Lakeland Industries, Inc. (NASDAQ:LAKE) Q1 2017 Earnings Conference Call June 14, 2016 4:30 PM ET
Christopher Ryan - Chief Executive Officer
Teri Hunt - Chief Financial Officer
Alex Fuhrman - Craig-Hallum
Doug Ruth - Lenox Financial Services
Peter Muckerman - Raymond James
Good afternoon and welcome to the Lakeland Industries’ Fiscal 2017 First Quarter Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions]
Before we begin, parties are reminded that forward-looking statements involve risks, uncertainties and assumptions as described from time-to-time in press releases and Forms 8-K, registration statements, quarterly and annual reports and other reports and filings filed with the Securities and Exchange Commission or made by management. All statements, other than statements of historical facts, which address Lakeland’s expectations of sources or uses for capital or which express the company’s expectation for the future with respect to financial performance or operating strategies can be identified as forward-looking statements. As a result, there can be no assurance that Lakeland’s future results will not be materially different from those described herein as believed, projected, planned, intended, anticipated, estimated or expected or other words which reflect the current views of the company with respect to future events. We caution readers that these forward-looking statements speak only as of the date hereof. The company hereby expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any such statements to reflect any change in the company’s expectations or any change in the events, conditions or circumstances on which such statement is based. Please note this event is being recorded.
I would now like to turn the conference over to Lakeland Industries’ Chief Executive Officer, Christopher J. Ryan. Mr. Ryan, you may begin.
Good afternoon to you all and thank you for joining our fiscal 2017 first quarter financial results conference call. We are going to provide brief opening statements in the status of operations and on 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 operation in financial results reflect our ongoing business since following our exit from Brazil, which was effectuated in the third quarter of fiscal 2016 with additional issues addressed thereafter.
Now, I would like to discuss our financial highlights, operating strategies and overall business with a view of our objectives as we move forward. As stated in our press release issued earlier today, the first quarter of fiscal 2017 showed progress on a number of operational and forward-looking objectives that position the company for its next phase of growth. Putting this into context, in recent years, we were very effective in building back our U.S. business with Lakeland branded products following the multiyear pullback and ultimate elimination of sales of DuPont or Tyvek-related products. At the same time, while we have undertaken an international growth and diversification strategy, we had a major setback in Brazil, which is now past us as we had exited that business which we had acquired and invested quite a bit in.
We believe it is an impressive testament to our brand and products as well as our global management team and workforce that we have been able to not just rebound from those negative business issues, but emerge in a much stronger financial condition and able to take on meaningful growth opportunities and withstand other challenges we may encounter through the normal course of business. Lakeland has shown incredible perseverance. Having proven ourselves, we are staying energized to outperform our sector as the global industry economy cycles back from the headwinds of the past four quarters or so.
Looking at our growth strategies, we are focused on organic opportunities by capitalizing on new customer segments and new products for our international operations in countries with higher GDP growth or less established personal protective equipment supply chains while taking market share in some of the more developed regions we serve. Incremental to all of these growth opportunities is emergency demand, such as Ebola-related orders we received in the early part of the prior fiscal year, which resulted in an unfavorable comparison on a year-over-year basis for the first quarter of the current year. These revenues were much higher than our traditional sales, so this skewed year-over-year comparisons.
Also negatively impacting the first quarter this year was the currency volatility in Argentina, Kazakhstan, Canada, China and the UK and the continued weakness in the global industrial economy, particularly in the oil and gas sector. This sector represents roughly 10% of our annual revenues. As with any business cycle, we anticipate a recovery in demand for our products as oil prices rebound. This one having started in August, with the continuing crash of oil prices and oil stocks, we may only have a few more months to go.
Orders were fairly slow in the first three months of the calendar year as oil prices remained below $42 per barrel for the most part. More recently or since early April, oil has rebounded by approximately 20% to nearly $50. And in the month of April, we began to see business picking up in North America, which we believe could lead to resumption of orders in other oil dependent markets like Russia, Kazakhstan and South America.
