Lakeland Industries, Inc. (LAKE) Q3 2017 Earnings Report, Transcript and Summary

Good day everyone and welcome to the Lakeland Industries Inc. Announces Q3 Fiscal Year 2017 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please also note that today’s event is being recorded. At this time I would like to turn the conference call over to Mr. Christopher J. Ryan, CEO. Sir, please go ahead.

Good afternoon to you all and thank you for joining our fiscal 2017 third quarter financial results conference call. We’re going to provide brief opening statements on the status of operations and our financial results for the quarter. The call will then be opened up, so that we may respond to your questions. Before we go any further, as you may know from our press release issued earlier today and from our most recent quarterly calls, we present our financial results based on our continuing operations. That will be the case with today’s conference call unless otherwise specified. The continuing operations financial results reflect our ongoing business following our exit from Brazil, which was effectuated in the third quarter of fiscal 2016 with additional issues addressed thereafter. Now I’d like to discuss our financial highlights, operating strategies, and overall business with a view of our objectives as we move forward. Our performance in the third quarter of fiscal 2017 continued the momentum we began to experience in the first quarter of this year. This is evidenced by our consolidated revenues of $23.2 million in the third quarter, increasing 4% from $22.3 million in the second quarter of fiscal 2017, and by nearly 14% from $20.4 million in the first quarter of our fiscal 2017. Although there have been economic challenges and sluggishness in the industrial sectors around the world for over a year, particularly for oil and gas markets, we have been successful in positioning Lakeland Industries towards next phase of growth. This is what I talked about on last quarter’s conference call and we have executed on our plan. I’ll talk more about that – this today. The company’s financial performance in fiscal 2017 third quarter ended October 31, 2016 reflects the strategic advantages of our unique operating platform, and our ability to generate solid cash flow from operations. Proof here is seen in our gross margin as a percent of sales in third quarter 2017 at 37%, flat with the same period of the prior year despite lower revenues and no contribution for sales of higher margin emergency demand orders this year – in this year’s period. Our third quarter 2017 gross margin increased by 1 percentage point, as compared with the average of 36% for the first two quarters of fiscal 2017. And our consolidated gross profit for third quarter 2017 of $8.5 million declined from $9.2 million in the prior year on lower volume and absence of very high margin emergency product orders, but increased from the average of $7.7 million for the first two quarters of fiscal 2017. And to the bottom line, net income increased to $1.5 million in fiscal third quarter from $1.4 million in the second quarter and a break-even in the first quarter. While driving margins and profits, we have generated substantial free cash flow, which is being used to pay down debt while the balance is found its way to our cash position if not reinvested in initiatives to drive growth in the future. Substantial opportunities remain in the U.S., which is a large part of a market share gain in our primary business for disposable products. Internationally, South American and Asian markets represent greenfield opportunities. Despite these opportunities, we still face competition and more importantly economic challenges. Among our challenges, we note that our quarterly financial performance progress in fiscal 2017 may be seen as less remarkable when compared to year earlier periods. This has been the case for the first three quarters of fiscal 2017 following the first nine months of fiscal 2016, if not the entire year which benefited from higher margin products or orders stemming from Ebola outbreak impacting many countries and spates of bird flu in North America. Next quarter, our fiscal fourth quarter ended January 31, 2017, we expect to have a year-over-year comparison that bears relevance. Since at this juncture neither period will benefit from exigent circumstances, where there is contributions to revenues and margins from higher margin product sales, such as Ebola, bird flu pandemic, SARS, major oil spills such as BP in the Gulf, hurricanes like Katrina, Sandy and terrorist incidents like 9/11 to name a few exigent types of circumstances that gun revenues and earnings for three to six-month period. Compounding these negative optics are the foreign currency exchange rates amid a strong U.S. dollar and oil prices, significant currency declines in fiscal 2017 and fiscal 2016 in our foreign markets reduce revenues as reported on a consolidated GAAP basis in U.S. dollars, even though our volume or unit sales were higher for many of the countries in which we do business. The oil and gas sector remains a drag in our business so long as prices are at or below $60 per barrel of oil. Oil prices have worked against us for most of