Lakeland Industries, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended July 31, 2013, filed September 12, 2013. Lakeland manufactures and sells protective garments and accessories for industrial and homeland-security markets. The company is classified as a smaller reporting company.
Financial performance
| Metric | Q2 FY2014 | Q2 FY2013 | Six months FY2014 | Six months FY2013 |
|---|---|---|---|---|
| Net sales | $24.6 million | $23.5 million | $46.4 million | $47.5 million |
| Gross profit | $7.5 million | $7.1 million | $13.5 million | $14.4 million |
| Gross margin | 30.3% | 30.4% | 29.2% | 30.4% |
| Operating profit | $1.3 million | $0.2 million | $1.1 million | $0.2 million |
| Operating margin | 5.3% | 0.6% | 2.3% | 0.4% |
| Net income (loss) | $4.2 million | $1.6 million | $3.3 million | $(8.5) million |
| Diluted EPS | $0.74 | $0.30 | $0.60 | $(1.62) |
Q2 sales increased 4.8%, while first-half sales declined 2.4%. The quarter and first half benefited from substantially lower operating expenses and improved operating results. Net income was significantly affected by a $4.5 million reversal of the deferred tax asset valuation allowance. The prior-year first half included a roughly $10 million Brazilian arbitration-related charge.
Cash flow, liquidity and capital structure
- Cash and cash equivalents were $5.8 million at July 31, 2013, down from $6.7 million at January 31, 2013.
- Working capital was approximately $41.0 million. Inventory increased to $40.4 million from $39.3 million, while accounts payable increased to $9.3 million from $6.7 million.
- Six-month operating cash flow was $0.4 million, compared with $2.1 million in the prior-year period. Investing cash flow was $0.4 million, including proceeds from the sale of the Qingdao, China property. Financing cash flow was a use of $1.6 million.
- On June 28, 2013, the company entered into a $15.0 million senior revolving facility at an initial and July 31 rate of 6.25%. Borrowings were $10.4 million, with reported availability of approximately $1.1 million.
- The company also obtained $3.5 million of subordinated debt, bearing 12% interest through December 27, 2016, with higher rates thereafter. A warrant for up to 566,015 shares was issued to the lender and valued at $2.2 million as original issue discount.
- The new financing was used primarily to repay approximately $13.7 million of former TD Bank debt and the Canadian warehouse loan. Total liabilities were $35.4 million and stockholders’ equity was $50.6 million at July 31, 2013.
Material changes versus prior period
- Q2 revenue growth was driven principally by China, the United Kingdom and the United States. Brazil sales fell $3.0 million, or 63.8%, in the quarter; first-half Brazil sales fell $6.4 million, or 64.8%.
- Worldwide sales excluding Brazil increased 22.0% in Q2 and 14.1% in the first half.
- Operating expenses declined 11.7% in Q2 and 12.5% in the first half, reflecting lower Brazil-related personnel and commissions, lower officer cash compensation, and other cost reductions.
- Gross margin was broadly stable in Q2 but declined in the first half because of weaker Brazil and Argentina margins, China shutdown costs and higher glove inventory reserves.
- The company sold its Qingdao, China real estate for approximately $1.0 million and sold an India property for approximately $0.4 million. Production was transferred to other China facilities, with no product lines discontinued as a result.
- The company remained current and in compliance with the senior and subordinated debt covenants at July 31, 2013.
Outlook, risks and unusual items
- Management expected FY2014 capital expenditures of approximately $1.0 million and reported no further specific plans for material capital expenditures.
- A China subsidiary borrowed approximately $0.8 million on August 12, 2013. The company also established a foreign-exchange facility with Wells Fargo after quarter end.
- The company must make 24 quarterly payments of $250,000 under the Brazilian arbitration settlement, beginning March 31, 2013. The settlement liability was $5.5 million at July 31, 2013; the company stated it was current on payments.
- Brazilian VAT claims could require judicial deposits or negotiated payments. The filing presents potential judicial deposits of approximately $7.8 million in total, although management expects amnesty or negotiated arrangements and has accrued $3.3 million of long-term VAT liabilities, net of available credits, on the balance sheet.
- Liquidity is constrained by limited revolver availability, debt covenants, required settlement payments and the need for possible additional outside funding. The filing states that failure to obtain additional funding could impair planned operations or expansion.
- Foreign exchange losses in Brazil were $0.4 million for the quarter and $0.4 million for the first half. International operations expose the company to currency, political, corruption, tax, supply-chain and execution risks.
- Management reported effective disclosure controls as of July 31, 2013, but continued to identify a material weakness in internal control over international financial reporting and review.
Important facts for investors to verify
- Whether Brazil sales and margins recover, and whether the company can fund the Brazilian VAT exposure and quarterly arbitration payments.
- Actual borrowing-base availability under the $15.0 million revolver and compliance with fixed-charge coverage, EBITDA and other covenants.
- The cash-flow effect of inventory growth, extended supplier payment terms and limited operating cash generation.
- The economic dilution and effective cost of the subordinated financing, including the warrant, potential interest shares and original issue discount.
- Whether the $4.5 million deferred-tax valuation allowance reversal is sustainable or represents a largely noncash, one-time benefit.
- Progress in remediating the material weakness in international financial controls and the outcome of Brazilian tax and other legal matters.