Lakeland Industries, Inc. (LAKE) Q3 2019 Earnings Report, Transcript and Summary

Greeting, and welcome to Lakeland's Third Quarter Fiscal Year 2019 Financial Results. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. I'll now turn the conference over to your host Christopher Ryan, CEO.

Good afternoon to you all, and thank you for joining our fiscal 2019 third quarter financial results conference call. We're going to provide opening statements on the status of operations and on our financial results. The call will then be opened up so that we may respond to your questions. Now onto my formal remarks. We're now in the fourth consecutive quarter of favorable global industrial growth trends, although our company's growth in fiscal 2019 third quarter was only modest year-over-year. To this end, we are disappointed in the reported revenues, although the primary reason for this less than ideal performance is understandable, and an end is in sight for issues that are within our control. Our sales, gross profit, operating expenses and cash flow continue to be negatively impacted by our enterprise resource planning or ERP System implementation. On August 1, 2018, the first day of our fiscal 2019 third quarter, we commenced usage of the system for financial reporting and other data inputs, including costing, order tracking and sales. The ERP implementation was expected to require significant effort and expense as well as lead to operational issues amidst such a massive undertaking. But the challenges exceeded what we had anticipated. As a result, we filed for a delayed reporting of third quarter results to ensure accuracy, while working with our orders to systematically and manually complete the financial reporting process. At that time and amid an overall pessimistic sentiment in the stock market, as the calendar year comes to a close, shares of our common stock sold off. Ultimately, we expect the ERP System to yield improved information, operational agility and inventory and cash flow management. While we believe we are past the most difficult and costly period, which was during our fiscal 2019 third quarter, the current implementation and training on the system is now expected to be completed by the end of April 2019. Upon completion, we expect to reduce inventory to a normalized level as we increase inventory in anticipation of certain disruptions. In third quarter, we had elevated expenses and reduced revenues in the U.S. as we were unable to process orders to the extent that reflects the true global demand that we are otherwise experiencing. We anticipate a similar, although diminished negative impact through April 2019 as we continue to train our workforce on efficient utilization of the ERP System. Some of our long standing customers have taken some orders to our competitors while committing to return to us, yet there have been a few isolated instances where we may have lost a smaller customer. We start to the fiscal fourth quarter with over 5 million in orders waiting to be cleared and shipped. Our order backlog historically have been approximately $3 million just in the U.S. The delay in shipping and revenue recognition caused by our ERP System essentially reduced reported revenue by an estimated $2.5 million or nearly 10% of total third quarter revenue, which would have brought our third quarter revenue growth significantly higher than only marginal improvement over the prior year period. We have recently implemented double shifts in order to get product out the door and reduce the backlog. Despite the [optics] [ph] presented by our ERP challenges and the reported revenues on a consolidated basis, our sales traction has been strong. A basket of currencies from countries in which we operate are down by about 5% year-over-year, yet on a reported basis, in U.S. dollars, our international sales in the quarter still increased 10% from the prior year. However, all major country operations were profitable in the third quarter, so we continue to maintain focus on our profitability metrics while investing in the future growth strategies. We have been strategically deploying our cash to position the company for continued growth. Teri will speak more about our capital expenditures and strong cash positions in our prepared remarks. Cash used since the beginning of the fiscal year includes planned investments in manufacturing operations in Vietnam and the company's upgraded technology system deployments as well as our digital marketing evolution. We now have a manufacturing staff approaching 400 in Vietnam. Earlier today we announced the launching of 9 new websites for our global operating regions. As was stated in the press release issued this morning, the launch of our new websites provides an advance user experience for our customers, distributors, channels partners, investors and media, who will be touching the sites daily. Our customers and partners represent some of the world's most progressive organizations in their respective fields and they will now be able to better leverage Lakeland's research, robust educational resources and innovative product offerings that act as the first line of defense in critical environments while improving worker safety. The new website launches are part of our digital marketing in e-commerce investments, which also includes our Amazon platform. We have deployed Amazon sales and distribution in five countries, and we invested nearly $2.2 million in equipment for use in Mexico, India, Vietnam and China as we prepare for continued global demand. Last quarter, we discussed the five salespeople who were added in calendar 2017, and we added at least three more sales and marketing people in calendar 2018. It typically takes 6 to 12 months for salespeople to meet their quotas where we begin to breakeven on them. Among our relatively new offerings, we have our cleanroom disposable garment targeting big pharma, which we believe is a $60 million global market overall. Presently, we are below $1 million in sales in this market, but we are gaining momentum. The utility market is a $200 million global opportunity for us. We are on track to achieve about $7 million in annualized revenues from this market by the end of fiscal year - by the end of the fiscal year, which is terrific given we've been in this market less than a year. Among the other macro issues, I believe it is worth mentioning tariff and the current Ebola outbreak. On the tariff front, presently, there are no tariffs for apparel made in China and sent to the U.S. So we have no exposure to the present saber rattling between these two countries. If one were to be introduced, we now have significant manufacturing operations in Vietnam, which has taken on a lot of current production in China, which was headed to the U.S., and there are no international tariffs between Vietnam and the U.S. or they other nations. On the Ebola outbreak, the Democratic Republic of the Congo has seen cases reported since August and spreading since that time. More than 40,000 people have been vaccinated, but there have been 500 reported cases with nearly half resulting in death. The outbreak is in the northeastern region of the country, which has long suffered from armed conflict, exacerbating local tensions between militants, healthcare professionals, aid providers and residents. This is the second largest Ebola outbreak on record. With no end in sight and limited availability of vaccinations, we are beginning to feel the enquiries regarding our protective clothing, although no meaningful orders have yet been received. We will be prepared to assist should the need arise. In conclusion, we have built a lot of momentum through the first 9 months of fiscal 2019 and remain very encouraged by our strong position in the market. As we look toward the balance of fiscal 2019 and beyond, we look forward to capitalizing on the progress we have made and will continue to make in our efforts to drive sustainable improvement in longer term top line results, as well as bottom line performance. 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 second quarter financial results.