fiscal 2017. Relief may be in sight. On November 30, an OPEC meeting announced an agreement to cut back on oil production thus reducing excess supply and weighing on oil prices. On the same day, Dallas Federal Reserve Bank President, Robert Kaplan spoke at the Economics Club of New York regarding the oil sector in jobs. And I know many of the people who have jobs in the oil sector, where are protective care apparel. Kaplan said, energy prices have substantially declined since June 2014. In early 2014, the mining sector composed substantially of oil and gas and services accounted for 2.8% of U.S. GDP. By early 2016, the sector had declined to approximately 1.3% of GDP. At the Dallas Fed, we believe that global oil production and consumption will get into rough bounds by sometime on the first-half of 2017. According to news reports in early November, the Dallas Fed reported that already data was suggesting that the state might be seeing the beginning of the end of the Texas slump, which oil prices set to move back into sustainable ranges that will bring jobs back. While these challenges of oil production and currency fluctuations are a function of our business in marketplace and not necessarily self-inflicted. We have made impressive progress and we have been investing to position the company for continued long-term growth. Long-term growth is in a large part within our control and we have been advancing our position. Key components of our growth plan were executed upon in the third quarter. Manufacturing capabilities have been bolstered by a new pilot program in India and increased capacity in Mexico to further supplement our large base in China. These steps follow our reduction in force and charges taken in the first quarter ended April 30, 2016, to move certain manufacturing from the U.S. to our other manufacturing plants. We have the leverage and the latitude to make these moves, which is integral to what we call our unique operating platform. Leveraging our global production footprint, we entered four new geographic markets, including South Korea, Indonesia, Malaysia and Vietnam. We have added to our direct sales force with higher – with the hiring of experienced personnel in these countries, as well as adding three new salespeople in the U.S. Contributions to our revenues in the third quarter are minimal for these new additions, but they have increased our operating expenses, which is in a large part why our spending in the quarter picked up from earlier periods. We intended to hire additional sales professions in Germany and in the U.S., particularly for new product line. I will address the new product lines and vertical market expansion in greater detail during our year ended conference call, but they have already been put in play. As for new hires, we do not expect for them to pay for themselves for about a year after hiring, which is the anticipated time frame based on our past experience. Our expansion of facilities, markets, and sales personnel are calculated initiatives intended to drive revenues and profits next year and beyond. Meanwhile remain vigilant in managing our cost bases and maximizing the generation of cash flow from operations. No better measure of our progress can be found in debt reduction and working capital improvements. Through the first nine months of the fiscal year, we had net cash provided by operations of $8.2 million, a significant reversal from the $3.9 million used in operating activities in the same period of the prior year. Inventory management was a key component of our cash flow, with inventories reduced by nearly $4.2 million in the fiscal year-to-date. Cash at October 31, 2016 was $8.5 million, up from $7.9 million at the end of the second quarter and $7 million at the beginning of the fiscal year. The increases in cash balances are impressive since we have been simultaneously and significantly reducing our debt. In the third quarter, we paid down $3.3 million of debt, which is the same reduction we recorded for the first-half of the year. Debt at the end of the fiscal third quarter was reduced by nearly 50% to $6.8 million from $13.4 million at the beginning of the fiscal year. During the same periods, working capital improved by nearly 10% from $42.2 million to $46.2 million. Based on our fiscal health and outlook for continued progress on an operational basis, our Board authorized a $2.5 million stock repurchase program. In the third quarter, we did not repurchase any shares, but have the flexibility in cash and the Board’s approval to opportunistically repurchase shares. We are pleased to have been able to materially improve our financial condition, while investing in our future growth. Although, there are some challenges throughout our global operating footprint, we have seen continued momentum in our business on a consolidated global basis that began at the start of this fiscal year. Lakeland Industries remains confident in its ability to increase sales, despite any pressure from global economic conditions, currency fluctuations, or the pullback in oil and gas sector. That concludes my remarks. I will now pass the call to our CFO, Teri Hunt to provide a more thorough review of the company’s financial results.

