HWKN

HAWKINS INC - 10-Q Summary (Quarter Ended June 30, 2006)

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2006, for HAWKINS INC, a Minnesota-based corporation. The company operates in three reportable segments: Industrial, Water Treatment, and Pharmaceutical. The company is an Accelerated Filer with 10,171,496 shares of common stock outstanding as of August 8, 2006.

Key Financial Metrics

Material Changes vs. Prior Period

• Sales Growth: Sales increased by 15.6% ($5.6 million) compared to the prior year, driven primarily by the Industrial segment (+17.8%) and Water Treatment segment (+16.3%). Growth was attributed to increased volumes and selling price increases to offset material cost rises.
• Margin Compression: Gross margin percentage declined from 27.6% to 26.1%. This was caused by product cost increases and competitive pressures that limited the ability to fully pass costs to customers, particularly in the Water Treatment and Industrial segments.
• Operating Expenses: Selling, general, and administrative (SG&A) expenses increased to $6.6 million (16.0% of sales) from $5.9 million (16.5% of sales). The dollar increase was largely due to consulting fees for Enterprise Resource Planning (ERP) system implementation.
• Cash Flow: Net cash used in operating activities improved significantly, decreasing from a use of $212,491 in 2005 to $49,552 in 2006. Investing activities shifted from a use of $1.46 million to a provision of $292,916, driven by reduced capital expenditures and investment maturities.
• Dividends: The company paid cash dividends of $2,034,299 during the quarter.

Guidance, Outlook, and Risks

• Outlook: Management expects capital expenditures for the remainder of the fiscal year to be comparable to the previous three years, focusing on facilities improvements and new route sales trucks. The company anticipates funding short and long-term needs with internally generated funds and does not expect to engage in significant financing activities.
• Seasonality: Cash requirements historically increase from April through September due to rising caustic soda inventory levels and seasonal increases in accounts receivable for the water treatment business.
• Risks:
  • Commodity Prices: The company is subject to cyclical fluctuations in commodity chemical prices. While they attempt to pass costs to customers, there is no assurance this will be possible in the future.
  • Investment Risk: The company holds a significant portfolio of fixed income securities and mutual funds subject to interest rate risk and market volatility. A loss of $30,595 was recorded on investments deemed other-than-temporarily impaired.
  • Asset Retirement Obligations: The company has not recorded a liability for asset retirement obligations related to land leases expiring in 2018, as the fair value cannot be reasonably estimated due to the likelihood of lease renewals.
• Unusual Items: The adoption of new accounting standards (SFAS 151, SFAS 123R, SFAS 153) effective April 3, 2006, did not have a material impact on results. The company is evaluating the impact of FIN No. 48 regarding uncertainty in income taxes, effective April 2, 2007.

Key Facts for Investor Verification

• Verify the sustainability of the 15.6% sales growth given the 1.5% decline in gross margin percentage.
• Monitor the impact of the ERP system implementation on future SG&A expenses and operational efficiency.
• Review the composition of the investment portfolio ($23 million total liquid assets) and the potential for further impairment losses given market volatility.
• Assess the company's ability to maintain pricing power in the Industrial and Water Treatment segments amidst rising material costs.
• Confirm the status of the LIFO reserve, which indicates inventories are valued at approximately $3.7 million less than current cost.