Lakeland Industries, Inc. (LAKE) Q2 2020 Earnings Report, Transcript and Summary

Okay. Before we begin, parties are reminded that statements made during this call contain forward-looking information within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934. Forward-looking statements are all statements other than statements of historical facts, which reflect management's expectations regarding future events and operating performance and speak only as of today, September 9, 2019. Forward-looking statements are based on current assumptions and analysis made by the company in light of its experience and its perception of historical trends, current conditions, expected future developments and other factors it believes are appropriate under the circumstances. These statements are subject to a number of assumptions, risks and uncertainties and factored into the company's filings with the Securities and Exchange Commission; general economic and business conditions; the business opportunities that may be presented to you and pursued by the company; changes in law and regulations; and/or other factors many of which are beyond the control of the company. Listeners are cautioned that these statements are not guarantees of future performance, and the actual results or developments may differ materially from these projected in any forward-looking statements. All subsequent forward-looking statements attributable to the company or persons acting on behalf are expressly qualified in their entirety by these cautionary statements. At this time, I'd like to introduce myself, Chris Ryan, Chief Executive of Lakeland Industries. So good afternoon to you, all, and thank you for joining our Fiscal 2020 Second Quarter Financial Results Conference Call. I'm joined here today with Lakeland's Chief Operating Officer, Charles Roberson; and for the first time, our newly appointed Chief Financial Officer, Allen Dillard. Welcome to the team, Allen. For those of you who did not see our press release over the summer, Allen was named our CFO effective August 12. So he's only had less than a month to close out our quarter and prepare for the earnings conference call. Allen comes to us with substantial experience spanning 3 decades in growing cross-border enterprises with public and private companies, including 10 years as an accountant with Ernst & Young. We believe he'll make a valuable contribution to our efforts in pursuing both domestic and international market expansion as well as driving meaningful improvements in profitability and cash flow growth. Today's call, we are going to discuss the status of the operations and our financial results. Then the call will be opened up so that we may respond to your questions. Now on to my formal remarks. We delivered solid financial and operating performance progress in the second quarter of fiscal 2020. Quarterly revenues reached the highest levels of company history due in large part to filling in backlog orders when not including sales relating to emergency demand, which goes back to the Ebola and bird flu orders in our fiscal 2016 year. Although there is an ongoing threat of a potentially devastating Ebola outbreak again taking place in Africa, our sales growth in fiscal 2019 do not include anything to-date that we can ascertain as being connected with this emergent situation. In our Q2, sales increased across a wide array of products, including disposable garments, chemical suits, fire retardant products and high visibility apparel. These products can be made from several of our manufacturing locations around the world with diversified supply chains to support our low-cost production practices. On a geographic basis, there was growth in the Americas, while Europe and China were negatively impacted by currencies as reported in U.S. dollars. The strong U.S. dollar against certain foreign currencies reduced consolidated revenues by approximately 3%. Our sales growth in Q2 was, to an extent, aided by our misfortune in prior periods as we were unable to process orders due to ERP challenges. Approximately $500,000 in revenues were recorded in the second quarter of fiscal 2020 for orders that had been ERP delayed. Excluding this approximate amount, Q2 revenues would have been $27 million or an increase of 5.5% over the prior year. Eliminating the impact of FX, you can see that demand for Lakeland products globally increased substantially, nearly 4x that of U.S. GDP growth of 2.1% in the second quarter. But we are targeting mature markets like the U.S. and Europe as well as higher-growth markets in Southeast Asia and Latin America and other parts of the world. For example, in Latin America, which was our third largest market in terms of Q2 revenues behind the U.S. and Asia, we had a 32% growth in sales over the prior year. Overall, new bookings in the second quarter of $16.3 million increased 25% from the prior year period and by nearly 7% from the first quarter. The big increase in U.S. sales came in direct containers which are not affected by the ERP system. Backlog at July 31, 2019, was $5.9 million, which increased from $5.4 million at the end of the first quarter due to increased bookings during the second quarter. This order flow is part of the reason for our increased inventory levels at the end of Q2. Absent any major shift in global economic activity or trade wars that has a psychological impact on our customers, we are experiencing a more normalized operating environment due to the confluence of 2 strategic imperatives which are gaining meaningful traction. The first