Thank you, Chris. The following addresses my review of the third quarter of fiscal 2017 ended October 31, 2016. The fiscal 2017 financial results that I discuss on this conference call will be from continuing ops unless otherwise noted. Net sales from continuing operations were $23.2 million, down from $24.9 million for the prior year period. Third quarter revenue of $23.2 million was 4% higher than $22.3 million in Q2 FY 2017, 14% higher than $20.4 million in Q1 FY 2017 and 13% higher than Q4 FY 2016. So our most recent quarterly revenue was the highest since the third quarter of last fiscal year, which marks the fourth consecutive quarter in which we had higher margin contributions of emergency sales associated with Ebola and/or the bird flu outbreaks. Although we reported the highest revenue in four sequential quarters, we continue to be subject to softness in the global industrial sector, partially resulting from the oil and gas industry, as well as currency headwind in several of the foreign countries in which the company has operations. The gross margin was 37% this quarter, compared to 37% in Q3 of FY 2016. In addition to lower sales volume in the most recent period, which weighed down margins, last year’s same period gross margin was favorably impacted by higher margin sale of products used in dealing with the bird flu, which we consider to be somewhat one-time in nature thus making comparisons difficult. As compared to the first quarter of the current fiscal year, the third quarter gross margin, as well as the second quarter gross margin of over 38% benefited from higher revenues and included cost reductions relating to a reduction in force in the U.S. implemented in the first quarter to move production to more cost effective facilities in Mexico and China. With the currency fluctuations, comparison of quarters in the current fiscal year are more appropriate than the year-over-year comparison, given a distortion from the year-ago period. The company’s ongoing efforts to reduce costs and operate more efficiently notwithstanding, we increased sales and marketing expenses with the addition of seven new direct salespeople. As a result, we reported higher operating expenses in the third quarter of this year as compared with the second quarter and the same period last year. Operating expenses worldwide were $6.3 million for the current year’s third quarter from $6.1 million last year’s third quarter, and $6 million in the second quarter of this year. As a percent of sales, operating expenses were 27% in Q3 FY 2017, 26.8% in Q2 FY 2017, 32.4% in Q1 FY 2017, and 24.4% in Q3 FY 2016. The main factor for the increase from the earlier year period was the sales were inflated due to higher margin emergency demand. The main factors for the increase in operating expenses from Q2 of this year is higher selling costs, which has not yet resulting – resulted in offsetting incremental sales. The reduced expense level from the first quarter of the current fiscal year was a result of the aforementioned operational cost containment initiatives, as well as severance associated with the layoff in Q1. Similar to the past few quarters, while our cost containment efforts continue to lead to reduced expenses in many areas, we increased spending in certain areas with respect to the implementation of growth strategies, including sales and marketing expansion initiatives, new product development, and enterprise planning systems. We had an operating profit of $2.2 million in Q3 FY 2017, down from $3.2 million in the same period last year, $2.6 million in Q2 of this year, and $0.2 million in Q1 of this year. The higher sales in the year earlier period were mainly a result of demand connected to a bird flu pandemic in the U.S. As compared to the first quarter of fiscal 2017, the improvement in operating profit is attributable to higher sales and reduced operating expenses. From Q2 FY 2017 to Q3 2017, we had higher sales, but a lower gross margin based on mix and higher operating expenses as we invested for future growth. Operating margins were 10% in Q3 of 2017, down from a 11.8% in Q3 2017 and 12.9% in last year’s third quarter, but up from 8% in this year’s first quarter. Third quarter net income was $1.5 million, or $0.21 per share, up from $1.4 million, or $0.20 per share in Q2 2017, and break-even in the first quarter of the year and as compared to $3.1 million and $0.29 per share in the third quarter last year. Against the prior year period, net income for the three months ended October 31, 2016 primarily reflects the lower sales volume from the lack of higher margin emergency demand. As compared to the first quarter of this year, the higher net income in the third quarter reflects improved traction for our organic growth initiatives and expense management initiatives. As a reminder relating to our tax rate, we don’t expect any significant changes year-over-year in the effective tax rate. We do continue to have the benefit of the tax credit from the worthless stock deduction relating to our exit from Brazil, so there should not be cash taxes in the U.S. for the next two plus years. Depending on our profitability in these periods and assuming no changes in the U.S. tax rights. We do, however, pay local taxes on certain country operations when those ops are profitable. On the balance sheet, cash and equivalents at the end of the third quarter increased to $8.5 million from $7.9 million at the end of the second quarter and from $7 million at the beginning of the fiscal year. Our cash balance reflects efforts to improve our overall financial conditions. At October 31, 2016, the balance of borrowings under our revolving credit facility stood at $5.8 million, a $3.7 million reduction from $9.5 million at the beginning of the year. $2.9 million of other debt was paid off since January 31, 2016, as we repaid all loans in China. With our short-term assets increasing and our short-term liabilities decreasing since the beginning of the year, our current ratio improved to 4.41 from 3.1 to 1. Total shareholders’ equity also improved from the beginning of the year going from $67.5 million to $70.6 million. That concludes my remarks. And I’ll turn the call back to the operator to begin Q&A.

