Lakeland Industries, Inc. — Q2 FY2016 Form 10-Q Summary
Business context and reporting period
Lakeland manufactures and sells industrial and public protective clothing and accessories, including disposable, chemical, fire-protection, reflective and woven garments. This unaudited report covers the three and six months ended July 31, 2015, with prior periods restated for discontinued Brazil operations.
Key financial metrics
| ($000s, except per-share data) | Q2 FY2016 | Q2 FY2015 | Six months FY2016 | Six months FY2015 |
|---|---|---|---|---|
| Continuing-operations net sales | $29,465 | $22,812 | $54,284 | $44,570 |
| Gross profit | $11,795 | $7,437 | $21,073 | $13,942 |
| Gross margin | 40.0% | 32.6% | 38.8% | 31.3% |
| Operating profit | $5,700 | $1,798 | $8,919 | $2,656 |
| Operating margin | 19.3% | 7.9% | 16.4% | 6.0% |
| Net income from continuing operations | $3,588 | $562 | $5,748 | $916 |
| Net income (loss) | $2,034 | $(386) | $3,263 | $(386) |
| Diluted EPS | $0.28 | $(0.07) | $0.45 | $(0.07) |
- Six-month operating cash flow was negative $4.305 million, compared with negative $0.586 million in the prior-year period. The principal uses were inventory growth of $5.0 million, a $3.4 million Brazil arbitration settlement payment and a $2.6 million increase in accounts receivable.
- Cash and cash equivalents were $5.065 million at July 31, 2015, down from $6.709 million at January 31, 2015. Management reported working capital of approximately $43.4 million.
- Capital expenditures were $0.475 million during the six months. Management expected approximately $1.0 million of FY2016 capital expenditures.
- Revolving-credit borrowings were $8.897 million, with stated availability of $6.1 million under the $15 million facility. The facility bears interest at 4.25% and matures June 28, 2017.
- Additional borrowings included approximately $2.746 million of short-term borrowings and $0.759 million of long-term Canada loan obligations. Total liabilities were $24.574 million and stockholders’ equity was $67.561 million.
Material changes versus the prior comparable period
- Continuing-operations sales increased 29.4% in Q2 and 21.8% for the six-month period, driven primarily by U.S. disposable and chemical-product demand related to bird-flu response activity and, for the year-to-date period, Ebola-related demand in the United States and United Kingdom.
- Gross margin expanded substantially because of price increases, stable costs and favorable product mix, particularly in disposable and chemical products. Operating expenses increased, but declined as a percentage of sales from 24.7% to 20.7% in Q2 and from 25.3% to 22.4% year to date.
- Interest expense declined to $0.210 million in Q2 and $0.393 million year to date, reflecting repayment of subordinated debt, lower senior-debt balances and the March 2015 reduction in the senior facility rate.
- The company completed a conditional closing on July 31, 2015 to dispose of Lakeland Brazil for R$1.00, with the buyer assuming Brazilian liabilities. The transfer remained subject to Brazilian Commercial Registry approval.
- Brazil was reported as discontinued operations. The six-month net loss from discontinued operations was $2.485 million, including a $1.286 million non-cash reclassification of accumulated other comprehensive income and a $0.515 million disposal loss.
- Inventory increased to $41.902 million from $37.092 million at January 31, 2015, reflecting planned production for the U.S. peak season and bird-flu response. Accounts receivable increased to $15.711 million from $13.277 million.
Guidance, outlook, risks and unusual items
- Management stated that current revolver availability, anticipated operating cash flow and cash-management practices were sufficient for liquidity needs over the next 12 months; no formal revenue or earnings guidance was provided.
- Management expected FY2016 capital expenditures of approximately $1.0 million and no further specific material capital projects.
- The company was in compliance with its senior-debt covenants at July 31, 2015, including a 1.1-to-1 fixed-charge coverage ratio, minimum rolling four-quarter EBITDA of $4.1 million and a $1.0 million annual capital-expenditure limit.
- Brazil-related exposures remained, including pending labor claims, VAT matters, possible liabilities arising from prior operations and obligations under the transfer agreement. The company also committed additional funding and potential future payments to support Brazilian operations and liabilities.
- The company expects a U.S. tax benefit of approximately $9.5 million, net of a $2.9 million valuation allowance, from a worthless-stock deduction related to Brazil. The IRS could challenge the deduction.
- Management concluded that the material weaknesses associated with Brazil and related entity-level controls were remediated upon the transfer of ownership. Investors should note the prior weaknesses and the conditional nature of the transaction at the reporting date.
- Principal ongoing risks include dependence on demand estimates and government-related protective-equipment demand, international manufacturing and currency exposure, supplier concentration, competition, product liability, customer credit, debt covenants, liquidity and key-person dependence.
- The CFO retired during Q2; the senior vice president of finance became acting CFO, and the former CFO remained as a consultant for 12 months.
Important facts for investors to verify
- Whether Brazilian Commercial Registry approval was obtained and whether any residual labor, VAT, tax or other liabilities remain with Lakeland.
- The sustainability of unusually strong bird-flu- and Ebola-related sales, pricing and gross-margin gains.
- Inventory normalization, receivables collection and conversion of reported earnings into operating cash flow.
- Availability under the revolver, covenant compliance and refinancing or maturity requirements for short-term borrowings.
- The defensibility and timing of the approximately $9.5 million Brazil-related worthless-stock tax deduction.
- Whether the remediation of Brazil-related internal-control weaknesses remains effective following the disposal and CFO transition.