LAKELAND INDUSTRIES INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements The following discussion and analysis should be read in conjunction with the historical financial statements and other financial information included elsewhere in this quarterly report on Form 10-Q. This Form 10-Q may contain certain forward-looking statements. When used in this Form 10-Q or in any other presentation, statements which are not historical in nature, including the words “anticipate,” “estimate,” “should,” “expect,” “believe,” “intend,” “project”, “plan,” “seek,” “will,” “may,” “might,” “would,” “could” and similar expressions, are intended to identify forward-looking statements. They also include statements containing a projection of sales, earnings or losses, capital expenditures, dividends, capital structure or other financial terms. The forward-looking statements in this Form 10-Q are based upon our management’s beliefs, assumptions and expectations of our future operations and economic performance, taking into account the information currently available to us. These statements are not statements of fact. Forward-looking statements involve risks and uncertainties, some of which are not currently known to us that may cause our actual results, performance or financial condition to be materially different from the expectations of future results, performance or financial condition we express or imply in any forward-looking statements. Some of the important factors that could cause our actual results, performance or financial condition to differ materially from expectations are: · we are subject to risk as a result of our international manufacturing operations and are subject to the risk of doing business in foreign countries; · a terrorist attack, other geopolitical crisis, or widespread outbreak of an illness or other health issue, such as the COVID-19 pandemic, could negatively impact our domestic and/or international operations; · our results of operations could be negatively affected by potential fluctuations in foreign currency exchange rates; · the implementation of our Enterprise Resource Planning ("ERP") system had, and may in the future as we implement ERP into foreign operations have, an adverse effect on operating results; · we have manufacturing and other operations in China which may be adversely affected by tariff wars and other trade maneuvers; · our results of operations may vary widely from quarter to quarter; · some of our sales are to foreign buyers, which exposes us to additional risks; · we deal in countries where corruption is an obstacle; · we are exposed to tax expense risks; · because we do not have long-term commitments from many of our customers, we must estimate customer demand, and errors in our estimates could negatively impact our inventory levels and net sales; · we face competition from other companies, a number of which have substantially greater resources than we do; · our operations are substantially dependent upon key personnel; · cybersecurity incidents could disrupt business operations, result in the loss of critical and confidential information and adversely impact our reputation and results of operations; · we may be subject to product liability claims, and insurance coverage could be inadequate or unavailable to cover these claims; · environmental laws and regulations may subject us to significant liabilities; · our directors and executive officers have the ability to exert significant influence on us and on matters subject to a vote of our stockholders; · provisions in our restated certificate of incorporation and by-laws and Delaware law could make a merger, tender offer or proxy contest difficult; · acquisitions and investments could be unsuccessful; · we may not achieve the expected benefits from strategic acquisitions, investments, joint ventures, capital investments and other corporate transactions that we have pursued or may pursue; · we may need additional funds, and if we are unable to obtain these funds, we may not be able to expand or operate our business as planned; rapid technological change could negatively affect sales of our products, inventory levels and our performance; and · the other factors referenced in this Form 10-Q, including, without limitation, in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the factors described under “Risk Factors” disclosed in our fiscal 2022 Form 10-K. 17 Table of Contents We believe these forward-looking statements are reasonable; however, you should not place undue reliance on any forward-looking statements, which are based on current expectations. Furthermore, forward-looking statements speak only as of the date they are made. We undertake no obligation to publicly update or revise any forward-looking statements after the date of this Form 10-Q, whether as a result of new information, future events or otherwise, except as may be required by law. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Form 10-Q might not occur. We qualify any and all of our forward-looking statements entirely by these cautionary factors. Business Overview We manufacture and sell a comprehensive line of industrial protective clothing and accessories for the industrial and public protective clothing market. Our products are sold globally by our in-house sales teams, our customer service group, and authorized independent sales representatives to a network of over 1,600 global safety and industrial supply distributors. Our authorized distributors supply end users, such as integrated oil, chemical/petrochemical, automobile, steel, glass, construction, smelting, cleanroom, janitorial, pharmaceutical, and high technology electronics manufacturers, as well as scientific, medical laboratories and the utilities industry. In addition, we supply federal, state and local governmental agencies and departments, such as fire and law enforcement, airport crash rescue units, the Department of Defense, the Department of Homeland Security and the Centers for Disease Control. Internationally, we sell to a mixture of end users directly, and to industrial distributors depending on the particular country and market. In addition to the United States, sales are made to more than 50 foreign countries, the majority of which were into China, the European Economic Community (“EEC”), Canada, Chile, Argentina, Russia, Kazakhstan, Colombia, Mexico, Ecuador, India and Southeast Asia. We have operated facilities in Mexico since 1995 and in China since 1996. Beginning in 1995, we moved the labor intensive sewing operation for our limited use/disposable protective clothing lines to these facilities. Our facilities and capabilities in China and Mexico allow access to a less expensive labor pool than is available in the United States and permit us to purchase certain raw materials at a lower cost than they are available domestically. More recently we have added manufacturing operations in Vietnam and India to offset increasing manufacturing costs in China and further diversify our manufacturing capabilities. Our China operations will continue primarily manufacturing for the Chinese market and other markets where duty advantages exist. Manufacturing expansion is not only necessary to control rising costs, it is also necessary for Lakeland to achieve its growth objectives. Our net sales attributable to customers outside the United States were $16.0 million and $18.4 million for the three months ended April 30, 2022 and 2021, respectively. We are continually monitoring the potential financial impact of the Russian invasion of Ukraine on our operations. For Q1 FY23, sales in Russia were approximately 2.8% of our consolidated sales and sales into Ukraine were not significant. We do not have any capital assets in Russia. We have not experienced any manufacturing capacity issues due to inability to source raw materials, government quarantine, or shelter-in-place orders, or due to COVID-19 outbreaks in any of our factories, however there can be no assurance that this will continue to be the case. In addition, we cannot predict any potential incremental cost that may be associated with any federal, state or local vaccine mandates or related testing protocol. While current economic indicators and industry data indicate an industrial market recovery, potential headwinds to revenue as we emerge from pandemic sales include the possibility of a recession and consumer stockpiled inventories that may temper demand within our regular markets in FY23. While we have not experienced any raw materials shortages in our Asian manufacturing operations, we are experiencing some issues with U.S. sourced raw materials due to labor and precursor shortages affecting our higher margin product lines. In both Asia and the U.S., increasing labor and freight costs, as well as inflationary pressures threaten to drive raw material costs up and may negatively impact our gross margins. Where we can, we will seek to recover increased costs with corresponding price increases. Additionally, we have experienced, along with most other companies across many industries, the macro-economic impact of a challenging employment environment related to hiring and retaining employees and wage inflation. We expect that these hiring, retention, and wage inflation challenges, as well as challenges related to maintaining our current workforce, will continue into FY23. These hiring, retention, and cost challenges may negatively affect our ability to grow our business and keep our best employees or increase our cost of operations. 18 Table of Contents Results of Operations Three Months ended April 30, 2022, Compared to the Three Months Ended April 30, 2021 Net Sales. Net sales were $27.3 million for the three months ended April 30, 2022, a decrease of $6.8 million or 19.9% compared to $34.1 million for the three months ended April 30, 2021. Sales of our disposable and chemical product lines were impacted in the first quarter due to a reduction in direct container sales driven by COVID-19 demand and continued softness in demand from our industrial markets. Other product lines such as fire, high performance, and high visibility, increased by $1.6 million due to strengthening demand in those markets. Sales were affected by customers over-ordering in prior periods, resulting in excess channel inventories, and shipping delays with ocean freight carriers. Gross Profit . Gross profit for the three months ended April 30, 2022 was $11.1 million, a decrease of $3.7 million, or 25%, compared to $14.8 million for the three months ended April 30, 2021. Gross profit as a percentage of net sales decreased to 40.5% for the three month period ended April 30, 2022, from 43.4% for the three months ended April 30, 2021. Gross profit performance in the fiscal 2022 period benefited from higher volumes including direct container shipments, related factory utilization and an improving product mix with pricing power. Major factors driving the decline in gross margins in the three months ended April 30, 2022, were: · Lower level of direct container sales in the current period. · Increases in transportation costs. Operating Expense . Operating expenses increased 18.5% from $8.1 million for the three months ended April 30, 2021 to $9.6 million for the three months ended April 