[Operator Instructions] And our first question comes from Mark Rosenkran from Craig-Hallum. Please go ahead with your question.

Great. Thanks for taking my questions and congrats on a really solid quarter.

Thank you.

Just a real quick. I was hoping you could give a little more on the customer inventory levels that’s been kind of an issue in the prior quarters. Where do you kind of see those? Do you think they’ve stabilized a little bit, or how do you kind of see the order flow, as we enter into 2017 here?

In terms of inventory levels…

Yes.

We anticipate they’ll rise some in Q4, not significantly as a rule. We have inventory in the pipelines right now, preparing for Chinese New Year, and then going into our – going to spring, which is generally one of our strongest times in terms of volume. There’s a kind of a change in the mix if you notice between raw materials and and finished goods and then there’s more raw material in the pipelines and finished goods, which would indicate that is the case, as we move into our busy season.

Okay, great. And then on the new geographic markets you announced in South Korea and Indonesia. Could you just discuss a little more on the opportunities you see there and kind of what’s the size you can see that coming in the next, two, three, four years down the road?

Well, that was virgin territory for us. We’ve sold into those countries previously, but now we have actual salesmen in those countries. Southeast Asia is growing a lot more quickly than Europe or the United States. So there the areas are really greenfields, and they’re also less expensive to operate in than the United States or Europe So you get more bank for your sales buck in terms of investment in those countries.

Okay, fair enough. And then last question for me, just on the U.S., another solid quarter. Just kind of describe where you see the main opportunities as we enter 2017 here, you’ve been pretty successful across a lot of new verticals and focusing on new customers, where do you kind of see the main focal points as we enter the new fiscal year here?

Well, the main focal points will be continuing block and tackle sales on the new products that we started up over the last year or two. And that is primarily looking at how far into the utility industry. It’s just block and tackle sales. One of the salesman we did hire is also a specialist in that industry and we only hired him recently. So we don’t expect him to be really profitable until about a year from now.

Okay, that’s helpful. Thanks for taking my questions.

Our next question comes from Shoon Huggett [ph] who is a private investor. Please go ahead with your question.

Hi, everyone. You hired a significant amount of new salespeople in those areas that in those greenfield areas you described. When do you expect their sales efforts to have a significant impact on top line revenue?

About a year.

A year. Do you have an idea of what kind of sales impact they will have?

Well, I think starting in about a year from now, you’re going to see organic growth of the consolidated global sales increased by about 10%. Now a lot of that will depend on the economy The GDP is the global countries that we really operate in. And if it’s really slow and we continue to have rising dollar and oil continues to stay 50 or below, that could be 8%. On the other hand if the United States GDP takes off, that could be 12%. So it’s somewhere between 8% and 12%, so I would like to say 10% organic growth, you’re going to start seeing about this time next year.

And have you seen impacts of the rising price of oil, any indications from purchasers that they might ramp up purchases or stock up on their inventory levels, any indication so far since the announcement a few weeks ago?

