Lakeland Industries, Inc. — Q1 FY2017 Form 10-Q Summary
Business Context and Reporting Period
Lakeland manufactures and sells industrial and public protective clothing and accessories through North American distributors, governmental customers, and international channels. The unaudited report covers the three months ended April 30, 2016, compared with the three months ended April 30, 2015. Brazil operations are reported as discontinued operations following the 2015 disposal.
Financial Results and Key Metrics
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Continuing-operations net sales | $20.369 million | $24.819 million | Down 18% |
| Gross profit | $6.776 million | $9.279 million | Down 27% |
| Gross margin | 33.3% | 37.4% | Down 4.1 percentage points |
| Operating expenses | $6.607 million | $6.059 million | Up $0.548 million |
| Operating profit | $0.169 million | $3.220 million | Down $3.051 million |
| Operating margin | 0.8% | 13.0% | Down 12.2 percentage points |
| Income before taxes | $(0.021) million | $3.052 million | Declined to a loss |
| Net income from continuing operations | $0.003 million | $2.160 million | Down $2.157 million |
| Net income | $0.003 million | $1.229 million | Down $1.226 million |
| Basic and diluted EPS | $0.00 | $0.17 basic; $0.17 diluted | Declined to approximately breakeven |
| Net cash provided by operating activities | $3.463 million | $(1.547) million | Improved $5.010 million |
Cash and cash equivalents were $10.331 million at April 30, 2016, versus $7.022 million at January 31, 2016. Working capital was approximately $44.5 million. Inventories declined to $38.891 million from $40.841 million, while accounts payable increased to $7.366 million from $4.254 million.
Total liabilities were $22.921 million and stockholders’ equity was $68.116 million at April 30, 2016. Debt included $9.281 million outstanding under the senior revolving facility, $3.198 million of short-term borrowings, $0.768 million of long-term Canadian debt, and $0.050 million of current Canadian maturities. The company reported $5.7 million of availability under its $15 million senior revolving facility, which matures June 28, 2017, and carried an interest rate of 4.25% at quarter-end.
Material Changes Versus the Prior Comparable Period
- Sales declined primarily because of global industrial-sector weakness, the oil and gas downturn, currency volatility, and unusually strong prior-year Ebola-related demand in the United States and United Kingdom.
- Domestic sales declined 5%, while international sales declined from $11.98 million to $8.18 million. UK sales fell 58%, China and Asia-Pacific sales fell 25%, and Latin America sales fell 37%; Canada increased 26%.
- Gross margin contracted because of lower volume, unfavorable product mix, weaker oil and gas demand, reduced Ebola-related high-margin sales, and approximately $0.3 million of severance costs associated with shifting production to Mexico and China.
- Operating expenses increased due primarily to higher payroll administration, professional fees, sales salaries, and travel expenses.
- Operating cash flow turned positive, primarily from a $2.425 million inventory reduction and a $3.010 million increase in accounts payable. Management stated that cash was retained in China in anticipation of a planned dividend to the parent company later in FY2017.
- Capital expenditures were approximately $0.03 million, compared with $0.307 million in the prior-year quarter.
- The prior-year quarter included a $0.931 million loss from discontinued Brazil operations; Q1 FY2017 reported no discontinued-operations loss.
Guidance, Outlook, Risks, and Unusual Items
- Management expects FY2017 capital expenditures of approximately $1.0 million and stated that no further material capital expenditures were specifically planned.
- Management believes current revolver availability, anticipated operating cash flow, and cash-management plans are sufficient for liquidity needs over the next 12 months, but covenant compliance and refinancing remain important because the senior facility matures in 2017.
- The company was in compliance with its debt covenants at April 30, 2016, including a 1.1-to-1 fixed-charge coverage requirement, rolling four-quarter EBITDA requirement of at least $4.1 million, and annual capital-expenditure limit of $1 million.
- Management identified continuing risks from weak industrial and oil and gas markets, foreign-exchange volatility, international manufacturing and corruption exposure, customer-demand estimation, supplier concentration, competition, key-person dependence, product liability, and potential reductions in government preparedness spending.
- Brazil-related exposure remains despite the disposal. The company may remain liable for certain labor claims, VAT matters, and potential claims under Brazilian law. As of April 30, 2016, continuing labor claims sought approximately $0.278 million, although management estimated the ultimate liability would be lower.
- The company claimed an approximately $9.5 million U.S. tax benefit from a worthless-stock deduction related to Brazil. The IRS could challenge the deduction, and the company may not prevail.
- The company recognized a $2.286 million reserve in Q4 FY2016 against collection of the Brazil-related loan; this filing states there were no subsequent events to report.
- Management concluded that disclosure controls and procedures were effective as of April 30, 2016, with no material changes to internal control over financial reporting during the quarter.
Investor Verification Priorities
- Verify whether sales volumes and margins recover after the unusually strong Ebola-related prior-year comparison and the continuing industrial and oil and gas weakness.
- Monitor compliance with the revolver’s EBITDA and fixed-charge coverage covenants and the June 2017 maturity or refinancing plan.
- Assess the sustainability of positive operating cash flow, particularly as the quarter benefited from inventory reductions and higher accounts payable.
- Review the collectability and settlement status of Brazil-related VAT, labor, and loan exposures.
- Evaluate the realizability of deferred tax assets and the risk that the IRS challenges the approximately $9.5 million worthless-stock deduction.
- Track foreign-exchange effects, especially in Argentina, Canada, Europe, China, Kazakhstan, and Russia.