Thank you, Chris. The following addresses my review of the fiscal '19 third quarter ended October 31, 2018. Net sales from continuing operations grew slightly to just over $24 million from just under $24 million in the year earlier period. Overall sales volume continues to benefit from global economic growth, a somewhat rebounded oil and gas sector and our ability to take market share in the U.S. while having early mover advantage in more developing nations internationally. As Chris mentioned in his remarks today, our sales in the fiscal 2019 third quarter would've been higher if our ERP processes were fully functional and we were able to ship products included in the backlog. The majority of this backlog constraint impacted our sales in the U.S. for disposables, our highest selling products family, and to a lesser extent for gloves and FR garments. Total sales in the U.S. declined 8% year-over-year in the third quarter, coming in at $11.8 million this year as compared with $12.9 million last year. Sales outside the U.S. increased 9% to $12.2 million. This growth was achieved despite a 5% decline in certain foreign currencies against the USD. Among the company's larger international operations, sales revenue in Europe, including the U.K., was flat year-over-year at $2.2 million, although the euro declined against the U.S. dollar by about 5% from last year. Sales in China and to the Asia Pacific Rim increased 21% from $4 million to $4.8 million, 10 [ph] of the sales decreased 8% to $2.1 million as compared to the prior year period. Russia and Kazakhstan sales combined for an increase of $0.3 million to $0.9 million as the company continues to gain customers in this region. Latin America sales were level at $1.7 million, and Mexico was up by 51% from $0.5 million to $0.8 million. Domestic sales were 49.2% and international sales were 50.8% of the total revenues in the third quarter of fiscal '19 as compared to 53.6% and 46.4% in the same period of fiscal '18. Gross profit decreased 6.4% to $8.5 million or 35.3% in the quarter as compared with $9.1 million or 37.8% for the prior year period. The gross margin decline reflects sales mix for certain product groups within disposable and chemical sales partially offset by price increases in select markets around the world. However, the key reason to lower gross profit and margin was increased expenses across distribution and supply chain management activities compounded by lower volumes within the U.S. operations associated with the ERP implementation. Operating expense increased nearly 14% to $7.3 million in the quarter from $6.3 million in last year's third quarter but were flat over the second quarter of this year. The main factors for the year-over-year increase in operating expenses are higher sales salaries and travel and related expenses for expanded sales force globally, an increase in temporary staff associated with the ERP implementation, an increase in computer expense as the company continues infrastructure improvements and increased equity compensation. We had $0.2 million favorable currency transaction effect, primarily in Vietnam, and a reduction to the bad debt allowance as a result of the collections on account of slower paying customers in various countries. As a result of the aforementioned, operating income decreased to $1 million in the quarter from $2.7 million from the same period in the prior year. Operating margins were 4.2% for this third quarter compared with 11.1% in the prior year. All primary geographic regions where we have revenues produced positive operating income for the quarter. Net income for the three months ended October 31, '18, was $0.5 million or $0.06 per share compared with $1.8 million or $0.23 per share for the 3 months ended October 31, '17. The results for three months ended October 31, '18, are primarily due to increased operating expenses, including spending on global growth initiatives, such as additional salespeople, and investment in lower cost manufacturing in Vietnam and on IT infrastructure. Income tax expense for the quarter was $0.5 million compared with $0.8 million in the same quarter last year. The company continues to be required to pay local taxes on certain country operations when those operations are profitable on a local basis and are paid in local currency. Cash paid for foreign sub-taxes in third quarter of fiscal '19 was $0.5 million compared with $0.2 million for the third quarter of fiscal '18. The increase in the foreign taxes was primarily attributable to profitability in Latin America and China. Adjusted earnings before interest, taxes, depreciation and amortization, a non-cash GAAP measure, which includes stock-based compensation, was $1.4 million as compared to $2.9 million in the prior year quarter. Adjusted free cash flow, also a non-GAAP measure, was a slide negative for Q3 FY '19, down from $2.6 million in the prior year period. The company incurred capital expenditures of approximately $1 million during the quarter as compared with $0.2 million for the third quarter of fiscal '18. Capital expenditures primarily relate to the build out of our manufacturing facilities in Vietnam and India and for the phased global ERP roll out. We expect total capital expenditures for all fiscal '19 to be approximately $2.5 million, up from $9 million in fiscal '18. Cash and cash equivalents decreased $11.7 million from $15.8 million at the beginning of the fiscal year to accommodate continued level growth in the ERP System switchover in the U.S., inventories increased to $46.6 million, up from $42.9 million beginning at the fiscal year. Working capital increased to $68.1 million from $66.1 million in January 31, '18. At October 31, '18, the balance of borrowings under our $20 million revolving credit facility stood at zero, which was the same as at our last fiscal year end. Total debt outstanding at October 31, '18, was $1.5 million, down from $1.7 million at the start of the fiscal year. That concludes my remarks. I'll turn the call back to the operator to begin the Q&A session.