of these relates to the ERP implementation which impacts our North American business that represents roughly half of our revenues. Products sold into this region are generally made in our manufacturing locations by volume in China, Vietnam, Mexico, India, the U.S. and Argentina. The ERP system is finally getting on track, and we are beginning to derive benefits in key performance indicators, such as order processing and delivering, raw material management and effective pricing and costing strategies. Delivery schedules have been met, and orders are being filled such that we are getting positive feedback from our customers. In the second, in the fiscal second quarter, we experienced improvement in cost of goods sold due to our ability to track materials and expedite orders. We are in the process of unwinding finished goods such that we may have improved working capital, which in turn may enable incremental growth on the sales front. We previously announced an update of our ERP system that took place in late July to bring on additional improvements and features that centered on inventory metering. To do this, we shut down our U.S. information system at the close of business on July 27 through August 4, which resulted in 5 lost days of domestic sales on a reported basis, with 3 of the days falling into our fiscal second quarter. So again, our sales growth in Q2 was even more impressive. In late July shutdowns to work on the ERP system, net inventory adjustments were not as significant as in previous quarters even though we had an inventory increase of $2 million from Q1 to Q2. This is largely attributable to unanticipated efficiency improvements from the stage planning work benches, which have effectively shortened lead times by 3 weeks, increasing our inventory by roughly $2.7 million. We have since adjusted our lead times to correct safety stock levels and canceled manufacturing orders for products that exceeded target stock levels. This work continues as we intend to reduce safety stock levels by an additional 10%, bringing the total reduction to nearly $44 million. The ERP system may shorten our overall product manufacturing cycle by about 2 weeks. This will eventually equate to a reduction in certain stock levels in the United States. The next step function for us is to begin realizing improved efficiencies that will result in decreased inventory levels, increased free cash flow as inventories are run down and reduced customer lead times. If we can do these, we have an excellent opportunity to not only grow our business domestically but take meaningful market share as we already has -- as we already have the lowest cost structure because we are the only major provider that owns and controls its manufacturing on a global scale. So the next operational aspect of interest to our customers is capacity and delivery timetables. To this end, the second important operational objective was the expansion of our manufacturing facility in Vietnam. While many manufacturers around the world are contemplating a partial or complete exit from China in light of the ongoing trade negotiations with the U.S. government, Lakeland's highly experienced management team further expanded the company's global manufacturing to include Vietnam. This was not done as a response to tariff wars but instead was a matter of vigilantly managing our cost structure. China is far more expensive for manufacturing today as compared to 23-plus years ago when we first arrived there and as compared to Vietnam or India today. We have a solid base of sales domestically in China, along with both manufacturing and regional Southeast Asian sales which will be maintained and grown as appropriate. Our China operation currently has a manufacturing team of nearly 540, down from as high as 800 just a few years ago. Two years into executing our planned expansion into Vietnam, we now have a manufacturing team of over 750 in this location and still can expand that by another 14%. Our manufacturing expansion into Vietnam is now essentially complete, including capital equipment purchases, investment in property and plant, hiring of staff and related organizational expense additions. While efficiencies are improving, we are not expecting to be fully maximized until the second half of fiscal 2021 on the cost side. This gives us ample runway for continued growth in our largest operating market, the U.S., where import tariffs are not applicable, as well as other international markets. We are now enjoying a considerable increase in interest in our non-China manufacturing capability. As a result of the development of our Vietnam and, to a lesser extent, Indian manufacturing and the ongoing trade war and tariff adjustments, more and more of our customers are seeking a permanent alternative to Chinese-manufactured goods. This bodes well for our ability to push Vietnam and India into full capacity, which in turn will maximize the speed with which they can attain optimum operating efficiency. Speaking of operating efficiency, we also performed well here in the second quarter. Operating income increased by 60%, while our operating margin as a percentage of sales grew as compared to the prior year period. We believe greater operating leverage can be achieved as we grow our global revenue base and effectively utilize our ERP system and our manufacturing in Vietnam reaches its productivity potential then India. That concludes my remarks. I will now pass the call over to CFO, Allen Dillard, to provide a more thorough review of the company's financial results.

