Lakeland Industries, Inc. 10-K Summary
Reporting period: Fiscal year ended January 31, 2017 (FY17), with comparison to FY16. The supplied metadata references “2015 Q4,” but the filing is the FY17 Form 10-K. Fourth-quarter data are unaudited.
Business Context
Lakeland manufactures and sells protective garments and accessories, including disposable and chemical-protective clothing, firefighting apparel, reusable woven garments, high-visibility clothing, gloves and sleeves. Products are sold through distributors and directly to industrial, government, public-safety and international customers in more than 40 countries. Manufacturing is concentrated in China and Mexico, with additional operations in the United States and other countries.
FY17 lacked the Ebola, bird-flu and major emergency-driven orders that materially benefited FY16. Industrial activity was weak, particularly in the U.S., China and Europe, while the oil and gas downturn, strong U.S. dollar and currency volatility pressured demand and reported international revenue.
Key Financial Metrics
| Metric | FY17 | FY16 | Change |
|---|---|---|---|
| Net sales | $86.2 million | $99.6 million | Down 13.5% |
| Gross profit | $31.6 million | $36.3 million | Down 12.9% |
| Gross margin | 36.7% | 36.5% | Up 0.2 percentage points |
| Operating profit | $6.8 million | $11.8 million | Down 42.0% |
| Operating margin | 7.9% | 11.9% | Down 4.0 percentage points |
| Income before tax | $6.3 million | $10.9 million | Down 42.5% |
| Net income from continuing operations | $3.9 million | $7.8 million | Down 50.0% |
| Diluted EPS from continuing operations | $0.53 | $1.07 | Down 50.5% |
| Net cash provided by operating activities | $11.5 million | $(0.5) million | Improved by $12.0 million |
FY17 net income was $3.9 million, or $0.53 diluted EPS, compared with FY16 net income of $3.9 million, or $0.53 diluted EPS, because FY16 included a $3.9 million net loss from discontinued Brazilian operations.
Domestic external sales were $46.5 million, or 54% of total sales, while international sales were $39.6 million, or 46%. Sales declined in the U.S., China/Asia-Pacific and the U.K.; Canada and Latin America increased.
Liquidity, Debt and Balance Sheet
| Balance-sheet metric | January 31, 2017 | January 31, 2016 |
|---|---|---|
| Cash and cash equivalents | $10.4 million | $7.0 million |
| Working capital | $47.8 million | $42.2 million |
| Inventory | $35.5 million | $40.8 million |
| Total liabilities | $13.0 million | $20.7 million |
| Stockholders’ equity | $71.5 million | $67.5 million |
| Revolving credit borrowings | $4.9 million | $9.5 million |
Operating cash flow was primarily supported by net income and a $5.5 million inventory reduction. Investing cash outflow was $0.4 million, while financing cash outflow was $7.7 million, principally from repayments of revolving and foreign short-term borrowings.
The $15 million senior revolving facility had $4.9 million outstanding and $10.1 million available at year-end, with a 4.25% interest-rate floor. The facility was scheduled to mature in June 2017, and management was negotiating a replacement facility as of April 26, 2017. The facility contains fixed-charge coverage, minimum EBITDA, capital-expenditure and foreign-subsidiary investment covenants and is secured by substantial company assets.
Material Changes Versus FY16
- Revenue declined because FY16 benefited from Ebola and bird-flu demand, while FY17 experienced weaker industrial and energy-sector activity.
- Gross margin was broadly stable because cost containment, production efficiencies and shifting production from the U.S. to China and Mexico offset unfavorable product mix and the loss of high-margin emergency orders.
- Operating expenses increased 1.1% despite lower sales, raising operating expenses to 28.8% of revenue from 24.6%.
- Inventory declined $5.3 million and revolving-credit borrowings declined $4.6 million.
- U.S. operating profit declined to $8.1 million from $11.4 million; China operating profit declined to $4.1 million from $4.7 million; U.K. operating profit declined to $0.3 million from $2.7 million.
- FY17 included a $0.2 million impairment write-down of Brazilian assets held for sale.
- Research and development expense increased to $0.5 million from $0.2 million.
Fourth Quarter, Outlook and Commentary
Fourth-quarter FY17 sales were $20.3 million, gross profit was $7.8 million and net income from continuing operations was $0.9 million. Fourth-quarter gross margin improved to 38.2% from 29.4% in the prior-year quarter, primarily due to cost reductions, manufacturing efficiencies and the prior-year quarter’s unusually low margin.
Management expected stronger organic growth in FY18, citing improving customer ordering patterns and a more favorable U.S. business climate, but provided no formal revenue or earnings guidance. Strategic priorities include new products, expanded sales and marketing personnel, entry into new sectors, broader international distribution of successful U.S. and China products, and upgraded systems and ERP capabilities.
Management expected FY18 research and development expense of approximately $0.5 million and capital expenditures of approximately $1.0 million, including a new ERP project. Management stated that cash, available borrowing capacity and anticipated operating cash flow were sufficient for the next 12 months and expected a replacement credit facility by June 2017.
Risks, Contingencies and Unusual Items
- Revenue and margins are exposed to weak industrial and energy markets, emergency-event variability, seasonality, competitive pricing and customer inventory decisions.
- Approximately 46% of FY17 sales were international, creating foreign-exchange, political, trade, regulatory and operational risks. The company hedges selected Canadian-dollar and euro exposures but does not hedge all currencies.
- The revolving credit facility’s June 2017 maturity and financial covenants create refinancing and liquidity risk.
- The company claimed a Brazilian worthless-stock tax deduction that generated an approximately $9.5 million tax benefit; the IRS could challenge the deduction.
- Former Brazilian operations remain subject to potential VAT and labor claims. The filing identifies approximately $0.5 million of VAT claims excluding interest, penalties and fees, and approximately $0.2 million of labor claims; recorded labor contingencies were approximately $0.1 million.
- Foreign cash balances may incur additional U.S. and foreign withholding taxes if repatriated. Approximately $7.7 million was held in China at year-end and would incur a stated 10% Chinese withholding tax upon repatriation.
- Management concluded that disclosure controls and internal control over financial reporting were effective as of January 31, 2017. The independent auditor did not provide an internal-control attestation because Lakeland qualifies as a smaller reporting company.
- The board authorized a $2.5 million share-repurchase program, but no shares had been repurchased as of the filing date. A $30 million shelf registration statement became effective in April 2017, and no securities had been issued under it.
Facts Investors Should Verify
- Whether the replacement revolving credit facility was completed before or shortly after the June 2017 maturity and on what terms.
- Compliance with fixed-charge coverage, minimum EBITDA, capital-expenditure and foreign-investment covenants.
- Whether FY18 revenue growth materialized after the absence of FY16 emergency-related demand.
- Inventory levels, product mix and gross-margin sustainability following the FY17 inventory reduction and production restructuring.
- Status and ultimate tax treatment of the Brazilian worthless-stock deduction.
- Resolution of remaining Brazilian VAT, labor and other contingent liabilities.
- Foreign-exchange effects, cash repatriation constraints and the concentration of cash in foreign subsidiaries.
- Execution costs and benefits from the planned ERP investment, sales-force expansion and new-product development.