Earnings Call Transcript - JRSH Q1 2023

Operator, Operator

Good day, and welcome to Jerash Holdings Fiscal 2023 First Quarter Financial Results. At this time, all participants have been placed on a listen-only mode and the floor will be open for questions and comments after the presentation. It is now my pleasure to turn the floor over to your host Roger Pondel, Investor Relations for Jerash Holdings. Sir, the floor is yours.

Roger Pondel, Investor Relations

Thank you, operator. Good morning, everyone, and welcome to Jerash Holdings Fiscal 2023 First Quarter Conference Call. I'm Roger Pondel with PondelWilkinson, Jerash Holdings’ Investor Relations firm. It will be my pleasure to momentarily 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. But before I turn the call over to Sam, I want to remind everyone today that the 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 Factors section of the company's most recent Form 10-K and Form 10-Q as filed with the Securities and Exchange Commission, 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, Walter. And hello, everyone. Our fiscal 2023 first quarter again reflected Jerash Holdings' reputation as the top quality garment manufacturer in Jordan and a competitive advantage to attract new global brand customers. We are happy to report that the company achieved key record first quarter revenue of $33.4 million. As retailers throughout the world face headwinds, including inflationary pressure and higher inventory levels, we are also feeling the impact. Receiving smaller purchase order quantities and an order mix shift towards products that command generally lower average selling prices, such as shorts, crew neck and pullover shirts. Despite the challenging economic environment, however, we see fiscal 2023 to be a transitional and opportunistic year from a business operation perspective, enabling Jerash to continue its goal of diversifying and expanding our customer base. As previously announced, we made key additions to our growing roster of high-profile global apparel brands earlier in the quarter, and we have to produce these initial orders of women's polos in our fiscal third quarter. Additionally, test orders for our first European-based high-end apparel brands are progressing well, and we are hopeful that this new customer will enable Jerash to be more visible among other European-based apparel brands. We are taking a conservative approach to our guidance, particularly in comparison with fiscal 2022, which experienced record high demand with the post-COVID reopenings. Gilbert will discuss those details momentarily, and we will leave plenty of time for questions. First, I will now turn the call over to Eric Tang, who stays in Jordan; and then Gilbert will cover our financial results. Eric?

