Earnings Call Transcript - JRSH Q4 2022

Operator, Operator

Good morning. And welcome to Jerash Holdings Fiscal 2022 Fourth Quarter and Full Year Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. I would now like to turn the conference over to Roger Pondel. Please go ahead.

Roger Pondel, Investor Relations

Thank you, Operator. Good morning, everyone. And welcome to Jerash Holdings fiscal 2022 fourth quarter and full year conference call. I’m Roger Pondel with PondelWilkinson, Jerash Holdings’ Investor Relations Firm. It will be my pleasure momentarily to introduce the company’s Chairman and Chief Executive Officer, Sam Choi; its Chief Financial Officer, Gilbert Lee and Eric Tang, who leads the company’s Operations in Jordan. Before I turn the call over to Sam, I want to remind our listeners that today’s call may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to numerous conditions, many of which are beyond the company’s control, including those set forth in the Risk Factor section of the company’s most recent Form 10-K and Form 10-Q as filed with the Securities and Exchange Commission and copies of which are available on the SEC’s website at www.sec.gov, along with other company filings made with the SEC from time to time. Actual results could differ materially from these forward-looking statements. Jerash Holdings undertakes no obligation to update any forward-looking statements except as required by law. And with that, it is my pleasure to turn the call over to Sam Choi. Sam?

Sam Choi, CEO

Thank you, Roger, and hello, everyone. Our fiscal 2022 fourth quarter and full year sales demonstrated Jerash's underlying foundational strength and the attractiveness of its manufacturing capabilities. While our topline was up sharply, gross profit for the fourth quarter was impacted by product mix that included fewer than expected jacket orders, as U.S. retailers faced the strains of a weaker economic environment due to inflation. On the positive side, we were able to quickly shift manufacturing to produce other premium brand sportswear items such as pants and polos, although these items carry lower margins. Jerash is in the fortunate position of having strong customer relationships along with the ability to attract new customers even during the current macroeconomic environment. Our operations in Jordan offer unique benefits due to free trade agreements with the U.S. and EU. Combined with our ability to produce highly complex apparel, the company is positioned as an attractive alternative manufacturing partner outside of Asia for global apparel brands. I’m happy to report that we have received orders from our first European-based high-end apparel brands. Other new customers are in the pipeline, as we continue to focus on diversifying and expanding our customer bases. We are taking a conservative approach with respect to our guidance, and Gilbert will discuss those details momentarily. From a growth and topline perspective, our business outlook remains strong. Accordingly, we are continuing to explore clients to increase capacity. In April, we started expansion in one of our existing factories to add approximately 1.3 million pieces to our capacity. This expansion is expected to be completed by the end of 2022. We also have room for in-house renovation in other premises that could increase an aggregate of 2 million pieces in preparation for continuous growth in customer demands. I’ll now turn the call over to Eric Tang, who is based in Jordan, and then Gilbert Lee will cover our financial results. Eric?

Eric Tang, Operations Lead

Thank you, Sam. Hello, everyone. Order volumes continue to be strong in the fiscal fourth quarter and into the new fiscal year from our current top global brand customers. Our manufacturing capacity is completely booked through December 2022. Further, we have received production inquiries from several new premium brand customers, which will allow us to further diversify our customer base. As Sam mentioned, we recently received orders from Jerash's first European-based high-end apparel brand to produce jackets and other outerwear for its sportswear division. Production from our new leased facility that we acquired and took over in August last year has now fully transitioned to manufacture products for our own customers. We continuously train our employees and enhance efficiency from this facility to further expand our capacity for new customer orders and new production categories. Construction of a new dormitory for our multinational workforce is progressing on schedule and is expected to be completed by September 2022. The high-quality living space with comfort designs and the highest safety measures will position us for growth and further our ESG goals. Please take a look at Jerash Holdings' website to see updated videos for the dormitory and recent factory expansion. Lastly, we are proud that Jerash was featured by the World Bank throughout this week for World Refugee Day on June 20th, highlighting the company’s ongoing efforts to employ Syrian workers at its factories and providing transportation for these workers. This recognition served as a prime example for the private business sector to help refugees settle into a new hosting country. With that, I will turn the call to Gilbert to discuss our financial results and the fiscal 2023 outlook. Gilbert, please.