[Operator Instructions] Our first question comes from the line of Dave King from Roth Capital. Please proceed with your questions.

Thanks. Good evening and good afternoon, Chris and Teri. First, a few questions on the ERP impact. Do you have what the dollar amount of outsize cost were in cost of goods sold and then operating expenses during the quarter? And then more importantly, what sort of impact should we be expecting for those line items in Q4 and Q1?

It's not perfectly quantifiable. We can't identify customers who didn't call or didn't place their orders. Obviously, the elevated expenses in terms of temp labor and some overtime, those types of things, probably in the neighborhood of $0.5 million.

In Q3? $0.5 million you think?

Yes, yes. But it's not - we're signing to a lesser extent will say that in Q4 into an even lesser extent in Q1. But I think it will be markedly less in Q4, even maybe half of that and even less in Q1 as our people get more and more efficient and their daily routines become just that, they become routine instead of being on a constant learning curve.

Okay. That helps. And then - so it sounds like then this next question might be tougher than to answer. But in terms of the revenue impact, it sounds like it was like a 10 point negative impact on revenue growth in the quarter. I guess, what sort of impact do you expect then in Q4 and then Q1 if at all? And I guess the bigger question from me on that one is, when do you expect that you have everything in order so that you're now no longer experiencing those cancellations, are we there yet or are we close to that?

We put in our second shift on - in the middle of Q4 or you know, just a couple of weeks ago, and we're seeing our backlog. We saw about 40%, 45% efficiency pickup in our warehouse operations with the second shift. So we are seeing a significant decrease in the backlog. It's management's estimate that we'll be back at a normal backlog by the end of Q4. Normal in the U.S. is more like $3 million versus at the beginning of $5.5 million or so.

