Lakeland Industries, Inc. — Form 10-Q Summary
Business Context and Reporting Period
Lakeland manufactures and sells protective garments and accessories for industrial, governmental, and public-safety markets. The filing covers the three and nine months ended October 31, 2015, representing Q3 and the first nine months of fiscal 2016. Results are presented primarily from continuing operations; Brazil was classified as discontinued operations following the transfer of its subsidiary.
Key Financial Metrics
| Metric | Three Months Ended October 31 | Nine Months Ended October 31 |
|---|---|---|
| Net sales from continuing operations | $24.9 million vs. $23.5 million | $79.2 million vs. $68.1 million |
| Gross profit | $9.2 million vs. $8.2 million | $30.3 million vs. $22.2 million |
| Gross margin | 37% vs. 35% | 38% vs. 33% |
| Operating profit | $3.2 million vs. $1.3 million | $12.1 million vs. $3.9 million |
| Operating margin | 13% vs. 5% | 15% vs. 6% |
| Net income from continuing operations | $2.1 million vs. $(1.8) million | $7.9 million vs. $(0.8) million |
| Total net income | $2.1 million vs. $(2.5) million | $5.4 million vs. $(2.9) million |
| Diluted EPS | $0.29 vs. $(0.42) | $0.74 vs. $(0.49) |
Revenue increased 6% in the quarter and 16% year to date. Growth was led by U.S. chemical and disposable products, including demand associated with bird flu preparedness, and by Ebola-related demand earlier in the year. International sales represented approximately 41% of continuing-operations sales for both the quarter and year-to-date period.
Operating expenses were $6.1 million in the quarter and $18.2 million year to date, compared with $6.9 million and $18.2 million, respectively, in the comparable periods. Interest expense declined to $0.2 million for the quarter and $0.6 million year to date, primarily following repayment of subordinated debt and the reduction in the senior facility rate.
Cash Flow, Liquidity, Debt, and Balance Sheet
- Cash and cash equivalents were $4.3 million at October 31, 2015, down $2.4 million from January 31, 2015.
- Operating activities used $3.9 million of cash year to date, primarily because of a $6.6 million inventory build, a $3.8 million arbitration settlement payment, and higher receivables.
- Investing activities used $0.3 million, including $0.7 million of capital expenditures partially offset by $0.5 million of real-estate sale proceeds.
- Financing activities provided $1.8 million, including $2.7 million of net borrowings under the revolving credit facility.
- Inventory increased to $43.5 million from $37.1 million at January 31, 2015. Management stated that inventory was intentionally built for anticipated volume and possible supply-chain delays.
- Working capital was approximately $48.6 million at October 31, 2015.
- The $15 million senior revolving facility had $8.4 million outstanding and $6.6 million of availability. It matures in June 2017 and carried a 4.25% interest rate at quarter-end.
- Other borrowings included approximately $0.8 million under a China loan, $1.3 million under another China facility, $0.2 million of Argentina borrowings, and $0.8 million of long-term Canada debt. No UK facility borrowings were outstanding.
- The Company stated that it was in compliance with all senior debt covenants at October 31, 2015 and believed available credit and anticipated operating cash flow were sufficient for the next 12 months.
Material Changes Versus the Prior Comparable Period
- Profitability improved materially as sales growth, lower product costs, favorable chemical and disposable product mix, and lower operating expenses expanded margins.
- Year-to-date gross margin increased five percentage points, while operating margin increased nine percentage points.
- U.S. external sales increased $8.8 million year to date, primarily from disposable and chemical products. UK sales increased $2.1 million, largely from Ebola-related demand.
- China and Asia-Pacific sales were broadly flat year to date, while Russia and Kazakhstan sales declined because of adverse currency and economic conditions.
- The Company repaid its Brazilian arbitration settlement obligation in full and completed the transfer of its Brazilian subsidiary, eliminating Brazil from continuing operations but leaving potential residual liabilities.
- Cash flow deteriorated from $3.1 million provided by operations in the prior-year period to $3.9 million used in the current period, mainly because of inventory investment and Brazil-related payments.
- The Company’s former CFO retired during the second quarter of fiscal 2016; the former senior vice president of finance became Acting CFO and was appointed CFO in November 2015.
Guidance, Outlook, Risks, and Unusual Items
Management anticipated approximately $1.0 million of capital expenditures for fiscal 2016 and disclosed no further specific material capital expenditure plans. No formal revenue or earnings guidance was provided.
- Demand benefited from Ebola and bird flu preparedness, creating a risk that subsequent-period comparisons may be less favorable if such demand does not recur.
- Brazil was disposed of for nominal consideration, but the Company provided funding and remains potentially exposed to Brazilian labor, VAT, tax, and other liabilities. A worthless-stock tax deduction was expected to provide an approximately $9.5 million tax benefit, net of a $2.9 million valuation allowance, but the IRS could challenge the deduction.
- In December 2015, subsequent to quarter-end, the Company entered into a roughly $2.3 million loan agreement with Qualytextil to fund settlement of major Brazilian VAT claims. The Company had not determined the collectability or required reserve, and any additional loss was expected to be recorded in fiscal 2016.
- The Company remains exposed to foreign exchange movements, international manufacturing and political risks, supplier concentration for certain fabrics, customer-demand estimation risk, product liability, competition, key-person dependence, and risks from government-funded preparedness programs.
- Debt agreements contain fixed-charge coverage, minimum EBITDA, capital expenditure, foreign-investment, reporting, and other covenants. A covenant default could accelerate repayment and permit lenders to act against pledged assets.
- Management concluded that previously identified Brazil-related material weaknesses and entity-level control deficiencies were remediated following the transfer of the Brazilian subsidiary. Investors should note the Company had experienced material weaknesses in prior periods.
- Other unusual items included a $1.3 million non-cash reclassification from accumulated other comprehensive loss related to Brazil, foreign-currency hedge losses, and continued deferred-tax reliance on foreign earnings and tax attributes.
Facts Investors Should Verify
- Whether elevated chemical and disposable demand related to bird flu and Ebola persists and how sales normalize after these temporary drivers.
- Inventory turnover, obsolescence reserves, and the ability to convert the $43.5 million inventory balance into cash without margin pressure.
- Compliance with the senior facility’s fixed-charge coverage and minimum EBITDA covenants as borrowing levels and working-capital needs change.
- The final accounting, collectability, and potential loss associated with the December 2015 Brazil VAT loan and remaining Brazil contingencies.
- Whether the claimed Brazil worthless-stock deduction is challenged by the IRS and the resulting cash-tax impact.
- The sustainability of improved gross margins, particularly in chemical and disposable products, and the effect of unfavorable product mix in wovens and fire protection.
- Execution of the CFO transition and the effectiveness of internal-control remediation following the historical Brazil weaknesses.