Thank you, Chris. The following address is my review of the fiscal 2020 second quarter ended July 31, 2019. As Chris mentioned, I've been with the company for about a month, so my comments will be limited. Net sales were $27.5 million for the 3 months ended July 31, 2019, as compared to $25.6 million for the 3 months ended July 31, 2018, and $24.7 million for the 3 months ended April 30, 2019. On a consolidated basis for the second quarter of fiscal 2020, domestic sales were $14.4 million or 53% of total revenues, and international sales were $13 million or 47% of total revenues. The company experienced sales growth domestically, benefiting from easing of earlier delivery challenges associated with the ERP implementation as well as in all operating regions in the Americas excluding Mexico. Sales in Mexico were lower due to a large, recurring customer bid for fire resistant garments that was previously won and filled but has not been republished yet this year. Foreign exchange currency translations negatively impacted sales in the UK, Europe and China as reported on a consolidated basis in U.S. dollars. China sales are included in our Asia Pacific business and led to a modest decline year-over-year on a reported basis in U.S. dollars. We do not anticipate a recovery unless the U.S.-China trade dispute is settled. And even then, it will require time for China's manufacturing GDP to recover. In the meantime, we have shifted our focus to Southeast Asia in efforts to replace lost sales revenue. India and Russia were also slightly weaker in the second quarter. But because of the relatively small size of their sales, this can recover relatively quickly. Gross profit of $10.4 million for fiscal 2020 second quarter increased from $9.2 million for the same period in the prior year and from $7.6 million in the first quarter of fiscal 2020. Gross profit as a percentage of net sales was 37.9% for fiscal 2020 second quarter, up from 35.7% a year ago and significantly higher than 30.6% recorded in the first quarter of fiscal 2020. Gross margin in dollars and as a percentage of sales benefited from higher volumes, which in part resulted from easing of ERP implementation issues, a more favorable mix of higher-margin product sales and improved contributions from the balancing of manufacturing between higher cost per unit and more efficient processing in China to lower cost, but less efficient processing in Vietnam, including substantial start-up expenses. Through the end of our fiscal second quarter, we do not believe we experienced any meaningful impact to order flow or issues related to tariff increases. Our strong sales in the U.S. were driven primarily by large container orders, which may have been placed by customers who purchased, who were under purchased in Q1 and were attempting to replenish and return their stock to normal levels. We have not seen consistent preemptive ordering for any industry or market due to what we believe are circumstances that are very much in flux. What is certain for the time being is the additional 15% tariff that was applied to select garment lines effective September 1. And in anticipation, we sent customers a letter towards the end of Q2 about our price increases that will reflect the new tariffs. We have attempted to spur preparatory purchases and reduce inventory by offering discounts on purchases from our existing inventories between August 2 and August 31. To-date, it is difficult to determine the level of success of that program because of its short duration. We are hoping that our announced price increases, along with the Trump administration's additional 15% duty, will drive customers to make purchases. Our strategy in dealing with the trade war and tariffs include sales and marketing campaigns, price increases and movement of production or subassembly out of China primarily to our Vietnam location, which has been a success so far. Operating expenses increased 3.7% to $7.8 million for the 3 months ended July 31, 2019, from $7.5 million for the 3 months ended July 31, 2018, and were up from $7.6 million for the first quarter of fiscal 2020. Operating expenses as a percentage of net sales was 28.3% for the 3 months ended July 31, 2019, compared to 29.3% for the 3 months ended July 31, 2018, and 31.9% for the 3 months ended April 30, 2019. As previously disclosed, we took a onetime charge of approximately $260,000 related to my predecessor as CFO, which is included in Q2 2020 OpEx. OpEx was further impacted by an increase in professional fees, offset by a decrease in stock-based compensation. The performance improvement pertaining to the decrease of operating expenses as a percentage of net sales reflects higher revenues amid favorable business conditions and the processing of backlog orders with the easing of prior ERP implementation challenges. Lakeland reported operating profit of $2.6 million for the 3 months ended July 31, 2019, up from an operating profit of $1.6 million for the 3 months ended July 31, 2018, and an operating loss of $0.3 million for the 3 months ended April 30, 2019. Operating margins were 9.6% for the 3 months ended July 31, 2019, 6.5% for the 3 months ended July 31, 2018, and a negative 1.3% for the 3 months ended April 30, 2019. Income tax expense consists of federal, state and foreign income taxes. Income tax expense was $1.2 million for the 3 months ended July 31, 2019, compared to $0.6 million for the 3 months ended July 31, 2018. Our estimated effective tax rate was increased primarily due to additional provisions in foreign jurisdictions and remeasurement and assessment of the GILTI tax impact. As a reminder, we evaluate the estimated tax provisions each quarter and adjust accordingly. The company reported net income of $1.4 million or $0.17 per basic share for the 3 months ended July 31, 2019, compared to net income of $1 million or $0.13 per basic share for the 3 months ended July 31, 2018, and a net loss of $0.5 million or $0.06 per basic share for the 3 months ended April 30, 2019. As of July 31, 2019, Lakeland had cash and cash equivalents of approximately $9.1 million. Cash and cash equivalents decreased approximately $3.8 million from the beginning of the fiscal year. The decrease was primarily a result of the net increase in other working capital elements, most noticeable is inventory increasing by $7 million due to increased raw materials and finished goods necessary to scale up the Vietnam operation and to catch up on remaining orders delayed due to the ERP installation. Total debt outstanding at July 31, 2019, was less than $1.6 million, up slightly from $1.3 million on January 31, 2019. The company has in excess of $10 million of borrowing capacity under its various lines of credit. Capital expenditures were approximately $0.4 million during the second quarter of fiscal 2020, down from $1 million in the second quarter of the prior year and up from $0.2 million in the first quarter of fiscal 2020. CapEx, or capital expenditures, for all of fiscal 2019 were $3.1 million and are expected to decline to approximately $2 million for fiscal 2020, with the majority of spending in the current year allocated towards the phased global rollout of the ERP system and additional manufacturing capacity in Vietnam and India. We've been strategically deploying our cash to position the company for continued growth. Cash used in fiscal 2020 and 2019 included planned investments in [Technical Difficulty] in Vietnam and, to a lesser extent, India and the company's upgraded information technology system as well as our digital marketing evolution. Depending on product mix, we currently believe our run-rate of revenue from a normalized and efficient manufacturing standpoint could be in the range of $130 million to $150 million, up from our current Q2 annualized revenues of about $110 million. That concludes my remarks. I will turn the call back to Chris for his final remarks before we open the call to questions.