Another factor to consider, given our U.S. GAAP reporting requirements, is that oil prices tend to be a leading indicator for currencies. So, if historical conditions repeat, as oil rebounds, so too may currencies. A movement in a positive trajectory will have favorable implications for our reported results from our international operations regardless of the orders being tied to the use in the oil and gas industry, particularly going forward on the basis of year-over-year comparisons.
I would now like to speak about some of our country operations. The Russian economy hit a bottom earlier in the year and we are now seeing it improve. The ruble is going up with the price of oil. Of note is the fact the ruble hit a low when oil hit $26 a barrel. Now with oil and currencies igniting economic activity in that countries, we are seeing opportunities emerge. We are relatively small player in Russia and neighboring Kazakhstan and because of this we maintain a low fixed cost base. Our larger competitors in the region faced serious financial pressures, if not restructuring mode, given their higher cost base and dependency. We are now in striking position to engage with customers amid these conditions. We are being very opportunistic in bidding on business that had previously been awarded elsewhere.
China, which is not considered a major oil producing or dependent state, faced its own economic slowdown. Once again, we were not immune and we reported a decline in country revenue, which was compounded by currency fluctuation as reported in U.S. dollars. Although economic growth in the country has slowed to about 6% a year, Lakeland has a sizable operation for manufacturing for all of our country operations and a relatively new beachhead for in-country sales. As previously disclosed, we expect revenues and earnings to be up in China on a constant currency basis this year. The slowdown in that country has stabilized and we have found a solid footing to further penetrate the market. We have seen a recent improvement in sales due to our efforts to attain market share as well as to add our new vertical markets and introduce new products.
In Mexico, the oil and gas sector weakness has negatively impacted our sales and results and operating loss for this country in the first quarter. Our major oil and gas customer is not buying as much, so we are diversifying into other oil companies and other areas that are growing much more quickly. In Canada, our sales in the first quarter were up 25% in local currency as compared to the prior year despite challenging economic conditions in this country. Our team in Canada has been very effective in promoting our high-quality products and relatively short production and delivery terms. This has enabled us on-tap in certain key accounts that have led to our sales growth despite the country’s economy being tied to a meaningful extent to oil and gas sector. We see no abatement in the business we have attracted in Canada in recent quarters. This trend began last fiscal year, where each sequential quarter improved from the prior one to set new records for us in that country. As economic conditions improve, we may have an opportunity for incrementally higher growth over the long-term.
In the U.S., where we have operated the longest and which has the most developed supply chain of any country where we operate, we have been very active in broadening our business for high visibility FR suits, and FR means fire-resistant. This is where we see perhaps the best opportunities for growth in the U.S., because we have not really gotten a lot of share in the market as compared to our manufacturing and distribution of disposable suits, which are of lower cost and lower margin. High visibility FR suits are higher margin, so it dovetails nicely with our intent to improve our margins and profitability. A key vertical market for our high visibility FR suit lines has been in the penetration of the utilities sector. The utilities are perhaps anywhere that you have a large outdoor workforce, is a defensive business less immune to economic growth and uncertainties because they have to protect their workers.
In more challenging economic times, lower priced products that have comparable performance characteristics are in greater demand as compared to the traditionally higher priced products from our larger competitors. So we believe our opportunities within the utilities sector and the growth we have achieved to-date have had – has created by a sluggish economy. Our low cost manufacturing and relatively low overhead enables us to deliver products and still upgrade our margins. Beyond the sales and marketing opportunities within our country operations, we have also been very active in addressing our global cost bases, overhead and productivity measures. We have taken steps to reduce our cost structure and at the same time, undertake certain operating efficiencies to enhance our global infrastructure in preparation of global sales growth and market share gains with or without industrial or oil sector recoveries, which have been in corresponding downturns for the last – past several quarters.
As previously disclosed, in the first quarter of fiscal 2017, we implemented a voluntary reduction in force for our U.S. operations, which resulted in the charge during the quarter of $300,000. This move will reduce payroll by over $1 million on an annualized basis beginning in the second quarter. Certain manufacturing functions will be assumed by our facilities in India and Mexico where our cost base is significantly lower. Overall, we were leveraging our global operations to drive costs lower, improve manufacturing efficiencies and increase sales. As of April 30, 2016, we had cash and cash equivalents of approximately $10.3 million, with this balance increasing by $3.3 million from the beginning of the fiscal year. Net cash provided by operating activities was $3.5 million for the fiscal 2017 first quarter, primarily due to effective cash management and inventory reductions.