Gilbert Lee, CFO

Thank you, Eric. Fiscal 2022 was a record-performing year for Jerash, achieving revenue of $143.4 million, up 59% from fiscal 2021. Net income jumped 91% to $7.9 million or $0.67 per share from $4.1 million or $0.37 per share in fiscal 2021. Revenue for our fiscal 2022 fourth quarter rose 30% to $30.9 million from $23.8 million in the same period last year. The increase was primarily due to higher shipments to our current customers due to increased capacity from our newest factory. Gross margin was lower by 445 basis points to 15.1% in the fiscal 2022 fourth quarter, compared with 19.6% in the same period last year. Gross margin was mainly impacted by fewer than expected jacket orders, which carry much higher margins. To a lesser extent, margins were impacted by high material and ocean freight costs during late 2021 and early 2022. But the good news is that the ocean freight costs are now coming down since Shanghai reopened earlier this month. Operating expenses totaled $4.4 million in the fiscal 2022 fourth quarter, compared with $3.5 million in the same period last year. The increase was primarily due to an increase in headcount and shipments and an increase in stock-based compensation and recruitment for new migrant workers, as well as higher shipping costs. Operating income for our most recent fourth quarter was $275,000, compared with $1.1 million in the same period last year. Income tax expense was $405,000 due to a higher provision for annualized consolidated global income. Net loss for the fiscal 2022 fourth quarter was $130,000 or $0.01 per share after $312,000 of stock-based compensation expenses, compared with net income of $681,000 or $0.06 per share a year ago. Jerash’s balance sheet and cash position remains strong, with cash of $25 million and net working capital of $56 million at the end of March 2022. Inventory was $28 million and accounts receivable amounted to $11 million. Net cash provided by operating activities was approximately $9 million in fiscal 2022, compared with net cash used of $1.5 million in fiscal 2021. The net change reflects working capital activity, primarily due to an increase in net income and inventory, and the increase in accounts receivable. In terms of our fiscal 2023 first quarter outlook, we’re projecting revenue to be in the range of $33 million to $35 million. Accordingly, we are expecting gross margin to return to the fiscal 2021 levels at around 17% to 18% for the next few quarters. As Sam mentioned, we’re taking a conservative approach to our guidance for the full year, given the inflationary environment that is affecting the U.S. retail market and consumer sentiment, along with a product mix shift pointing toward apparel items that typically carry lower margins. While customer orders remain strong, we’re anticipating that revenue growth will be marginal for the full fiscal 2023. We will continue to closely monitor developments over the next few months and plan to provide an update on our next call. Our Board of Directors approved a regular quarterly dividend of $0.05 per share to our common stockholders on June 3, 2022 to stockholders of record as of May 27th. In addition, reflecting this confidence in the company’s long-term performance, our Board has authorized a share repurchase program of up to $3 million. The program will be in effect through the end of the company’s current fiscal year, March 31, 2023. With that, we will now open up the call for questions.

Operator, Operator

Certainly. And the first question is coming from Mike Baker from D.A. Davidson. Mike, your line is live. Please go ahead.

Mike Baker, Analyst

Hi, thanks everyone. I have a couple of questions. First, can you discuss the percentage of sales from new customers and what that is expected to look like in 2023, as well as its impact on your gross margins? Specifically, I’d like to understand if the pressure on gross margins is primarily due to a shift away from jackets towards pants or other apparel, or if it’s also influenced by the integration of more new customers, which could be beneficial in the long run, but I understand that new customers typically start with lower gross margins.

