LAKELAND INDUSTRIES INC annual report, FY2014

Lakeland Industries, Inc. Form 10-K Summary

Business context and reporting period

Lakeland manufactures and sells industrial protective clothing and accessories, including disposable garments, chemical suits, firefighting apparel, reusable woven garments, high-visibility clothing, gloves and sleeves. Products are sold through distributors, sales representatives and directly to industrial and government customers in more than 40 countries.

The filing covers the fiscal year ended January 31, 2014, with comparisons to the fiscal year ended January 31, 2013. The fourth quarter ended January 31, 2014 is also presented on an unaudited basis. The company is a smaller reporting company listed on Nasdaq under the symbol LAKE.

Financial results and key metrics

Metric	FY14	FY13
Net sales from continuing operations	$91.4 million	$95.1 million
Gross profit	$24.8 million	$27.3 million
Gross margin	27.2%	28.7%
Operating loss	$(0.4) million	$(1.0) million
Loss from continuing operations	$(0.1) million	$(25.8) million
Net loss	$(0.1) million	$(26.3) million
Basic loss per share	$(0.02)	$(4.97)
Cash flow from operating activities	$(3.9) million	$1.4 million
Capital expenditures	$0.8 million	$1.4 million
Cash and cash equivalents	$4.6 million	$6.7 million

Domestic sales increased to $46.7 million from $40.8 million, while international sales declined to $44.7 million from $54.4 million. Brazil sales fell by approximately $9.6 million, largely due to lower sales and the absence of large bid contracts. U.S. disposable sales, reflective products, Fyrepel products, and sales in the United Kingdom, Russia and Kazakhstan improved.

Operating performance improved outside Brazil. U.S. operating profit before corporate expenses increased to $5.2 million from $1.1 million, and China operating profit increased to $3.5 million from $2.9 million. Excluding Brazil, worldwide operating profit increased to approximately $4.1 million from $0.7 million. Brazil generated an operating loss of approximately $4.4 million.

Gross margin benefited from price increases, improved product mix and the recovery of Lakeland-branded products following the loss of the DuPont license. These benefits were offset by inventory write-downs, weak Brazilian margins, lower glove margins and international pricing and currency pressures.

Liquidity, debt and financial condition

Working capital was $38.5 million at January 31, 2014, compared with $36.0 million at January 31, 2013.
The company used $3.9 million of cash in continuing operating activities, principally because of inventory investment, financing-related prepaid fees and foreign-currency effects.
A new $15 million senior revolving credit facility closed on June 28, 2013. Borrowings were $12.4 million at year-end, leaving approximately $2.6 million of availability. The facility bears interest at a rate based on LIBOR plus 5.25%, subject to a 6.25% floor, and matures in June 2016.
The refinancing also included $3.5 million of subordinated debt, shown net of approximately $2.0 million of unamortized original issue discount. The subordinated debt carries 12% interest initially, increasing to 16% in December 2016 and 20% in December 2017, and matures in June 2018.
The subordinated lender received a warrant initially exercisable for up to 566,015 shares at $0.01 per share, subject to adjustment. The filing states that up to 1,068,506 shares could ultimately be issued under the warrant and related provisions.
The company was in compliance with its senior and subordinated debt covenants at January 31, 2014. Covenants limit capital expenditures, advances to Brazil and investments in foreign subsidiaries.
Total liabilities were $36.7 million and stockholders’ equity was $47.0 million at January 31, 2014.

Material changes versus the prior comparable period

Sales declined 3.9%, primarily because of the reduction in Brazil and other international sales.
Operating loss narrowed by approximately $0.7 million despite lower sales and a $2.5 million decline in gross profit.
FY13 included substantial unusual charges: a $10.0 million Brazilian goodwill and intangible impairment, a $7.9 million Brazilian arbitration charge, a $4.5 million deferred-tax valuation allowance and a $0.5 million discontinued India operations loss. These charges did not recur in FY14.
FY14 included approximately $2.6 million of inventory-obsolescence provisions, including $1.3 million in the United States and China and $1.5 million in Brazil.
The Qingdao, China plant was sold and production was consolidated into other facilities. The Pennsylvania plant was scheduled to close in FY15, with production moving to Mexico and sales and administrative functions moving to Alabama.
The company discontinued its India glove manufacturing operations; no discontinued-operations loss was recorded in FY14.
The company reported no customer representing more than 5% of sales in FY14; one customer represented 7% of FY13 sales.

Guidance, outlook, risks and unusual items

Management expects to focus on returning Brazil to profitability during FY15 through new local management, a revised strategy emphasizing industrial and smaller government sales, and cost reductions. Management also expects approximately $1.0 million of FY15 capital expenditures and approximately $200,000 of research and development spending. No assurance is provided that Brazil will return to profitability.

The company stated that its current credit availability, expected operating cash flow and cash-management strategy should meet liquidity needs for the next 12 months. However, operating cash flow was negative in FY14, cash declined, and much of the company’s cash is held overseas and may be subject to local repatriation restrictions.

Brazil remains the principal operating and liquidity concern. The company has a remaining arbitration settlement liability of $5.0 million, payable in quarterly installments of $250,000 through 2018, without interest.
Brazil is subject to VAT claims. The filing identifies aggregate claims of approximately $7.7 million, with one major claim characterized as probable. A judicial process may involve a claim approximately 20% greater than the reported amount, or about $6.6 million for the principal disputed claim. The company is seeking an escrow or collateral arrangement and expects a future amnesty, but outcomes are uncertain.
Management identified four material weaknesses in internal control over financial reporting involving China, Brazil, related-party transaction identification and entity-level oversight of foreign subsidiaries. Disclosure controls were determined to be ineffective as of January 31, 2014. The weaknesses were not fully remediated at year-end, although management stated that they did not result in a reported financial-statement misstatement.
FY14 related-party payments of approximately $587,000 were made by the Weifang facility to a company partly owned by subsidiary managers; FY13 payments were approximately $435,000. Management believes the transactions were at arm’s length.
Approximately 49% of FY14 sales were to customers outside the United States. Currency exposure is significant, particularly to the Brazilian real, which the company does not hedge. The company uses selected forward contracts and cash-flow hedges for other currencies.
The company faces competition from substantially larger companies, including DuPont, Honeywell and Kimberly-Clark, and depends on suppliers for specialized fabrics and components.
The company has not paid cash dividends since inception and does not anticipate paying dividends in the foreseeable future. Debt agreements restrict dividend payments.

Important facts for investors to verify

Whether Brazil achieves the expected FY15 turnaround and generates sufficient cash to fund operations, debt service, arbitration payments and potential VAT obligations.
Compliance with the senior facility’s fixed-charge coverage, EBITDA, capital-expenditure and foreign-investment covenants.
The remaining $5.0 million Brazilian arbitration liability and the timing of required quarterly payments.
The status, funding requirements and ultimate resolution of Brazilian VAT claims, including the probable claim and any judicial escrow requirements.
Progress in remediating the four material weaknesses in internal controls, particularly in China and Brazil.
Whether negative operating cash flow and limited revolver availability constrain inventory purchases and growth.
The potential dilution from the subordinated lender’s warrant, interest shares and anti-dilution provisions.
The effect of currency movements, especially the Brazilian real, on revenue, margins, debt and cash flows.
The company’s ability to sustain improved U.S. and China margins after the loss of DuPont-sourced products.