Lakeland Industries, Inc. — Q2 FY2015 Form 10-Q Summary
Business Context and Reporting Period
Lakeland manufactures and sells protective garments and accessories for industrial, governmental, homeland-security, and safety markets. The report covers the three and six months ended July 31, 2014, compared with the corresponding periods in 2013. The company is classified as a smaller reporting company.
Key Financial Metrics
| Metric | Q2 FY2015 | Q2 FY2014 | Six Months FY2015 | Six Months FY2014 |
|---|---|---|---|---|
| Net sales | $24.6 million | $24.6 million | $48.1 million | $46.4 million |
| Gross profit | $8.1 million | $7.5 million | $15.2 million | $13.5 million |
| Gross margin | 32.8% | 30.3% | 31.5% | 29.2% |
| Operating profit | $1.5 million | $1.3 million | $2.0 million | $1.1 million |
| Operating margin | 6.0% | 5.3% | 4.3% | 2.3% |
| Net income (loss) | $(0.4) million | $4.2 million | $(0.4) million | $3.3 million |
| Basic EPS | $(0.07) | $0.75 | $(0.07) | $0.61 |
| Interest expense | $0.7 million | $0.5 million | $1.3 million | $0.7 million |
Operating performance improved despite essentially flat second-quarter sales. Net losses were driven largely by current-period tax expense versus a substantial tax benefit in the prior-year periods.
Six-month operating cash flow was $(0.3) million, compared with $0.4 million provided in the prior-year period. Investing cash flow was $(0.2) million, including $0.2 million of capital expenditures. Financing activities provided $2.1 million, producing a $1.6 million increase in cash to $6.2 million at July 31, 2014.
Working capital was approximately $38.5 million. Current assets were $69.9 million, including $39.5 million of inventory and $16.0 million of accounts receivable. Total assets were $88.0 million and stockholders’ equity was $47.0 million.
Debt and Liquidity
- Borrowings under the $15.0 million senior revolving credit facility were $13.4 million at July 31, 2014, leaving approximately $1.6 million of availability. The stated interest rate was 6.25%; the facility expires June 30, 2016.
- Short-term borrowings were $4.5 million, including approximately $1.5 million under the United Kingdom invoice-finance facility, $0.8 million under a China loan that was repaid on August 4, 2014, and approximately $1.3 million under a China credit line.
- Subordinated debt was reported at $1.7 million net of original issue discount, PIK interest, and a $0.5 million prepayment made in July 2014. The subordinated loan carries a 12% stated rate through December 2016, with higher rates thereafter.
- The arbitration settlement balance was $4.5 million, payable in quarterly installments of $250,000 through December 31, 2018.
- Management stated that current credit availability, expected operating cash flow, and cash-management plans should cover liquidity needs for the next 12 months, but also noted that covenant compliance and borrowing-base availability may restrict flexibility.
Material Changes Versus the Prior Comparable Period
- Six-month sales increased 3.8%, primarily from China, the Asia-Pacific region, the United Kingdom, Latin America, and U.S. disposable and fire-protection products.
- Gross margin improved by 2.3 percentage points for the six-month period, aided by improved Brazil results, higher volume, and cost reductions. Offsetting pressures included China contractor costs, product mix, inventory reserves, and a one-time reflective-plant relocation charge.
- Brazil improved substantially but remained loss-making, with six-month operating loss of approximately $0.6 million versus approximately $1.8 million in the prior-year period. Mexico also reported a six-month operating loss of approximately $0.2 million.
- Operating expenses increased 5.1% for the six-month period, reflecting sales and marketing hires, commissions, travel, information-technology and ERP costs, bank fees, and foreign-currency effects.
- Interest expense increased approximately $0.6 million for the six-month period because of the 2013 financing, higher rates, and approximately $0.2 million of non-cash original issue discount amortization.
- The prior-year net income included a $4.5 million reversal of a deferred-tax valuation allowance. Current-period taxes included approximately $325,000 related to a China dividend and approximately $200,000 of additional U.S. taxes on United Kingdom and Canada income.
- Accounts receivable increased $2.2 million from January 31, 2014, while cash increased $1.6 million. Short-term borrowings increased $1.9 million, primarily to support higher United Kingdom inventory and China sourcing.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management expected fiscal 2015 capital expenditures not to exceed $1.0 million.
- Management expected Brazil operating losses to continue at least through fiscal 2015, although results had improved under new management and cost-cutting initiatives.
- Brazilian tax authorities asserted an approximately $1.0 million tax claim related to goodwill amortization. Management believed it would prevail and recorded no provision.
- Brazil VAT claims totaled approximately $7.3 million, including a larger claim classified as probable and recorded as a $3.3 million long-term liability. Several other claims were classified as remote.
- A Brazilian labor judgment of approximately $1.1 million was received in June 2014. The company recorded a $380,000 charge in the second quarter based on counsel’s estimate of the likely outcome and intended to appeal.
- The company had material weaknesses in internal control over financial reporting involving China, Brazil, and entity-level controls. Disclosure controls were therefore deemed ineffective as of July 31, 2014. Remediation efforts included hiring a China controller and internal auditor and engaging outside advisers in Brazil.
- Key risks include limited revolver availability, restrictive debt covenants, significant secured debt, the arbitration payment obligation, continued Brazil losses, foreign-currency volatility, international operating and compliance risks, customer-demand uncertainty, supplier concentration, competition, and potential product-liability claims.
Important Facts for Investors to Verify
- Whether operating improvements in Brazil and China are sustainable and whether Brazil reaches profitability.
- Revolver borrowing-base availability, covenant compliance, refinancing requirements, and the scheduled maturity of the United Kingdom facility.
- Progress in remediating the China, Brazil, and entity-level internal-control material weaknesses.
- Ultimate outcomes and cash requirements for the Brazilian VAT claims, tax audit, labor judgment, and arbitration settlement.
- Whether working-capital needs, inventory levels, and weak operating cash flow create additional borrowing requirements.
- The effect of tax charges, PIK interest, original issue discount amortization, warrants, and potential interest shares on future earnings and dilution.