Sam Choi, CEO

You’re absolutely right, Mike. It’s actually both. We’re taking on new customers. But, of course, the percentage or the mix of new customers is not going to be big for this coming fiscal year anyway. A new customer takes a while to get into the ordering stream. We do have first orders from our European-based premium brand customers that we just successfully brought on board, plus a few other global brand customers. But those are not going to be significant compared to our existing customers. So even though, yeah, their margins are going to be lower at the beginning, we will gradually improve on the margins for these new customers once we get to learn how to make their products and get up to speed on efficiencies and pricing and so on. But the other impact is also coming from the mix of the products. A lot of our existing customers, especially VF and New Balance, they placed a lot of orders in fiscal 2022, especially VF because of the North Face; most of their orders are on outerwear and jackets. So that grew exponentially in 2022 compared to 2021. That’s how we achieved a 59% growth in sales and a significant amount in terms of gross margin. But that kind of pull-down, especially in the last fiscal quarter, the fourth quarter of 2022. So we had to switch our gear and fill up the capacity with low-margin products, with lower-margin customers, mainly customers who are more local in nature, like in Jordan, and also customers who are in the mass merchandising area, such as Costco and Walmart. So we anticipate this to continue because the outlook in the upcoming year is kind of uncertain, so we don’t know whether or when the recession will hit and how it will affect the ordering behavior of our customers, such as VF and New Balance. So we will lower their participation or their mix in our projection and put more because we can always fill up our capacity. Well, not without effort, we can always find customers but at a lower margin. So that’s why we’re projecting a lower margin and we experienced a lower margin in the fourth quarter and we’re just kind of extending that out in fiscal 2023.

Mike Baker, Analyst

That makes sense. I have another question. At the midpoint, your sales guidance for the first quarter is up 15%. You mentioned that the full year is expected to increase marginally. Does that mean it will be less than a 15% increase, suggesting slower growth for the remaining three quarters after the first quarter? Is that the correct understanding and why?

Sam Choi, CEO

Well, for the first fiscal quarter, Q1, we’re projecting it will have, I guess, a 15%.

Mike Baker, Analyst

$34 million…

Sam Choi, CEO

But…

Mike Baker, Analyst

... is 16%. Yeah.

Sam Choi, CEO

Right. And then, I think Q2, Q2 last year was exceptionally high. So we don’t see much growth in Q2, and we’re already at full capacity. Then Q3, we also anticipate Q3 will be strong. So that will have pretty significant growth compared to Q3 of 2022. However, after that, it will be really difficult to see on Q4. So I think, overall, we’re looking at the full year growth of about 14% to 15% just from this point of view.

Mike Baker, Analyst

Thanks for the clarification. I have one more question. You mentioned experiencing some margin pressure due to ocean freight and material costs. How well can you pass those costs onto your customers through price increases, or will they need to absorb those expenses?

Sam Choi, CEO

Well, for new orders, we normally could pass it on as soon as we find out that the raw material costs, when we source the fabrics and the other materials that we know the pricing are coming up, then we can negotiate to increase our prices with our customers. But for orders that are already in the system, if we experience a certain change in prices of raw material cost and those in freight, it is almost impossible to get the customers to absorb it because they have already committed or we already committed to the price. It would be a mixed bag; sometimes we can get the customers to absorb the increased price and sometimes we have to eat it.

Mike Baker, Analyst

Understood. Okay. I’ll pass it on to someone else. Thank you.

Operator, Operator

Thank you. And your next question is coming from Mark Argento from Lake Street. Mark, your line is live. Please go ahead.

Mark Argento, Analyst

Hi, guys. Just a quick question on capacity, maybe could you just remind us what capacity you’re at right now in terms of the number of pieces? Then I think, Sam, in your opening remarks, you’ve mentioned that you’re undertaking expansion; if you could, in particular facility, can you just talk about what you have today, specifically, in terms of piece capacity, what you think you can expand that to? It sounds like this mix from quarter in, quarter out moves around, but really the gating factor to growth here is the ability to source additional capacity. So just wanted to drill down on that a little bit? Thanks.