To further increase our productivity and leverage our global workforce, we have been bolstering our country sales management and financial personnel while investing in management information systems infrastructure to enhance our costing, inventory, bidding and workflow management. Some of our enhancements and product initiatives have already led to certain improvements in profitability. In the first quarter of fiscal 2017, our gross margin increased sequentially from Q4 FY ‘16 by four percentage points, with each period having similar currency valuations and global business conditions as well as neither quarter benefiting from higher margin emergency product orders, such as Ebola and bird flu related demand in the prior year.
With our ongoing corporate expense management initiatives as discussed in our last conference call, fiscal 2017 first quarter net income returned to profitability from a net loss in the fourth quarter of fiscal 2016. Another enterprise wide effort, the ongoing implementation of new MIS systems would have allowed us to better identify the excess supply in the marketplace of disposable garments and in turn, adjust our internal production and inventory of goods following the increased production and sales last year of products for emergency demand. Although not complete, the MIS rollout continues and has been increasingly effective. Inventories have decreased to approximately $39 million at April 30 from $41 million at January 31 and $44 million at October 31.
At or within 5% of the current levels, we believe we have the appropriate inventory to continue to execute our global growth strategy. Regardless of the overall market’s growth and any continued economic uncertainties, we see a multitude of organic growth opportunities. These opportunities expand the conversion of customers to Lakeland products, to the entrance into new verticals, to the introduction of new products. An example of our strategy is the redesigning of our disposable products for use in clean rooms, estimated at approximately $100 million annually in the U.S. Aided by a strong balance sheet bolstered by $3.5 million of net cash provided by operations in Q1 FY ‘17, we are well on our way to realizing the benefits of our market and product diversity to deliver long-term sustainable growth in revenues, profitability and cash flow.
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 first quarter of fiscal year 2017 ended April 30, 2016. The fiscal 2016 financial results that I discuss on this call will be from continuing operations, unless otherwise noted. The discontinued operations relate to the operating results in Brazil. As Chris mentioned, we have completed the details pertaining to our exit from Brazil and we exercised discontinued operations accounting for Brazil. Our first quarter of fiscal 2017 financial results included net sales from continuing operations of $20.4 million for the three months ended April 30, 2016, compared to $24.8 million for the prior year period or a decrease of 18%. The gross margin was 33.3% this quarter compared to 37.4% in Q1 FY ‘16 and 29.4% in the fourth quarter of FY ‘16. In addition to lower sales volume in the most recent periods, which weighed down margins, last year’s same period gross margin was favorably impacted by higher margin sales of products relating to the Ebola crisis and other cost saving efforts making comparisons difficult.
Also included in Q1 FY ‘17 were severance payments associated with the reduction in force in the U.S., which Chris described to move production to more cost effective facilities in Mexico and China. Further, with the currency fluctuations, the comparisons of fourth quarter to first quarter results is more appropriate given the distortions from the year ago period. Operating expenses worldwide increased from $6.1 million last year to $6.6 million for the current year’s first quarter and $6.3 million in the fourth quarter of FY ‘16. As a percentage of sales, operating expenses were 32.4% in Q1 FY ‘17, 30.8% in Q4 FY ‘16 and 24.4% in Q1 FY ‘16. The main factors for the increase in operating expenses are a $0.3 million increase in payroll administration and salaries for the expansion of the company’s global sales management among other activities, $0.5 million increase in professional fees for audit, tax and legal work and $0.1 million increase in travel expense.
Similar to the fourth quarter, while our cost containment efforts continue to lead to reduced expense 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 developments and enterprise planning systems. We had an operating profit of $0.2 million from a loss from operations of $0.3 million in the fourth quarter of FY ‘16 and an operating profit of $3.2 million in Q1 FY ‘16. Operating margins were 0.8% for the three months ended April 30, ‘16, compared to negative 1.5% in the fourth quarter of FY ‘16 and 13% in Q1 FY ‘16.
