Lakeland Industries, Inc. Form 10-Q Summary
Reporting period: Three months ended April 30, 2019, compared with the three months ended April 30, 2018. The request metadata identifies “2018 Q1,” but the filing is for Q1 fiscal 2020 and was filed June 10, 2019.
Business Context
Lakeland manufactures and sells industrial protective clothing and accessories through more than 1,600 distributors in over 50 countries. Products include disposable, chemical, fire-resistant, high-visibility, woven and glove products. Manufacturing operations are located primarily in China, Mexico, Vietnam, India and Argentina, with substantial international sales and foreign-currency exposure.
Key Financial Metrics
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Net sales | $24.684 million | $24.344 million | +1.4% |
| Gross profit | $7.554 million | $9.504 million | -20.5% |
| Gross margin | 30.6% | 39.0% | -8.4 percentage points |
| Operating expenses | $7.869 million | $7.088 million | +11.0% |
| Operating profit (loss) | $(0.315) million | $2.416 million | Declined to loss |
| Operating margin | (1.3%) | 9.9% | -11.2 percentage points |
| Net income (loss) | $(0.465) million | $1.867 million | Declined to loss |
| Diluted EPS | $(0.06) | $0.23 | Declined to loss |
| Cash flow from operations | $1.514 million | $0.881 million | +$0.633 million |
| Capital expenditures | $0.168 million | $0.272 million | Lower |
Liquidity, Debt and Balance Sheet
- Cash and cash equivalents were $14.282 million at April 30, 2019, up from $12.831 million at January 31, 2019, but below $16.285 million at April 30, 2018.
- Working capital was approximately $64.0 million. Current assets were $80.119 million and current liabilities were $15.990 million.
- Total debt was approximately $1.439 million, consisting primarily of $1.121 million of long-term U.S. term debt, $0.158 million of current maturities and $0.160 million of U.K. borrowings.
- The $20.0 million secured revolving credit facility had no revolver balance and no outstanding letters of credit at April 30, 2019. The facility matures May 10, 2020.
- The company was not in compliance with its fixed charge coverage ratio at April 30, 2019. SunTrust granted a waiver on June 7, 2019 covering the reported quarter and the quarters ending July 31 and October 31, 2019. The company must maintain at least $10.0 million of borrowing availability from May 31 through December 31, 2019.
- Adoption of ASC 842 resulted in recognition of $2.234 million of operating lease right-of-use assets and $2.235 million of operating lease liabilities.
Material Changes Versus the Prior Comparable Period
- Sales increased modestly, primarily from stronger U.S. deliveries, Canadian refinery turnaround demand and Latin American flame-resistant garment contracts. These gains were partly offset by lower U.K., Mexico and Asia-Pacific sales.
- Gross margin contracted sharply because of higher freight, payroll, overtime and labor costs; temporary inefficiencies in Vietnam; ERP-related planning and delivery issues; competitive pricing pressure; and unfavorable product mix.
- ERP implementation continued to affect production planning, order fulfillment and operating results. Management stated that many ERP issues had been resolved, but adverse effects were expected to continue in the near term.
- Operating expenses increased due to ERP implementation costs, higher bad-debt expense, expedited outbound freight and higher equity compensation, officer salaries and director fees.
- Inventory rose $4.396 million from January 31, 2019 to $46.761 million, primarily for Vietnam production scale-up, delayed Gloves, Fire and Hi-Vis orders, and a new utilities product line.
- Sales by product line shifted toward Chemical and Hi-Vis products, while Disposables declined from $13.08 million to $12.36 million.
Guidance, Outlook, Risks and Unusual Items
- Management anticipated approximately $2.0 million of fiscal 2020 capital expenditures for ERP implementation and manufacturing-capacity expansion in Vietnam and India.
- Management expected short-term, progressively diminishing adverse effects from ERP-related manufacturing and delivery issues, but provided no formal revenue or earnings guidance.
- The company disclosed material weaknesses in internal control over financial reporting. Disclosure controls were not effective as of April 30, 2019, and remediation was expected to be completed before the end of fiscal 2020.
- Brazil-related labor and civil contingencies remain outstanding. The company had accrued approximately $1.1 million at April 30, 2019, compared with $1.2 million at January 31, 2019. Management believes the identified claims are unlikely to result in significant additional expense, but acknowledges potential exposure under Brazilian law.
- Income tax expense included approximately $0.1 million of non-cash GILTI-related tax expense. The company maintained a $1.3 million valuation allowance against deferred tax assets.
- Key ongoing risks include ERP execution, covenant compliance and liquidity, foreign currency movements, international manufacturing and political conditions, competitive pricing, customer-demand forecasting, supplier concentration, cybersecurity, environmental obligations, tax matters and potential liabilities related to former Brazilian operations.
Investor Verification Items
- Verify whether ERP-related production inefficiencies, expedited freight and elevated labor costs normalize and whether gross margin recovers.
- Monitor compliance with the amended bank covenants, the $10.0 million availability requirement and the resumption of fixed charge coverage testing in January 2020.
- Assess inventory growth, particularly raw materials and work-in-process tied to Vietnam, delayed orders and the new utilities product line.
- Review remediation progress for the disclosed material weaknesses and the effect on the timeliness and reliability of future reporting.
- Track Brazil litigation and labor exposure, including potential claims following the March 2019 shutdown of Lakeland Brazil operations.
- Confirm execution of the approximately $2.0 million fiscal 2020 capital expenditure plan and its effect on Vietnam and India capacity.