Hawkins, Inc. — Q2 Fiscal 2019 Form 10-Q
Reporting period: Quarter and six months ended September 30, 2018; comparative periods ended October 1, 2017. Unaudited. Hawkins sells chemicals and specialty ingredients through its Industrial, Water Treatment, and Health and Nutrition segments.
Financial performance
| Metric | Q2 FY2019 | Q2 FY2018 | Six months FY2019 | Six months FY2018 |
|---|---|---|---|---|
| Sales | $145.3 million | $125.4 million | $295.1 million | $259.1 million |
| Gross profit / margin | $25.8 million / 17.7% | $24.1 million / 19.2% | $54.2 million / 18.4% | $50.1 million / 19.3% |
| Operating income / margin | $10.8 million / 7.4% | $9.3 million / 7.4% | $24.3 million / 8.3% | $19.5 million / 7.5% |
| Net income | $7.4 million | $5.2 million | $16.5 million | $11.0 million |
| Diluted earnings per share | $0.69 | $0.49 | $1.54 | $1.04 |
- Quarterly sales rose 15.9%; first-half sales rose 13.9%. Management attributed growth across the segments to higher volumes, specialty-product sales, and—in some cases—higher selling prices reflecting raw-material costs.
- Gross margin declined in both comparison periods. Higher transportation and fuel costs and operating overhead, including unplanned repairs and maintenance, weighed on profitability. Industrial quarterly gross profit was flat despite higher sales; Water Treatment and Health and Nutrition gross profit increased.
- SG&A was $14.9 million for the quarter and $29.9 million for the half-year, compared with $14.8 million and $30.6 million, respectively. Operating margin was unchanged for Q2 and improved for the half-year.
- Effective tax rates fell to 26.6% for Q2 and 27.0% for the half-year, from 38.5% in both prior-year periods, primarily reflecting the Tax Act’s lower federal corporate rate. The prior fiscal year included a one-time $13.9 million tax benefit from remeasuring deferred tax liabilities; that benefit is not part of current-period earnings.
Cash, debt, and liquidity
- Six-month operating cash flow was $24.9 million, versus $4.5 million a year earlier. Investing activities used $4.1 million, including $4.2 million of capital expenditures, compared with $13.0 million and $13.2 million, respectively, in the prior-year period.
- Financing activities used $21.7 million, including $7.1 million of dividends, $5.0 million of term-loan repayments, and $10.0 million of net revolver repayments. Cash declined $1.0 million to $4.0 million from April 1, 2018.
- At September 30, 2018, total debt was $86.0 million, down from $101.0 million at April 1, 2018. The company had $80.0 million outstanding on its term loan and $6.0 million on its revolving facility. The $65.0 million revolver is part of a $165.0 million secured credit facility scheduled to mature December 23, 2020.
- Current assets were $139.9 million and current liabilities were $58.8 million. Inventory rose to $67.8 million from $59.7 million at fiscal year-end. Management said cash needs typically increase from April through November as caustic soda inventory builds.
- Management expects cash, operating cash flow, and credit-facility availability to fund ongoing operations for the foreseeable future. The company reported compliance with all credit covenants. Its effective borrowing rate was 2.9%; a 25-basis-point rate change was estimated to affect annual interest expense by approximately $0.1 million. An interest-rate swap hedges part of variable-rate debt.
Outlook, risks, and unusual items
- No numerical earnings or revenue guidance was provided. Management noted that interim results are not necessarily indicative of full-year results and described potential future acquisitions as part of its growth strategy.
- Commodity chemical prices are cyclical. Hawkins seeks to pass raw-material cost changes to customers but cautioned that it may not always be able to do so; the company does not hedge commodity purchases. Rising fuel and carrier costs also affected results.
- A $0.6 million liability was recorded in fiscal 2018 for estimated remediation at the Minneapolis facility. No adjustment was made in the first half of fiscal 2019; management warned the reserve could prove insufficient and could not estimate any further potential impact.
- The company reported no material pending legal proceedings and no material changes to previously disclosed risk factors. Disclosure controls were deemed effective, with no material change in internal control over financial reporting during the quarter.
- Revenue-recognition guidance adopted April 2, 2018 had no impact on financial statements or retained earnings. Hawkins was still evaluating the expected effects of the new lease-accounting standard, including lease-extension provisions.
Key investor items to verify
- Whether sales growth is being sustained by underlying volumes and product mix, rather than selling-price increases tied to higher raw-material costs.
- Whether gross-margin pressure from freight, fuel, repairs, and operating costs moderates, particularly in Industrial and Water Treatment.
- Inventory growth and seasonal working-capital requirements, and their effect on operating cash flow in subsequent quarters.
- Debt reduction, revolver availability, covenant headroom, and sensitivity to variable interest rates.
- Whether the Minneapolis remediation reserve remains adequate and how the company finalizes its Tax Act accounting and lease-standard assessment.