Lakeland Industries, Inc. — Q1 FY2015 Form 10-Q Summary
Business context and reporting period
Lakeland manufactures and sells protective garments and accessories for industrial, governmental, homeland security, and related markets. The filing covers the three months ended April 30, 2014, compared with the three months ended April 30, 2013. The company reported 5,358,509 common shares outstanding as of June 12, 2014.
Financial performance and position
| Metric | Q1 FY2015 | Q1 FY2014 | Change |
|---|---|---|---|
| Net sales | $23.5 million | $21.7 million | Up 8.1% |
| Gross profit | $7.1 million | $6.1 million | Up 16.8% |
| Gross margin | 30.2% | 28.0% | Up 220 basis points |
| Operating profit (loss) | $0.6 million | $(0.2) million | Improved by $0.8 million |
| Operating margin | 2.5% | (1.1)% | Improved |
| Interest expense | $0.6 million | $0.3 million | Increased approximately $0.3 million |
| Net loss | $64 | $844,480 | Near breakeven versus prior-year loss |
| Net loss per share | Approximately $0.00 | $(0.16) | Improved |
Net sales outside the United States increased to approximately $11.3 million from $9.9 million. China, Latin America, U.S. disposables, fire protection, and reflective products contributed to growth, while Russia and Kazakhstan declined.
Operating cash flow was $1.6 million, compared with $0.7 million in the prior-year quarter. Capital expenditures were $89,820, and investing cash flow was negative $89,820. Financing activities provided $0.9 million, primarily from additional revolver borrowings. Cash increased to $7.0 million from $4.6 million at January 31, 2014.
At April 30, 2014, working capital was approximately $39.0 million. Current assets were $69.9 million and current liabilities were $31.0 million. Inventories were $40.4 million, and accounts receivable were $14.6 million.
Reported borrowings and similar obligations included $13.5 million outstanding under the senior revolving facility, $2.5 million of short-term borrowings, $2.0 million of subordinated debt net of original issue discount and PIK interest, approximately $1.1 million of long-term Canada and Brazil loans, and $4.6 million of remaining arbitration settlement obligations. The filing states that $1.5 million was available under the senior revolving facility at April 30, 2014.
Material changes versus the prior comparable period
- Sales increased $1.8 million, primarily from stronger international activity, including China and Latin America, and higher U.S. sales.
- Gross margin improved because of better product mix, higher volume, improved Brazil pricing, and stronger chemical, U.K., and fire-protection performance. These benefits were partly offset by lower disposable-product margins, a $0.3 million glove reserve, and a $0.3 million one-time plant-relocation charge.
- Operating expenses increased only 3.2% and declined as a percentage of sales to 27.7% from 29.1%, reflecting cost reductions in Brazil partly offset by higher commissions, professional fees, and foreign-exchange effects.
- Brazil’s operating loss improved to approximately $0.3 million from $0.9 million. Management stated that Brazil sales had stabilized under new management.
- Interest expense increased substantially because of the newer financing structure, higher borrowing rates, and amortization of subordinated-debt original issue discount.
- Accounts payable increased $1.8 million, while accrued expenses increased $0.8 million, partly due to production relocation, facility closure, severance, and extended supplier payment terms.
Guidance, outlook, risks, contingencies, and unusual items
- The company did not provide formal revenue or earnings guidance. It expects fiscal 2015 capital expenditures not to exceed $1.0 million.
- Management expects losses in Brazil to continue at least through the first half of fiscal 2015, although results had improved in the quarter.
- Management expects available revolver capacity, operating cash flow, and cash-management measures to cover liquidity needs for the next 12 months, but notes that covenant compliance and borrowing capacity could be affected by future results.
- The company was in compliance with the senior and subordinated debt covenants at April 30, 2014. The senior facility requires a fixed-charge coverage ratio, minimum EBITDA thresholds, and limits on capital expenditures and foreign-subsidiary investments.
- The subordinated financing carries a 12% coupon through December 2016, increasing thereafter, and includes a warrant for up to 566,015 shares at an exercise price of $0.01 per share. The company valued the warrant at $2.2 million and reported an effective debt rate of approximately 47% before considering the related senior debt.
- The company owes $4.75 million under a Brazilian arbitration settlement, payable in quarterly installments of $250,000 through December 31, 2018. Payments were current at April 30, 2014.
- Brazilian VAT claims totaled approximately $7.7 million before the accepted amnesty adjustment. Management considered the principal claim probable and was evaluating a judicial-deposit strategy; the ultimate cash impact and timing remain uncertain. An approximately $153,000 accrual related to an accepted smaller claim was recorded in the prior quarter.
- A Brazilian tax audit included a claim of approximately $1.0 million related to goodwill amortization. Management believed it would ultimately prevail and recorded no provision.
- Disclosure controls and internal control over financial reporting were deemed ineffective because of material weaknesses involving China, Brazil, and entity-level oversight of foreign subsidiaries. The company initiated remediation and hired a China controller and internal auditor in May and June 2014.
- Foreign-exchange movements, international cash-transfer restrictions, customer-demand estimates, supplier concentration, product liability, competition, government funding, and dependence on key personnel remain material risks.
Important facts for investors to verify
- Whether the company can sustain near-breakeven earnings after the significant improvement from the prior-year loss.
- Progress in remediating the material weaknesses in Brazil, China, and entity-level controls.
- Compliance with senior-loan EBITDA and fixed-charge coverage covenants as operating conditions change.
- Liquidity after scheduled $250,000 quarterly arbitration payments, debt maturities, and potential Brazil VAT or tax payments.
- The effective cost, dilution potential, and refinancing implications of the subordinated debt and 566,015-share warrant.
- Whether Brazil’s expected continuing losses and international foreign-exchange exposure could reverse the quarter’s operating improvement.
- Inventory quality and reserves, particularly given $40.4 million of inventory and the reserve for remaining Nitrosol gloves.