Not quite yet, because at $50 it’s good for the Permian basin, but it’s not good for Gulf offshore oil drilling. And a lot of the drillers have really basically lowered their operating profit level. But as an easy way to say, you’re only – people only started hiring workers back at the rig – the exploration rigs. When you’re going to see the price of oil stay above $50 for, at least, a couple of months, then the Gulf will probably go on once oil is above $60 for a couple of months. So it’s going to be very slow. You’re not going to see a lot of these oil companies hire people back probably for three to six to nine months.

And in the next few quarters, are you targeting zero debt balance, or is the strategy of paying down debt going to continue, or are there other uses for that cash that will be coming up CapEx programs or share repurchases, acquisitions perhaps, can you comment on that?

We’ll continue to drive debt down, but we’ll also continue to invest in inventories in these new products that we’re going to be offering over the next year. On CapEx?

CapEx, we are looking at a global ERP solution that will – we still don’t anticipate CapEx exceeding $1 million in the next year, even with the global ERP implementation and some of the growth initiatives that we’ve taken on.

Okay, that’s helpful. Thank you, all.

Our next question comes from Jeff Briggs from Singular Research. Please go ahead with your question.

Hi. So this is a little bit of a follow-up on the comment you made sort of about the 8% to 12% organic growth. And so, there’s a couple of things that come from, it could be from new products, growth in existing products, or geographically. Can you comment a little bit on sort of what the main driver you see of that organic growth, is it sort of growing existing product lines, or is it predominantly the new products?

It’s going to be growth in new products and probably growth in international sales.

Okay.

In fact, our international sales picked up this quarter.

And then as a little bit of follow up on the international side. So you mentioned sort of some of the strong dollar hurting the dollar impact after you convert those sales back to dollars on top line growth. Are there any additional opportunities in terms of – I know you talked about moving some production to lower cost manufacturing areas. Is there any additional opportunity to lower production costs or cost of goods sold with current suppliers, as the dollar gets stronger against those currencies?

Yes, that automatically happens. I mean, as the dollar strengthens, it does two things. It makes our manufacturing cost lower, but it makes our sales lower also okay. And we – since we’re operating all over the world, it’s hard that you got to go country by country. But yes, we plan on lowering our manufacturing costs for getting currencies okay, by expanding further in India, which we have done. As China becomes more expensive, India is – one of the answer is, Vietnam is also another answer to lower actual manufacturing costs. Did we lose everybody?

You actually cut out for a minute there, but you’re back now.

Okay.

Okay.

India is – right now, India and Vietnam are our answers for lowering manufacturing costs despite what the currencies do.

Okay. Thank you.

[Operator Instructions] Our next question comes from Geoffrey Scott from Scott Asset Management. Please go ahead with your question.

Good afternoon. A couple of follow ups on the the additional salespeople. For the three in the U.S., you said, one was going to focus on the utilities. Are the other two going to focus on new verticals, or better geographic coverage?

New verticals.

Can you tell which ones?

Well, it’s fire, utilities and those three and we’ll probably be hiring another one in the United States next year and one in Germany next year. And the three guys in Southeast Asia, they’re pushing all products.

Okay. Going to Southeast Asia, of the four countries you mentioned, which one will be the first to get up to your target sales goals, and which one do you think will be the laggard?

Malaysia will be the first one and probably Vietnam will be the laggard and that’s based on the time that these salesmen have had to run with the ball.

Okay, all right. In both the U.S. and the international, you said it will take about 12 months to start seeing some reasonable revenues. Is that because the sales process, is that long, or is that because once a customer has decided to change to your product, they have to run down their existing inventory before they can buy meaningful amounts of years?

Both.

Is either one more…

It’s a balancing act, more so, it takes a while to get the customer comfortable enough to start put in his first PO and then you generally have to wait, at least, three months while they run down their current inventory. So it’s really both, that’s why it takes about a year. This is an industry that people do not make quick decisions.

So it’s essentially six months for a sale decision and then six months to run off inventory, 12 months before you start supplying?

It’s more like nine months, three months to run off their inventory.

Okay. So nine months from now, you’ll have a much better idea of your degree of success?

Yes, we will.

Three months you will not, six months, you may or may not, nine months, you will?

