Lakeland Industries, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended July 31, 2019, corresponding to Q2 FY2020. The request metadata identifies “2018 Q2,” but the filing reports 2019 results and compares them with 2018.
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, firefighting, high-visibility, woven and glove products. International manufacturing and sales expose the company to currency, tariff, geopolitical and operational risks.
Financial Performance and Liquidity
| Metric | Three months ended July 31, 2019 | Three months ended July 31, 2018 | Six months ended July 31, 2019 | Six months ended July 31, 2018 |
|---|---|---|---|---|
| Net sales | $27.5 million | $25.6 million | $52.2 million | $50.0 million |
| Gross profit | $10.4 million | $9.2 million | $18.0 million | $18.7 million |
| Gross margin | 37.9% | 35.7% | 34.5% | 37.3% |
| Operating profit | $2.6 million | $1.6 million | $2.3 million | $4.1 million |
| Operating margin | 9.6% | 6.4% | 4.5% | 8.1% |
| Net income | $1.4 million | $1.0 million | $0.9 million | $2.9 million |
| Diluted EPS | $0.17 | $0.12 | $0.11 | $0.35 |
- Six-month net cash used in operating activities was $3.8 million, compared with $0.7 million of cash provided in the prior-year period. The principal uses were a $7.2 million inventory increase and a $1.6 million increase in accounts receivable.
- Capital expenditures were $0.6 million in the first six months, compared with $1.2 million in the prior-year period.
- Cash and cash equivalents were $9.1 million at July 31, 2019, down from $12.8 million at January 31, 2019. Working capital was $65.6 million.
- Inventory increased to $49.4 million from $42.4 million at January 31, 2019. Management attributed the increase to Vietnam production scale-up, delayed orders related to the ERP implementation, and preparation for a new utilities product line.
- Debt outstanding totaled approximately $2.1 million, consisting of U.S. borrowings of $1.6 million and UK borrowings of $0.5 million. Operating lease liabilities totaled $2.7 million after adoption of the new lease standard.
- The company had a $20.0 million secured revolving facility, with $0.3 million drawn at July 31, 2019, and a $1.2 million term loan outstanding. Interest rates were 3.9% on the revolver and 4.4% on the term loan.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales increased 7.2%, primarily due to stronger U.S. sales and improved customer deliveries that reduced order backlogs.
- Second-quarter gross margin improved to 37.9%, driven by a more favorable product mix, lower freight costs and improved Vietnam manufacturing efficiency.
- Second-quarter operating expenses rose 3.7%, reflecting higher legal and professional fees, compensation, severance and depreciation, partly offset by lower stock-based compensation.
- Six-month gross profit declined 3.7% and operating profit declined 42.8%, mainly because ERP implementation inefficiencies increased freight, labor and other operating costs during the first quarter.
- Six-month net income fell 67.8% to $0.9 million. Income tax expense increased despite lower year-to-date earnings, partly because of a $0.3 million GILTI tax provision.
- The company adopted ASC 842 on February 1, 2019, recognizing approximately $2.7 million of operating lease right-of-use assets and corresponding liabilities.
- The company repurchased 9,200 shares for approximately $97,000 during the quarter. Approximately $1.24 million remained available under the repurchase authorization at July 31, 2019.
Guidance, Outlook, Risks and Unusual Items
- Management expects the adverse effects of the ERP implementation to continue lessening as remediation proceeds and expects improved financial performance from the system over time.
- FY2020 capital expenditures were expected to be approximately $2.0 million, supporting ERP implementation and manufacturing capacity expansion in Vietnam and India.
- The company received a June 2019 waiver of its fixed-charge coverage ratio covenant for the quarters ending April 30, July 31 and October 31, 2019. Testing resumes for the quarter ending January 31, 2020. The company must maintain at least $10.0 million of borrowing availability through December 31, 2019.
- Disclosure controls were not effective at July 31, 2019 because previously reported material weaknesses in internal control over financial reporting remained outstanding. Management expected remediation before the end of fiscal 2020.
- The company recorded a $0.4 million additional accrual for Brazilian labor litigation during the quarter and paid $1.3 million for related professional fees and claims. The remaining accrual was $0.2 million at July 31, 2019.
- A $260,000 severance charge was recorded for a former officer under a separation agreement.
- Management identified a $447,000 reversal of previously recognized stock-based compensation because 2017 performance awards were no longer expected to meet the minimum vesting level.
- Key risks include ERP execution, internal-control remediation, reliance on China and other international manufacturing, tariffs and trade disputes, foreign currency movements, Brexit, cybersecurity, customer-demand forecasting, supplier concentration, tax exposure, Brazilian contingencies and compliance with debt covenants.
Investor Verification Points
- Verify whether ERP remediation has been completed and whether inventory, freight, labor and order-backlog effects have normalized.
- Monitor operating cash flow, inventory growth and cash held in foreign subsidiaries, including the potential 10% withholding tax on repatriation of approximately $5.1 million held in China.
- Confirm compliance with the $10.0 million availability requirement and the resumption of fixed-charge covenant testing in January 2020.
- Assess the effect of the unresolved internal-control material weaknesses on financial reporting reliability.
- Review developments in Brazilian labor and civil claims and the adequacy of related accruals.
- Track gross-margin sustainability, particularly the product mix, Vietnam efficiency gains and freight-cost improvements reported in the second quarter.