Sam Choi, CEO

Well, yeah, Mark, at the end of our last fiscal year, which is March 31st, we estimated our capacity for our annual capacity was about 14 million pieces. We started expansion of one of our existing factories and that will add about a little bit less than 10%, which is 1.3 million pieces to our capacity. We also have plans to add production lines to our other factories and that would give us another 2 million pieces. So, altogether, maybe by the end of this fiscal year, we will have another 3.3 million pieces, which is about a 20% increase in our current capacity.

Mark Argento, Analyst

Great. And then, so for fiscal year you just completed, was that a 14 million pieces, is that what you said or is that a year ago?

Sam Choi, CEO

Yeah. No. That’s the fiscal year that we just ended.

Mark Argento, Analyst

Okay. And then the business you acquired, you’re kind of weaning off some of their existing customers and then bringing Jerash customers on. It sounds like that’s fully complete. What was the capacity again of that facility and how much additional Jerash capacity you gain here this year by having it fully under manufacturing for your customers?

Sam Choi, CEO

Okay. That’s the MK Factory that we purchased last year and we brought online in August. Eric, can you give an update on the capacity of that factory?

Eric Tang, Operations Lead

Yeah. When we took up the MK Factory last October, the total capacity for the whole year was around 3.5 million pieces. After we took up the factory immediately, we added another 100 workers from overseas and created another two production lines. Now our annual capacity from MK Factory has jumped from 3.5 million pieces to an additional 1 million, totaling 4.5 million pieces a year.

Mark Argento, Analyst

And then when you were shifting from the legacy customers to the Jerash customers, does that have a big impact in terms of margins? Was that running at much lower margin on the existing or the previous customers? I’m just trying to understand that the dynamic there and how that might work through into the numbers this year?

Eric Tang, Operations Lead

Because in the beginning when we took up the MK Factory, we had to spend some time training the workers to the level they could produce Jerash’s own orders. So in the beginning, for two to three months, we only assigned the MK Factory workers some subcontract orders taken from outside. We did not allocate any of our own FOB orders to the workers in order to play it safe, but after two to three months of training, they are now very capable and we see that the efficiency and capability to produce our own customers' orders is there. So starting November last year and December, we started filling up the MK Factory with our own orders.

Mark Argento, Analyst

Great. That’s helpful. And then just my last question…

Sam Choi, CEO

Yeah. Okay.

Mark Argento, Analyst

... in terms of. Go ahead.

Sam Choi, CEO

I’m sorry, Mark, I guess, to answer your question. At the beginning, because we were just using the MK Factory to produce low-margin products, more simple items, items that we do for contract manufacturing, typically much lower than the FOB orders produced for the North Face and New Balance. However, since then, since the end of the last calendar year, they are now able and have the skills and efficiency to produce our higher-margin FOB orders.

Mark Argento, Analyst

Great. Thanks, guys.

Sam Choi, CEO

Thank you.

Eric Tang, Operations Lead

Thank you.

Operator, Operator

Thank you. Your next question is coming from Rommel Dionisio from Aegis Capital. Rommel, your line is live. Please go ahead.

Rommel Dionisio, Analyst

Thanks and good morning. I think on a prior conference call you discussed the possibility of looking for alternative sources of fabric in the Jordan area and I wonder if you could just give us an update on how that initiative is going and if you’ve made some progress there? Thank you.

Sam Choi, CEO

Sure. Eric, you want to talk about the fabric sourcing?