Yes. And we’re – we’ve got seven people this year with two more next year. So and they’re all being hired at different rates. Next quarter, I’ll try to tally that up for you now that I know, you’re asking this question. I can actually sit down and maybe do some percentages for you.

Okay. Chris, I look forward to the call. Thank you.

Okay.

[Operator Instructions] Our next question comes from Larry Negrin. [ph]. Please go ahead with your question.

Hi, Chris, a pleasure to talk to you guys. And my question, as I’m looking at the balance sheet, specifically the property and equipment and the assets held for sale. And I’m curious, I’m assuming it’s not a reduction of $730,000 in depreciation between for the property and equipment. So I’m curious how much of the property and equipment account is actually property, real property that the Corporation actually owns? And what also with regard to the assets held for sale, what was actually sold in there, because that had a decline of about $125,000. And then if you don’t mind, I’m curious for the amount of property that’s probably on here as part of that property and equipment that’s being shown obviously at a historical cost, what would you say the fair market value of the real property would be that the company owns? Thanks.

With respect to the asset held for sale, that is a property that our corporate area still holds in Brazil, it’s land, and a building. And we have – we’re responding to the – what we perceive is the market value there, the management estimate was reduced due to the economic situation in Brazil. So we’re writing that that property down to what we believe is market value. So we’ll probably take it down another $75,000 or so in Q4, which we believe is appropriate thing to do with that equipment. As far as property and equipment in other places, we have, of course, we have machinery in the U.S. and property in the U.S. and Alabama. We’ve got a facility we own in Weifang, China. We have a Mexico property that we own, as well as equipment in both of those places and the manufacturing facility in India and the warehouse and office space in Canada. So with respect to these properties, I don’t believe we have any properties anywhere else that don’t reflect something approaching fair market value on – currently on the books. We don’t routinely shop our equipment, because we’re not looking to sell it and we haven’t shopped any of the properties, because we’re not looking to sell those either, but I don’t know…

Well, the only – the reason I was asking was really more a curiosity on the actual, should we say, cost basis versus a fair market value based on stock price?

Well, I think the property that we own in China, we’ve owned it since 1996. Property you don’t depreciate the raw property, but the value of that property has gone up. We don’t do mark-to-market on real estate. But I think it’s fair to say that that what we have in China is a 50-year lease. That lease is assignable. We had a factory in Qingdao a couple of years ago that we sold and we signed the lease and we made a profit on the sale. But this property is probably worth three or four times more than what we paid for it.

Okay.

Simply, because we’ve owned it for 20 years, and property values have expanded in China. With Mexico, probably worth the same; U.S., probably worth a little bit more; in the U.S., real estate prices haven’t boomed, but they’ve gone up 1% or 2% a year.

So if you were actually valuating the stock using fair market value, should we say, where it closed at $11.40 today, how close would that theoretically be if the asset, especially the real state was priced at its fair market value? I mean, would the book value – I mean, would the stock, the value of the stock be closer to $12, $13, or are we taking – is book value somewhere around the $10 or $11?

Well, the tangible book value is, when we look at the numbers is what $9.20, $9.75, okay. In order to get rid of the real estate, well, you could do sale leasebacks without closing down the company. But I believe if we were to close down the company and liquidate it and we had two years, you’d take a hit on the inventory, but you’d make a lot of money on the real estate. So I think it could be liquidated for $8 a share. If it was just sale leaseback, you could probably pick up some significant book value.

Got it. Thanks, Chris.

Okay.

And ladies and gentlemen, at this time I’m showing no additional questions. I’d like to turn the conference call back over to management for any closing remarks.

Well, we appreciate your participation on Lakeland’s fiscal 2017 third quarter financial results conference call. As we are committed to delivering value for our shareholders, we believe this is the best achieved for Lakeland Industries through the continued implementation of strategies for effectively managing its balance sheet, controlling expenses, and capitalizing on long-term global growth initiatives. We’re very encouraged by our growth prospects as we will are well-positioned to grow organically through overall market expansion and as well as capturing market share. Thank you, again, and goodbye.

Ladies and gentlemen, that does conclude today’s conference. We do thank you for attending. You may now disconnect your telephone lines.