Thanks for the nice job, Allen. To conclude my formal comments, I'd like to address our stock buyback program. On our last earnings call in mid-June when our share price was about $12, we cited an outlook for improving cash levels as the reason for taking a closer look at our stock repurchase program. That was halfway through the second quarter, so we already knew to a meaningful extent what our cash would be at the half year mark given our anticipated capital allocation strategy. What's changed since that time is that we spent according to our plan, the second quarter was strong and our share price went even lower, perhaps reacting to the constant machinations by political leaders on cross-border trade issues. With this backup, we began to buy some shares towards the end of the second quarter. 9200 shares were purchased in the quarter as part of our $2.5 million stock buyback program approved on July 19, 2016. To-date, $1.2 million was spent to repurchase 114,848 shares with no shares purchased in the fourth quarter of fiscal 2020 and all of the other purchases made in fiscal 2019 fourth quarter. We are encouraged by the company's direction and progress including potential cash flow generation, which would be an even greater catalyst to encourage us to buy more shares. As we close out the first half of this fiscal year, we believe we are very well positioned with an impressive array of products for basic daily use and specialized applications, a diversified manufacturing presence around the world that provides us with flexibility to navigate an erratic macroeconomic environment, financial health and a growing global team to capitalize on the opportunities ahead. That concludes my remarks. I will turn the call back to the operator to begin the Q&A session. Operator?