And then is there any way to gauge yet of the orders that are getting cancelled? Have you seen - I guess what I'm trying to figure out is, have you seen any of those customers come back after they've cancelled? I guess what I'm trying to figure out is how many of those do you think are lost? Or is too early to tell where you may have lost some customers?

Our key U.S. sales management feels confident that the customers that did go somewhere else, for the most part, it was a short term solution for inventory issues that they had to resolve. But the key - all of the sales force in the U.S. are staying in constant touch with our customers and getting positive feedback that the customers are staying with us through this.

Okay, great to hear. And then I guess one more from me, switching gears. It sounds like demand is still pretty strong out there, personal protective, Chris, I guess just how's demand in China, in particular? You're hearing a lot about macro pressure there. Are you seeing any signs of that whatsoever?

Well, certainly not in their numbers. Their numbers were way up this quarter. China is slowing down, though those are the numbers they are putting out there, but tough to say.

Okay. Putting up good numbers but no signs of weakness from your end is best that you can…

We're not seeing the weakness. In fact, last quarter was one of their best quarters. The one place we see growing there, which we can service quite well, is the nuclear market, because the Chinese are prepared to build 100 new nuclear plants over the next 20 years and they are churning them out right now. So that's a real growth market for us in terms of disposable clothing because every time you service a nuclear plant, they have to go through maintenance once a year, that's when they use container loads of our disposable garments.

Okay, good to hear. Thanks for taking my questions and good luck for the rest of the year.

Okay. Thank you.

[Operator Instructions] Our next question comes from the line of Alex Fuhrman from Craig-Hallum. Please proceed with your question.

Great. Thanks for taking my question. I'm trying to get a better sense of gross margin. It sounds like there's a lot of moving pieces here. Obviously, the ERP implementation had a big impact on the third quarter. And then you've got shifting product mix, diversifying where you're producing your product, you took a price increase recently. Can you give us a sense, just when all of the dust settles with this ERP implementation, can you give us a sense of where your gross margin should shake out in the second half of next year?

Well, if our ERP settles down by April 30, being the end of the first quarter with the majority of it done through probably January 31, we should be looking at the gross margins returning to about 37%, okay? The only thing that's really moving then is the operating margins with the sales and marketing salaries, will these guys plug in and start breaking even in terms of generating revenues from zero up to whatever they need to do breakeven or actually start producing a profit. That's the real move. And then how fast can we introduce these new products, which are higher margin products. But I think the dust will really have settled by the first quarter ended April 30. I mean, we should see a lot - all the ERP stuff pretty much out of the way. And if I - if you were to ask me, well, what is the day that the ERP starts contributing something or more positive than it is negative, which it is right now, it would probably be sometime in February or March, such that it's - when we start - we could start writing reports, we can start getting real information out of it and starts being more of a plus than a negative.

Great. Thanks. That’s helpful. And then just thinking also about your sourcing, I think you mentioned in the prepared remarks that if things were to get tougher for you guys from a tariff perspective in China, you now have more production capabilities in Vietnam and working on them in India. Is the intention to shift most of your production to those markets over time regardless of how the tariff situation plays out? Can you talk a little bit about just your production cost in China versus Vietnam, and how that would play out, assuming there is no big tariff issue?

Okay. We don't expect a tariff issue. But right now Vietnam is almost in the position to supply the United States 100% of its basic disposable garments, okay? We can grow India. We haven't been growing it yet. We've been trying to get Vietnam up to about 500 people and we're at 400 now, so we're 80% of the way there. But if we had to yes - we could - we don't see it because there are no proposed tariffs on our products yet. But even if it happened, we could switch into India and Vietnam, have them supply the United States and have China supply the rest of the world. But long term, yes. Vietnam's labor is about half that of China. Productivity is going down in China compared to what it used to be in 2000. So you've got increased wages and lowering productivity in China whereas wages are half what the - in Vietnam half what they are in China. And I would say, the productivity of the Vietnamese is getting pretty close to the lowering productivity of the Chinese and it's really the new age group coming into China. So you have a lot - you can really increase your gross margins by cutting your labor cost. And if you took a million cases, say, pretty close to what we do in disposables, and you do it in $2 cheaper in Vietnam, you save $2 million on a $2 million investment. Of course, it's not happening all at once. But we should hit that 500 person, full operational, 100% efficiency, by July of next year in Vietnam. So that will increase our gross margin significantly from just purely labor point of view. And Vietnam has some advantages in tariff, selling into places like Russia where the tariffs will be lower. But it will significantly reduce labor. And then as we - as our sales grow, we can grow in India where the labor is even cheaper than Vietnam. But more importantly, where there is unbridled amount of labor. I mean, there are about, what, 750 million people under the age of 30 in India. That is just so much different than China. It's an endless source of labor probably for the next 20 years and again at half that of Vietnam. It's just that India's is more difficult to do business in as the government, that's about the only negative. But it's a good market. It'll probably be a growing market for the next 20 years domestically too. So basically those are where gross margins are really going to increase. Basically, labor savings and the introduction of new products, which carry much higher margins than our typical normal products. And from there it's just getting the operating expenses under control, okay, which we'll concentrate on and basically getting the salesmen up to par. And a lot of these sales - a lot of the sales and marketing is on these new products, which have high margins. And salesmen are a little scared to jump out of the gate in the 100 yard dash with the ERP System. They want to be certain that it's - that we're delivering on time because you really can't make a mistake the first time with a new product introduction.

