Lakeland Industries, Inc. — Form 10-Q Summary
Reporting period: Three months ended April 30, 2017, compared with the three months ended April 30, 2016. The request metadata identifies “2016 Q1,” but the filing is the company’s first quarter of fiscal 2018. The financial statements are unaudited.
Business Context
Lakeland manufactures and sells protective garments and accessories, including disposable, chemical, fire, heat, reflective and woven apparel, gloves and arm guards. Products are sold through distributors and directly to industrial, governmental and international customers. Manufacturing operations are concentrated in China and Mexico, with sales and distribution activities across North America, Europe, Asia and Latin America.
Key Financial Metrics
| Metric | Q1 FY18 | Q1 FY17 | Change |
|---|---|---|---|
| Net sales | $23.0 million | $20.4 million | +12.7% |
| Gross profit | $8.6 million | $6.8 million | +26.3% |
| Gross margin | 37.3% | 33.3% | +4.0 percentage points |
| Operating expenses | $6.1 million | $6.6 million | -7.9% |
| Operating profit | $2.5 million | $0.2 million | Material improvement |
| Operating margin | 10.8% | 0.8% | +10.0 percentage points |
| Net income | $1.7 million | $3 thousand | Material improvement |
| Diluted EPS | $0.23 | $0.00 | Improved |
| Operating cash flow | $4.3 million | $3.5 million | +23.3% |
All dollar amounts in the table are approximate unless otherwise indicated. Income before taxes was $2.4 million versus a $21 thousand loss in the prior-year quarter. Income tax expense was $688 thousand, compared with a $24 thousand benefit in the prior-year quarter. Interest expense declined to $76 thousand from $198 thousand.
Liquidity, Balance Sheet and Debt
- Cash and cash equivalents were $11.8 million at April 30, 2017, versus $10.4 million at January 31, 2017.
- Working capital was approximately $49.9 million. Accounts receivable increased to $12.7 million from $10.7 million, while inventory declined to $32.1 million from $35.5 million.
- Total liabilities were $10.7 million and stockholders’ equity was $73.2 million at April 30, 2017.
- Debt consisted primarily of $2.4 million outstanding under the revolving credit facility, $678 thousand of long-term Canadian debt, $50 thousand of current maturities and $9 thousand of Argentine short-term borrowings.
- Operating cash flow of $4.3 million was partly used to repay $2.5 million under the revolving credit facility and other borrowings. Capital expenditures were $141 thousand.
- Management stated that current cash and projected revenue should be sufficient to fund operations for the next twelve months, although much of the company’s cash was held outside the United States and could be subject to withholding and other taxes upon repatriation.
Material Changes Versus the Prior Comparable Period
- Sales growth was led by China and the Asia-Pacific region, which increased 25.1%, Latin America, which increased 84.4%, and stronger U.S. fire, woven and flame-resistant product sales.
- Gross margin improved primarily from production efficiency, cost containment and the migration of production to lower-cost facilities in Mexico and China. Fire protection and woven product margins showed particularly significant improvement.
- Operating expenses declined due principally to lower payroll administration and officer compensation, including reversals of payroll accruals and executive departures.
- International sales increased to $10.3 million from $8.2 million and represented 44.7% of consolidated sales, compared with 40.1% in the prior-year quarter.
- Cash increased despite debt repayments, supported by net income and a $3.2 million reduction in inventory. This was partly offset by a $1.9 million increase in accounts receivable.
Outlook, Commentary, Risks and Unusual Items
- Management projected fiscal 2018 capital expenditures of approximately $1.0 million, principally including a planned ERP project.
- On May 10, 2017, after quarter-end, the company replaced its AloStar facility with a SunTrust agreement providing a $20 million revolving credit facility, including a $5 million letter-of-credit subfacility, and a $1.575 million term loan. The revolver may be increased to $30 million subject to conditions and matures May 10, 2020.
- The SunTrust agreement requires a minimum fixed-charge coverage ratio of 1.10 to 1.00 beginning with the quarter ending July 31, 2017, and contains customary restrictions on acquisitions, investments, additional debt, liens, operations and stock repurchases.
- Principal risks include foreign currency volatility, international manufacturing and corruption risks, customer-demand uncertainty, supplier concentration, competition, product liability, dependence on key personnel and compliance with debt covenants.
- The company remains exposed to potential liabilities associated with its former Brazilian subsidiary, including VAT and labor claims and possible parent-company liability under Brazilian law. Management believes the exposure is diminishing.
- The company claimed an approximately $9.5 million tax benefit from a worthless-stock deduction related to Brazil. The IRS could challenge the deduction, and the filing states that the outcome is uncertain.
- The company has approximately $25.4 million of foreign subsidiary earnings treated as permanently reinvested. Repatriation could create an estimated U.S. deferred tax liability of approximately $3.4 million, in addition to potential foreign withholding taxes.
- No material litigation claims were outstanding according to management as of April 30, 2017. Disclosure controls and procedures were assessed as effective.
- The company adopted inventory measurement and stock-compensation accounting updates in the quarter without a material reported impact. It planned to adopt the revenue standard in fiscal 2019 and was evaluating the impact of the lease standard.
Investor Verification Checklist
- Confirm that the intended period is Q1 fiscal 2018, ended April 30, 2017, rather than Q1 2016 as stated in the request metadata.
- Evaluate whether the sharp margin improvement is sustainable or primarily reflects prior-year restructuring, production transfers, product mix and cost reductions.
- Review subsequent filings for the terms, borrowing-base availability and covenant compliance under the SunTrust credit agreement.
- Monitor inventory, receivables and cash conversion, particularly because cash flow benefited from inventory reductions while receivables increased.
- Assess the potential tax consequences of the Brazil worthless-stock deduction and foreign earnings repatriation.
- Track residual Brazilian VAT, labor and fraudulent-bankruptcy exposure.
- Assess sensitivity to foreign exchange movements, especially the Canadian dollar, euro, British pound, Chinese RMB and Argentine peso.
- Verify execution and spending associated with the planned approximately $1.0 million fiscal 2018 ERP and capital-expenditure program.