[Operator Instructions] Our first question comes from Alex Fuhrman of Craig-Hallum.

Congratulations on a really nice quarter. I wanted to ask about the composition of the backlog. It sounds like you guys have made nice progress now implementing the ERP system and starting to get some results there. And it sounds like you had a nice amount of that backlog related to the ERP implementation that you were able to work through here in the quarter, but the backlog still looks pretty big, actually got a little bit bigger during the quarter. So just thinking about the orders still in that backlog. Are there still orders related to the ERP implementation? Or is this just more recent business that's come up in the quarter?

You want to pick that up, Charlie?

Yes, Chris. Our backlog, currently, the $0.5 million that we took out in this quarter represents the bulk of the ERP backlog. Most of what we have now is incurred from sales in the current quarter.

Okay. That's really helpful. And then just thinking about gross margins and your product manufacturing, really strong looking gross margins here in the second quarter. Can you give us a sense of what the impact could be to your gross margins as you think about taking price increases to offset tariffs that could be coming? And then thinking about your manufacturing in China, obviously, you can diversify your supply chain for many years long before these tariffs. Can you give us a sense of how much of the product that you're currently manufacturing in China is then sold in China or elsewhere in Asia as opposed to being imported?

I'm going to jump in here and try to answer that, and I'll kick it off to Charlie. Just jump in whenever you're ready, Charlie. As we look at margins, we really look at on, number one, where can we get the most manufacturing efficiency; and number two, based on that backlog of order flow. So kind of where we are margin-wise is we think we're seeing a more normalized margin environment, particularly as we begin to migrate our production to the lower-cost facilities. If you look at the numbers, you can tell that the bulk of the manufacturing that occurs in China comes to the U.S. and other markets. So as we migrate that to the lower cost, we believe that we're going to see some stabilization or normalization in our margins going forward. And I'll let Charlie kind of speak to how we're managing the production levels in those different facilities.

Yes, to put a specific range on the margin right now is difficult because there are some headwinds to it. The entire trade situation is still very much in flux, and we're currently evaluating our Chinese product mix to see what we can and cannot move out of there. Not all of those products lend themselves to new operations. So we're reviewing our capacities globally trying to rationalize that in lieu of the new tariffs. But the bigger complication is knowing what the psychological impact of the trade war is going to be on our customer base. In the U.S., it represents 50% of our income. I think that there's an opportunity here for us or nearly, I'd say, to improve our margins. But in the current business environment and customer concerns over the trade war, we're looking for additive business outside of the U.S. to make sure that we have the capacity to keep everything running.

What's important to note is that our Chinese operation can sell to every country in the world, or 49 countries currently, and cannot sell really to just one country, United States, unless they pay that 15% tariff. So when we look at the United States, we have our Indian operation, our Mexican operation and our Vietnamese operation able to export into the United States duty free. So we have a lot of flexibility here, and that's what I want to emphasize. It's only the United States that is putting a tariff on Chinese goods. The rest of the world is not.

Our next question comes from Dave King of Roth Capital Partners.

This is Scott stepping on for Dave. First, on the ERP system, do you have a dollar amount in cost of goods sold from the ERP impact in the quarter?

That would be Allen.

I don't know that we actually have the exact number. We know what the backlog was. We could go back and look at it. We could try and calculate that, but I don't have an estimate of what that might be currently at hand.

Okay. That's helpful. Now that ERP seems to be behind you, how are you feeling about your ability to meet demand? And did you happen to lose any customers during the ERP implementation?

Charlie?

Dave, one of the things that we learned through our ERP implementation, you've got to remember that a bulk of the most complex part of it was our operations in Mexico, and we did have a number of customers that came to us and told us upfront that they were going to have to go elsewhere while we get through this. And we have seen, in the last quarter, a number of those customers return. I don't think we have all of them back yet. I think other people are still waiting to see more, but we don't anticipate significant customer loss at the end of this.

Okay. And lastly, how are some of your oil and gas customers holding up given some of the recent weakness there? Similarly, how's demand been in China given some of the matters of concern there?

China is feeling that. Their GDP and industrial output has taken a hit, and we have seen some declines there. A lot of the diversification efforts that we've been through in the past year have been to lessen our reliance on the oil and gas sector. It's still significant. But our introduction of cleanroom products, work in electrical utilities are all meant to diversify ourselves away from the gyration, the fluctuations of that particular market. And I think we've been successful to a large degree.

But oil and gas revenues have held steady with the exception of one customer in Mexico.

Thank you very much.

And this will conclude our question-and-answer session. I will now turn the conference back over to Mr. Ryan for any closing comments.

Okay. Well, we do appreciate your participation on Lakeland's Fiscal 2020 Second Quarter Financial Results Conference. We continue to be poised for continued growth in sales, market share attainment and profitability in fiscal 2020, which we believe will deliver value for our shareholders. If you are an institutional shareholder or a potential investor, we will be presenting at the Sidoti conference on September 25 in New York and look forward to seeing you there. Thank you again for joining us on today's conference call, and goodbye.