First quarter net income was $0.0 million or zero per share from a net loss of $0.03 million or a negative $0.01 per share in the fourth quarter of FY ‘16 and net income of $1.2 million or $0.30 per share in Q1 FY ‘16. The results for the three months ended April 30, ‘16, are primarily due to low sales volume and increased spending on the company’s global growth strategies. 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 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 2 years to 3 years. We do however, pay taxes on certain country operations when those operations are profitable on a local basis. In the balance sheet, with $3.5 million of net cash provided by operations in Q1 ‘17, driven by cash management and reduced inventories, cash and cash equivalents at the end of the quarter increased to $10.3 million from $7.0 million at the beginning of the fiscal year. Inventories, as Chris mentioned have declined for the second sequential row – quarter in a row.
That concludes my remarks and I will turn the call back to the operator to begin the Q&A session.
We will now begin the question-and-answer session. [Operator Instructions] The first question is from Alex Fuhrman at Craig-Hallum.
Great. Thank you very much for taking my questions. Certainly, it seems like things have stabilized a little bit following the last quarter. I was wondering if you could talk a little bit more about the MIS rollout. When do you envision that being completed? And just as you think about your customers’ inventory levels, when do you imagine that distributors’ inventory levels will get back to where they were kind of in mid 2015? Is that one or two quarters out? Just trying to understand I guess what you are talking about with when you envisioned some of those trends normalizing over the next few quarters?
Okay. With respect to the MIS, we have done a lot of front-end work that would have been somewhat disruptive with our response to the Ebola and bird flu events. We have – we continue to streamline our processes and clean up our databases, so that we are prepared to implement the MIS. We have been looking at one system for some time and working with it and are still finalizing a decision that this is absolutely the direction the company wants to go. There are a couple of options where technology has improved over the last year or so as we have moved through the front-end that we are taking into consideration. That being said, the spending that we have discussed in the past should not change with any significance. In terms of the implementation, though, we are probably still looking at the 18-month range on the U.S. – probably U.S. Canada solutions.
And on the inventory levels of our customers, we have been in constant contact, particularly with some of the larger distributors like Grainger. And the larger guys started adjusting their inventories downward last August. We had a very powerful third quarter ending October 31 with bird flu, so it wasn’t seen in our numbers, but we were hearing it from the distributors. And they have been reducing inventories ever since August. But only about last month, we have heard that they are beginning to think about starting to build them and we have heard that from some of the bigger guys. So, I sort of expect our sales to pickup in the area of 5% to 7% over the next couple of quarters as they start reordering, because they sort of hit bottom certainly on the oil and gas stuff that they buy. I mean, they have virtually nothing there. And oil broke through $50 and stayed there, over $50 for the day, I won a bet based on that back in February. So, I think the oil and gas industry will pick up relatively well over the next year although I don’t think hiring will come back for at least a year, but we are seeing our major distributors. And when we talk about guys who buy a lot from us, they are all beginning to buy now. So, I think other than the slow point that we always feel in August when everybody goes on vacation that it should sequentially pick up certainly in the second and even more in the third. That’s what we are looking at.
Great. That’s really helpful. Both of you thank you. And then also I was curious about the new biodegradable product – or maybe not biodegradable is the right word, but the more eco-friendly product that can be dissolved in boiling water. How much traction have you been getting there as you have been kind of showing that product and presenting that to potential customers? And is it fair to assume that – as that product comes online in a more meaningful way, is it fair to assume that, that could be potentially going after new business from – taking away from some of your competitors or should we think of that more as an up-sell to your existing product line within your existing customer base?
Well, first of all, we haven’t perfected it. We have a problem with finding the right machinery in China to make it the way we patented it. And there is a few things we still need to work out. It has been much longer than I thought and we probably won’t even introduce it for a year. On the other hand, we are moving into a new vertical with existing products, so that’s where we are really looking for the – probably the new revenues to come in. This is on the clean room side as opposed to the green side.
Great. That’s really helpful, Chris and Teri. Thank you both very much.
The next question is from Doug Ruth at Lenox Financial Services.
Hi. I also appreciate the sequential improvement from the fourth quarter it’s really nice to see. What kind of – are you quantifying at all what kind of international growth you might be projecting for the next year or two?