Eric Tang, Operations Lead

Yes. Maybe I can talk a little bit. So all along, Jerash's sourcing team has been located in Hong Kong and China. But our recent strategy is that we are now setting up a new marketing, sourcing, and development department in Jordan. We have already employed some very experienced staff to fill up key positions. The purpose of this department is to help customers source trims and fibers in the Middle East countries, like Turkey, Egypt, etc. One of the main reasons why we are doing this is under the request of most of the buyers. We have been facing logistic problems from containers leaving from China, Vietnam, Taiwan, and Korea to Jordan, which creates a much longer lead time than before during the epidemic. Especially in the couple of months before when Shanghai experienced lockdown, we faced delays with containers that also jeopardized the production of garments and affected the delivery schedule set by the buyers. If we can source trims and fibers from neighboring countries like Turkey and Egypt, the lead time to Jordan is much shorter, maybe by 50% to 60%, and it will become much more controllable and accessible for the buyers. Another reason is that due to concerns about Xinjiang cotton in China, many buyers have stopped sourcing from there, and many would like alternatives for trims and fabrics from Middle Eastern countries. So this is why we have started this new development, marketing, and sourcing department. Our teams consist of more than 10 members who have already begun making studies and visiting fabric mills and trim suppliers in Turkey and Egypt. Business has already started, and recently we also received orders from buyers that we supplied with trims and fabrics from Turkey and Egypt instead of China or Taiwan, as we had before. This is the latest situation, and I think this trend will continue, and our department will grow due to this new setup.

Rommel Dionisio, Analyst

Okay. Thank you very much. It’s very helpful.

Sam Choi, CEO

Thank you.

Operator, Operator

Thank you. We have a follow-up question from Mike Baker from D.A. Davidson. Mike, your line is live. Please go ahead.

Mike Baker, Analyst

Thank you. I wanted to follow up on the question or the point about potentially delaying some of your construction. And I guess, the question, two-part question, but one, what are you seeing in terms of inventory in the U.S.? Is there an apparel or a jacket inventory glut and are you seeing order cancellations, and is that what is leading you to maybe push out some of that construction?

Sam Choi, CEO

Well, we do feel that our key customers do have an abundance of inventory because they have reduced their orders. They won’t tell us that they have too much inventory, but we think that the inventory situation is only going to slow down the increase in purchasing. It is not going to cause them to cancel orders because we do have orders that filled up our capacity until the end of December. So we’re not worried about kind of like when the pandemic hit, and customers canceled their orders or postponed. We won’t see anything like that.

Mike Baker, Analyst

Okay. One more if I could, I think, in your 10-K from last year, you disclosed the jackets were 25% of your mix, which had come down pretty substantially. Any idea what it was? I guess, we’ll wait and see the K, but what it was in 2022 and where we should expect that to be for 2023?

Sam Choi, CEO

You mean the mix of jackets?

Mike Baker, Analyst

Yes.

Sam Choi, CEO

I don't remember what we said on the 10-K about the mix of product categories, but maybe we can give an estimate. Eric, do you know what the mix of jackets was for 2022?

Eric Tang, Operations Lead

Our expectation for 2023 is that orders from current customers will likely decrease slightly, including jacket orders. This is different from last year when customers were requesting us to increase capacity. One reason for this change is that they have sufficient inventory to meet customer needs for a certain time. However, I believe that after six to seven months, customers will start placing orders again as they did before, whether for jackets, polo shirts, or pants.

Mike Baker, Analyst

Okay. Thanks for the color.

Operator, Operator

Thank you. This does conclude the Q&A session for today. I would now like to turn the call back to Mr. Choi for closing remarks.

Sam Choi, CEO

Oh! Thank you, Operator. And thanks again to all of you for joining us today. We appreciate your support and interest in our company and we look forward to speaking with you again soon on our fiscal 2023 first quarter call. Thank you everyone.

Eric Tang, Operations Lead

Thank you.

Gilbert Lee, CFO

Thank you.

Roger Pondel, Investor Relations

Thank you.

Operator, Operator

Thank you, ladies and gentlemen. This does conclude today’s conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.