Great. That’s really helpful. Thank you, Chris.

Our next question comes from the line of Pete Muckerman from Raymond James. Please proceed with your question.

Thank you. Hey good afternoon to you all. Mr. Ryan, can you - the majority of my questions have been answered, but I've got a couple. You guys did not touch on the buyback, or if you did, I missed it and I apologize if that's the case. But given the tumult in the market and given kind of the transformation that you all are going through, have you initiated the buyback? And if not, what is the rationale behind that?

We can, and we will initiate the buyback with legal, which I understand is two business days after today.

I see. Okay. A follow on question would be, can you shed just a little bit more light on or a little more color on where Lakeland stands when it comes to - and for instance, these fires out in California, the Ebola, the - I know that there was a swine flu in China that was going berserk, things like that. Can you tell us where kind of places in the day and the life of Lakeland inside when the - behind the doors? Is the phone ringing or the - is the - the sales people are obviously making outbound calls on things like that or I'm just curious. I mean, these fires…

Yes. We picked up a lot of business in the west as a result of those fires. And we picked up some significant new accounts. More importantly, they are doing now that it's beginning to rain in California and the fire season comes under some control, this is when they sort of do their inventory and they figure out when they need new garments. So we should be - see some significant pickup in business in spring and summer. So as I said, most of the firefighters are just getting home. They'll look at their inventories and then they'll start ordering in spring or summer for the next fire season, which basically starts in the summer. So they have used a lot of stuff, my guess and the orders are going to be rather nice come this spring. You also brought up something - there was another piece of that question?

No. It was just a little color on - you mentioned earlier that your field in calls on Ebola is - my sense is - and this is widely unfortunate that the rebel groups over there are starting to - they've decided to kind of weaponize this disease, which is mind numbing in many respects that they're killing - from the reports I've read anyway, they're killing the volunteers and the doctors and the – they are burning these little huts where people are receiving care. I mean, it's just a nightmare. I mean, I'm just curious to what - how that conversation has been going, that's all?

Well, that's a - that's why we're beginning to get inquiries from the various European and American agencies and Doctors Without Borders. People like that. We're beginning to see increase. That is the problem, it's spreading simply because they are killing the aid workers. And without aid workers, they really can't stop the disease from spreading. They're ringing it with vaccines. But there's only for minor strains, 300,000 vaccines available right now. So it will probably continue to spread. And then I guess, if it gets to a bursting point, which is when it starts entering large cities, then there probably be a demand for more garments. We'll see.

All right. Thank you.

Ladies and gentlemen, we've reached the end of the question-and-answer session. And I would like to turn the call back over to management for closing remarks.

Okay. Well, we appreciative your participation on Lakeland's Fiscal 2019 third quarter financial results conference call. Our expanded global team is working extremely hard at implementing our ERP system and forging our company into a more efficient, higher growth and more profitable enterprise. We believe we have the right mix of products, manufacturing presence around the world, financial strength, global staffing and leadership to capitalize on the opportunities ahead. We are very well positioned for continued growth in sales, market share and profitability, which we believe will deliver value for our shareholders. I thought, and this is not in my speech, but if you really want to get into good shape, no pain, no gain. Good bye and thank you.

Thank you.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.