30, 2022. This increase is attributable to increases in travel and trade show expenses, administrative expenses and currency fluctuations. Currency fluctuations accounted for $0.8 million of the increases due primarily to the fluctuation in the Chinese yuan. Operating expenses as a percentage of net sales was 35.2% for the three months ended April 30, 2022, up from 23.9% for the three months ended April 30, 2021 primarily due to the lower volume of sales. Operating Profit . Operating profit declined to $1.4 million for the three months ended April 30, 2022 from $6.6 million for the three months ended April 30, 2021, due to the impacts detailed above. Operating margins were 5.3% for the three months ended April 30, 2022, as compared to 19.4% for the three months ended April 30, 2021. Income Tax Expense . Income tax expense consists of federal, state and foreign income taxes. Income tax expense was $0.3 million for the three months ended April 30, 2022, compared to $1.6 million for the three months ended April 30, 2021. The decrease is due to the reduction in pre-tax income. The effective rate for the three months ended April 30, 2022 was 20.2%. The Company recorded deferred tax benefits of $0.2 million related to accruals for China social taxes. Excluding this discrete benefit the effective rate was 32.9%. The effective rate for the three months ended April 30, 2021 was 24.4%. Net Income. Net income decreased by $3.9 million to $1.1 million for the three months ended April 30, 2022 from net income of $5.0 million for the three months ended April 30, 2021. Significant Balance Sheet Fluctuation April 30, 2022 , Compared to January 31, 2022 Cash decreased by $1.9 million, primarily as continued profitability and working capital management generated $1.9 million of cash flow from operations offset by our additional investment of $1.9 million in Bodytrak and $0.4 million of share purchases under our Existing Share Repurchase Program. Accounts receivable decreased due to improved collections and lower sales levels compared to prior year. Inventory increased $2.2 million due to planned increases to offset freight delays, and reduced demand as compared to prior year. Accounts payable, accrued compensation, and other accrued expenses increased $1.7 million. Capital expenditures for the three months ended April 30, 2022 were $0.4 million. 19 Table of Contents Liquidity and Capital Resources At April 30, 2022, cash and cash equivalents were approximately $50.8 million and working capital was approximately $106.0 million. Cash and cash equivalents decreased $1.9 million and working capital decreased $2.6 million from January 31, 2022, primarily due to treasury stock purchases of $0.4 million, additional investment in Bodytrak of $1.9 million and $0.4 million of capital expenditures. Of the Company’s total cash and cash equivalents of $50.8 million as of April 30, 2022, cash held in Latin America of $1.7 million, cash held in Russia and Kazakhstan of $0.5 million, cash held in the UK of $0.8 million, cash held in India of $1.0 million, cash held in Hong Kong of $2.7 million and cash held in Vietnam of $0.2 million would not be subject to additional US tax in the event such cash was repatriated due to the change in the US tax law as a result of the December 22, 2017 enactment of the 2017 Tax Cuts and Jobs Act (the “Tax Act”). In the event the Company repatriated cash from China, of the $35.5 million balance at April 30, 2022 there would be an additional 10% withholding tax incurred in that country. Net cash provided by operating activities of $1.9 million for the three months ended April 30, 2022 was primarily due to net income of $1.1 million, non-cash expenses of $0.4 million for deferred taxes, depreciation and amortization and stock compensation, and increase in current liabilities of $2.5 million offset by an increase in current assets of $2.1 million. Net cash used in investing activities of $2.4 million for the three months ended April 30, 2022 reflects office and manufacturing equipment purchases and the additional investment in Bodytrak of $1.9 million. Net cash used in financing activities was $1.1 million for the three months ended April 30, 2022, due to $0.4 million in shares repurchased under our Existing Share Repurchase Program and shares returned to pay income taxes on shares vested under our equity compensation program. We believe our current cash balance and cashflow from operations will be sufficient to satisfy our projected working capital and planned capital expenditures for the foreseeable future. On June 25, 2020, we entered into a Loan Agreement (the “Loan Agreement”) with Bank of America (“Lender”). The Loan Agreement provides the Company with a secured $12.5 million revolving credit facility, which includes a $5.0 million letter of credit sub-facility. The Company may request from time to time an increase in the revolving credit loan commitment of up to $5.0 million (for a total commitment of up to $17.5 million). Borrowing pursuant to the revolving credit facility is subject to a borrowing base amount calculated as (a) 80% of eligible accounts receivable, as defined, plus (b) 50% of the value of acceptable inventory, as defined, minus (c) certain reserves as the Lender may establish for the amount of estimated exposure, as reasonably determined by the Lender from time to time, under certain interest rate swap contracts. The borrowing base limitation only applies during periods when the Company’s quarterly funded debt to EBITDA ratio, as defined, exceeds 2.00 to 1.00. The credit facility will mature on June 25, 2025. Borrowings under the revolving