Lakeland Industries, Inc. — Form 10-Q Summary
Business context and reporting period
Lakeland manufactures and sells protective garments and accessories for industrial, governmental, and public-safety markets. Its products include disposable and chemical-protective clothing, firefighting and heat-protective apparel, gloves, arm guards, and reusable woven garments. Manufacturing operations are located primarily in China, Mexico, India, and Argentina, with sales in the United States and more than 40 foreign countries.
The filing covers the three and six months ended July 31, 2017, representing the second quarter and first six months of fiscal 2018. The request metadata identifies “2016 Q2,” but the filing itself is a 2017 Form 10-Q for Q2 FY18; the comparable prior period ended July 31, 2016.
Financial performance and key metrics
| Metric | Three months ended July 31, 2017 | Three months ended July 31, 2016 | Six months ended July 31, 2017 | Six months ended July 31, 2016 |
|---|---|---|---|---|
| Net sales | $23.9 million | $22.3 million | $46.9 million | $42.6 million |
| Gross profit | $8.7 million | $8.6 million | $17.2 million | $15.4 million |
| Gross margin | 36.3% | 38.6% | 36.8% | 36.0% |
| Operating profit | $2.2 million | $2.6 million | $4.7 million | $2.8 million |
| Operating margin | 9.1% | 11.8% | 10.0% | 6.6% |
| Net income | $1.8 million | $1.4 million | $3.6 million | $1.4 million |
| Diluted EPS | $0.25 | $0.20 | $0.49 | $0.20 |
Six-month net cash provided by operating activities was $6.3 million, compared with $4.3 million in the prior-year period. Capital expenditures were $0.5 million, versus $0.05 million in the prior-year period. Net cash used in financing activities was $3.1 million, primarily reflecting $4.9 million of repayments under the revolving credit facility. Cash increased to $13.2 million from $10.4 million at January 31, 2017.
At July 31, 2017, working capital was $53.1 million. Current assets were $64.3 million, including $34.1 million of inventory and $13.8 million of accounts receivable. Total liabilities were $13.3 million and stockholders’ equity was $75.4 million.
Total debt was approximately $2.8 million, consisting of $0.4 million of short-term borrowings, $2.1 million of long-term debt, and $0.2 million of current maturities. No borrowings were outstanding under the revolving credit facility at July 31, 2017. The company stated that its cash position and projected revenue should provide sufficient funding for operations over the next twelve months.
Material changes versus the prior comparable period
- Six-month sales increased 9.9%, led by growth in China and the Asia-Pacific region, the United States, Latin America, and selected fire, woven, chemical, and disposable product lines.
- Three-month sales increased 7.4%, but gross margin declined 230 basis points because of product mix, pricing pressure in disposables, lower-margin woven products, discounted products ahead of revised fire-protection standards, and weaker UK performance.
- Six-month gross margin improved 80 basis points, supported by manufacturing shifts to lower-cost Mexico and China facilities, improved volume, and stronger fire and FR product mix.
- Six-month operating expenses were essentially flat at $12.6 million, reducing expenses as a percentage of sales to 26.9% from 29.5%.
- Six-month operating profit increased 66% to $4.7 million, while quarterly operating profit declined 17% because of lower quarterly gross margin and higher operating expenses.
- Interest expense declined to $0.1 million for the six-month period from $0.4 million, reflecting lower borrowings and interest rates.
- Net income benefited from a U.S. tax benefit associated with vesting of restricted stock. The filing also notes that the prior Brazil-related worthless-stock deduction generated an approximately $9.5 million tax benefit, subject to potential IRS challenge.
- On May 10, 2017, the company replaced its AloStar financing with a SunTrust facility consisting of a $20.0 million secured revolver, including a $5.0 million letter-of-credit subfacility, and a $1.575 million term loan. The facility matures May 10, 2020, subject to its terms.
Outlook, commentary, risks, and unusual items
Management cited improving industrial activity, customer inventory replenishment, stronger fire-distributor penetration, and increased demand in China, Latin America, and portions of the United States. It anticipated approximately $1.0 million of fiscal 2018 capital expenditures, including a new ERP project.
The SunTrust agreement requires a minimum fixed-charge coverage ratio of 1.10 to 1.00 beginning with the quarter ended July 31, 2017, along with customary restrictions on additional debt, liens, investments, acquisitions, business combinations, and stock repurchases.
- Foreign exchange exposure is significant because nearly half of sales are international. The company uses forward contracts and cash-flow hedges, but not all currencies are hedged. The cash-flow hedge notional amount was $1.9 million at July 31, 2017.
- Variable-rate debt creates interest-rate risk. Management estimated that a 1% increase in rates would increase fiscal-year interest expense by approximately $0.2 million.
- Cash is concentrated outside the United States, including approximately $9.6 million in China. Repatriation could create withholding and U.S. tax costs.
- The company remains exposed to possible liabilities related to its former Brazilian subsidiary, including VAT claims and labor litigation. Four labor cases remained active, including a counterclaim seeking approximately $0.7 million; management believes the claim is without merit.
- The IRS could challenge the approximately $9.5 million worthless-stock deduction related to Brazil. A tax-rate reduction from future tax reform could also produce a material noncash deferred-tax adjustment.
- The company expects to adopt the new revenue-recognition standard in the first quarter of fiscal 2019 using the retrospective method; management did not expect a significant impact but had not completed its evaluation.
- On August 22, 2017, after quarter-end, the company completed an offering of 725,000 common shares at $13.80 per share and received approximately $9.1 million of net proceeds. The underwriters did not exercise their option for an additional 108,750 shares.
- Management reported effective disclosure controls as of July 31, 2017 and no material changes to internal control over financial reporting during the quarter.
Facts investors should verify
- Confirm that the applicable reporting period is Q2 FY18, ended July 31, 2017, rather than 2016 Q2.
- Assess whether quarterly gross-margin pressure from product mix, pricing, NFPA-related discounting, and UK weakness is temporary or structural.
- Review compliance with the SunTrust fixed-charge coverage covenant and the terms of the secured credit facility.
- Evaluate the sustainability of earnings excluding the restricted-stock tax benefit and other tax-related items.
- Monitor foreign-currency movements, cash repatriation costs, and the concentration of cash in foreign jurisdictions.
- Track the resolution and potential financial exposure from Brazilian VAT and labor claims and the IRS treatment of the Brazil tax deduction.
- Incorporate the post-quarter-end equity offering into share-count, liquidity, and per-share analyses.