumed liabilities, including potential contingencies; and the useful lives of the acquired assets. The assumptions used are determined at the time of the acquisition in accordance with accepted valuation models. Projections are developed using internal forecasts, available industry and market data and estimates of long-term rates of growth for the business. The impact of prior or future acquisitions on our financial position or results of operations may be materially impacted by the change in or initial selection of assumptions and estimates. See Note 2, Acquisitions included in Part II, Item 8 of this Form 10-K for further discussion of business combination accounting valuation methodology and assumptions.

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