credit facility bear interest at a rate per annum equal to the sum of the one-month LIBOR Daily Floating Rate (“LIBOR”), plus 125 basis points. LIBOR is subject to a floor of 100 basis points. All outstanding principal and unpaid accrued interest under the revolving credit facility is due and payable on the maturity date. The one-month LIBOR is expected to cease publication after June 30, 2023. The Loan Agreement provides that if the rate is not available for any reason, then the rate will be determined by such alternate method as reasonably selected by the Lender. On a one-time basis, and subject to there not existing an event of default, the Company may elect to convert up to $5.0 million of the then outstanding principal of the revolving credit facility to a term loan facility with an assumed amortization of 15 years and the same interest rate and maturity date as the revolving credit facility. The Loan Agreement provides for an annual unused line of credit commitment fee, payable quarterly, of 0.25%, based on the difference between the total credit line commitment and the average daily amount of credit outstanding under the facility during the preceding quarter. On June 18, 2021, the Company entered into an Amendment No. 1 to Loan Agreement (the “Amendment”) with the Lender, which modifies certain terms of the Company’s existing Loan Agreement with the Lender. The Amendment increases the credit limit under the Loan Agreement’s senior secured revolving credit facility from $12.5 million to $25.0 million. The Amendment also amends the covenant in the Loan Agreement that restricts acquisitions by the Company or its subsidiaries in order to allow, without the prior consent of the Lender, acquisitions of a business or its assets if there is no default under the Loan Agreement and the aggregate consideration does not exceed $7.5 million for any individual acquisition or $15.0 million on a cumulative basis for all such acquisitions. The Loan Agreement requires the Company to maintain a Funded Debt to EBITDA (as each such term is defined in the Loan Agreement) ratio of 3.0 to 1.0 or less and a Basic Fixed Charge Coverage Ratio (as defined in the Loan Agreement) of at least 1.15 to 1.0. The Loan Agreement also contains customary covenants, including covenants that, among other things, limit or restrict the Company’s and/or the Company’s subsidiaries ability, subject to certain exceptions and qualifications, to incur liens or indebtedness, pay dividends, or merge, consolidate or sell or otherwise transfer assets. The Company was in compliance with all of its debt covenants as of April 30, 2022. 20 Table of Contents Other than the changes described above, the terms and conditions of the Loan Agreement remain in full force and effect. Stock Repurchase Program . On February 17, 2021, the Company’s board of directors approved a stock repurchase program under which the Company may repurchase up to $5 million of its outstanding common stock. On July 6, 2021, the Board of Directors authorized an increase in the Company’s current stock repurchase program under which the Company may repurchase up to an additional $5 million of its outstanding common stock (the “Existing Share Repurchase Program”). On April 7, 2022, the Board of Directors authorized a new stock repurchase program under which the Company may repurchase up to $5 million of its outstanding common stock (the “New Share Repurchase Program”). The New Share Repurchase Program will become effective upon the completion of the Existing Share Repurchase Program, which has approximately $0.4 million remaining for repurchases as of April 30, 2022. The New Share Repurchase Program has no expiration date but may be terminated by the Board of Directors at any time. Shares repurchased in the three months ended April 30, 2022 totaled 25,017 shares at a cost of $0.4 million leaving $5.4 million remaining available for repurchase under the Existing Share Repurchase Program and the New Share Repurchase Program at April 30, 2022. Capital Expenditures. Our capital expenditures for the first three months of FY23 of $0.4 million principally relate to capital purchases for our manufacturing facilities in Mexico, Vietnam and India, enhancement of our global IT infrastructure and furnishing our new corporate headquarter office. We anticipate FY23 capital expenditures to be approximately $3.0 million as we continue to deploy our ERP solution globally, invest in strategic capacity expansion, and replace existing equipment in the normal course of operations. The Company may also seek to expend funds in connection with acquisitions. Critical Accounting Policies and Estimates The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. A summary of our significant accounting policies is included in Note 1 to our consolidated financial statements in our fiscal year 2022 Form 10-K. Certain of our accounting policies are considered critical, as these policies are the most important to the depiction of our financial statements and require significant, difficult or complex judgments, often employing the use of estimates about the effects of matters that are inherently uncertain. Such policies are summarized in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section in our 2022 Form 10-K. There have been no significant changes in the application of our critical accounting policies during the three months ended April 30, 2022. Item 3. Quantitative and Qualitative Disclosures About Market Risk A smaller reporting company is not required to provide the information required by this Item and therefore, no disclosure is required under Item 3 for the Company.