We are, as a rule, not projecting exact numbers on international growth. We are seeing improvements, as Chris pointed out, in the currencies and understanding that on our actual volume in terms of units has held steady and even grown in some areas. We have seen in Canada historically the best results we have ever seen. We are on – so we are projecting some growth there. We have made some structural changes in the UK in terms of our sales management and our overall international organizational management for kind of the business manager in there underneath our VP, International Sales hired somebody in Australia. So, certainly we are expecting growth in that area. I think one of the stronger metrics above and beyond the sales growth that we do anticipate in most of our regions is, as the economy improves, we expect to see the gross margins improve as we streamline some of our processes. And with the additional focus that we are putting on the sales force that we are putting on efficiencies, I think we anticipate nicer margins in some areas.
We anticipate growth in all our foreign markets going forward except one, Argentina.
Okay. Do you think like the first quarter maybe represents like a trough in Europe and that perhaps the sales will trend somewhat higher from that level generated during that time period?
Well, Europe had a really tough comparison, because Europe did most of the Ebola sales, a lot of Ebola sales in this first quarter last year. So, it’s a really rough comparison to that. I mean, I think that we had almost $4 million in sales in the first quarter last year.
So the numbers that we are seeing are more normalized, is that sort of what you are suggesting?
They are more normalized and they are a little bit sub-par, because Europe has also slowed down. I mean, now that oil is climbing, it’s going to help the currencies in Mexico, Russia, Kazakhstan, Canada, a lot of countries. And as oil goes up, the oil and gas sector will maybe improve a little bit, but it really, really pushes the currencies and it pushes the overall economy of that particular country. When you see in Mexico, and oil is a large part of their GDP, as it is in Kazakhstan, as it is in Russia, as it is in Canada, it’s not only going to bump the currencies, it’s going to bump their GDP.
I think Chris’ metric of 5% to 7% just probably holds.
On the international front.
On the international side as well.
Okay. I was impressed too that the margins seemed to hold up on the U.S. disposables sales, even though the volume went down. That was pretty impressive.
Thank you. Now the game is to get them even higher.
Well, thank you for answering my questions and it sounds like you had survived some tough times but we are looking forward for higher sales going forward, so that’s the one, yes.
Yes, I mean it’s even incremental improvement from the fourth to the first and we hope to have roughly the same type of incremental improvement from the first to the second and so on.
Yes, that sounds terrific. Thank you.
[Operator Instructions] And our next question is from Peter Muckerman at Raymond James.
Hey, guys. Thanks for taking the questions. My question pertains to the unfortunate – well, the unfortunate media thing with the 60 Minutes, with I guess it’s your competitor. Has that resulted in potentially any higher sales for you as you – as they are kind of having to deal with that issue? And then also, I think Zika has yet to play out in the United States, but is that something – the funding to help fight that, is that something where you are seeing any sort of growth?
Okay. Number one, you are referring to the 60 Minutes bashing of Kimberly-Clark and I don’t think we have really recovered even on the stock price from that, because we – there were some shorts out there engaged in a whisper campaign and the stock went from 9 to 8 on that day. And of course, we have absolutely nothing to do with that. There will be no lawsuits against us. It’s all Kimberly-Clark’s problem. Have we gained business from that, I can’t specifically say no one part [ph] left, but I think over time, yes we will, if we use it correctly, with the right customers. The second question regarded Zika and I told people, it’s not – unless something really changes here, we will pick up some nice new business, maybe $0.25 million, but that’s all I really expect out of Zika, of course unless something happens and it’s on the front page of the New York Post and then all our customers panic and they start buying like nutcases, I don’t expect that.
Alright. Well, yes, the 60 minutes thing was unfortunate, it was very frustrating, but it is what it is, I guess. But thank you for taking the question.
This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.
We appreciate your participation on Lakeland’s Fiscal 2017 first quarter financial results conference call. As we are committed to delivering value for our shareholders, we believe this is 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 are very encouraged by our growth prospects as we are well positioned to grow organically through our overall market expansion as well as capturing the market share. Thank you again and goodbye.
The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.
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