Eric Tang, Operations Lead

Thank you, Sam. Hello, everyone. With the challenging external environment and the generally anticipated economic downturn by retailers, recent orders placed by our top global brand customers have been smaller, particularly for fleece jackets compared with orders received last year. We continue to proactively communicate with our existing customers to reconfirm their orders and shipment schedules. We believe this trend will continue through fiscal 2023 as retailers sell through the excess inventories and work through economic and inflation recovery, which would impact all fulfillment and delivery schedules. Fortunately, Jerash's competitive advantage and ability to attract new customers is keeping us busy. Our manufacturing capacity remains fully booked through December 2022. The global trend continues to diversify supply chains away from Asia, especially China, to a more stable and duty-free country such as Jordan. As good news, we have received production inquiries from several new premium brand customers, which will allow us to further diversify our customer base. On the new customer front, we will start production for Timberland and Sketchers in the third quarter, although initial orders are for lower margin products and smaller quantities. Besides Timberland, there are two other VF brands that we are in the process of bringing onboard. As Sam mentioned, we are optimistic about working with our new customers, and we are confident that, over time, these new global brands will grow in a meaningful way. The new dormitory for our multinational workforce is on schedule to be completed by the end of next month. The high-quality, energy-efficient living space with comfort designs and high safety measures will help position us for future growth as well as further our ESG goals on improving operational efficiencies to conserve electricity and water usage. We plan to move approximately 1,500 of our multinational workers to this new dormitory at the end of 2022. Lastly, we are in talks with the United Nations and Jordan Government to add an additional 100 to 150 CRM refugees to work at our factories as we continue to focus on our social responsibility efforts, serving as a trusted employer to help refugees settle into the 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. Revenue for our fiscal 2023 first quarter rose 12% to $33.4 million from $29.9 million in the same period last year. Gross margin expanded 100 basis points to 19.8% for the fiscal 2023 first quarter from 18.8% in the same period last year, reflecting lower average cost bases from larger production scale after the integration of MK Garments in October 2021 and, to a lesser extent, margin improvements for products sold to local customers. Operating expenses totaled $4.4 million in the fiscal 2023 first quarter versus $3.3 million in the same period last year. The increase was primarily due to higher headcount from the acquisition of MK Garments, an increase of approximately $294,000 in stock-based compensation and expenses related to the recruitment of new migrant workers and the associated travel expenses since COVID restrictions have limited our foreign worker recruitment for the past two years. In addition, we have established our Middle East and North Africa, the MENA region sorting team and expanded our merchandising and sampling operations in Jordan over the past few months. This strategic move will enable us to diversify our material and supply sourcing to reduce dependency in Asia as well as to shorten material lead time. Through strengthening our merchandising and sample development in Jordan, we will be able to facilitate quicker responses to customer inquiries and open up opportunities to other European-based customers as well as global brand customers with EU market presence. This increase in SG&A expense will pay off considerably in the long run. More near term, we anticipate saving approximately $0.5 million in annual rent expense with the new dormitory geometry starting next calendar year. Operating income totaled $2.2 million in the fiscal 2023 first quarter versus $2.3 million in the same period last year. Income tax expenses for the most recent fiscal first quarter was $560,000 compared with $418,000 in the same period last year, with the increase in part reflecting a higher tax rate in Jordan as well as higher expenses in our China and U.S. entities that cannot be used to offset income in Jordan for tax purposes. Net income for the fiscal 2023 first quarter was $1.7 million or $0.14 per share compared with $1.9 million or $0.17 per share in the same period last year. Jerash's balance sheet and cash position remained strong with cash of $21.5 million, and net working capital of $55.6 million on June 30, 2022. Inventory was $29 million, and accounts receivable amounted to $11 million. Net cash used in operating activities was approximately $473,000 in fiscal 2023 first quarter compared with $11.5 million in the same period last year. The net change reflects working capital activities, primarily due to the decreases in inventory and accounts receivable. As Sam mentioned, we are taking a conservative approach to our guidance given the inflationary environment affecting retail markets and consumer sentiment, along with a product mix shift to apparel items with lower margins and lower ASP. Our fiscal 2023 second quarter revenue outlook is expected to be in the range of $41 million to $43 million compared with $45.7 million last year. We are also expecting margin to be lower to 16% to 18% on average for the full year. While customer order volume in total remains healthy, we anticipate that revenue growth will be moderate for the full fiscal 2023, considering customers are placing smaller purchase orders and the product mix shift. Again, we view fiscal 2023 to be transitional and opportunistic for Jerash as last year, we were unable to accommodate new customer orders when capacity demands from our top global customers were at exceptionally high levels. That said, we are now continuing to focus on growing our customer base to expand our production and improve productivity for the reasonably added new customer orders. 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 August 24 to stockholders of record as of August 17. Reflecting the Board and management's confidence in the long-term future of Jerash Holdings, on June 13, 2022, the Board authorized a $3 million share repurchase program, which will be in effect through March 31, 2023. To date, approximately 23,557 shares have been repurchased at an average price of $5.76 per share, and we will remain active in the market in the months ahead. With that, we will now open up the call for questions. Operator, may we have the first question, please?

Operator, Operator

First question is coming from Michael Baker from D.A. Davidson.

Michael Baker, Analyst

I have a couple of questions. Back in early June, you mentioned to expect full year sales around 15%. You just referred to it as moderate sales growth for the year. It seems to me that moderate sales growth is less than 15%. Is that an accurate interpretation of your full year sales outlook?

Gilbert Lee, CFO

Well, right now, we're looking at the full year of 2023 to be basically flat comparing to 2022. But there are hopes that we will be able to come back stronger in the second half. But right now looking at the first half, as you know, we grew only 12% in the first quarter. We anticipate the second quarter to be slightly lower than the second quarter of last year. Looking at the orders that we have already and then projections from our existing customers, the third and the fourth quarters together will be about even with our last fiscal year, but we're not going to really guide the whole year because there are a lot of uncertainties with the global market being in this situation, with the war going on in Europe and inflation. So it is just very difficult to say, but we're working hard with our new customers, and we may bring on board a few more new customers. So for this time, we're just going to say that this upcoming year is not going to be very clear.

Michael Baker, Analyst

It seems to me that the outlook has become more cautious compared to just a few months ago. Please correct me if I'm mistaken. As a follow-up, we know there is an inventory surplus in apparel in the U.S., which is contributing to the slowdown. Have the retailers made any progress in addressing this? Is the situation better, worse, or about the same as it was two months ago? Any indications of improvement in managing this inventory issue?

Gilbert Lee, CFO

Right now, what we are seeing is it is a little bit worse than 2 months ago. But to us, it is an opportunity to utilize our capacity, and we are building additional capacity. And comparing to last year, we do have more capacity. So we want to use that to absorb and to bring on board new customers that we have been trying to bring in the past year or two. So it is a good opportunity for us.

Michael Baker, Analyst

Yes, sure. No, that's definitely a good silver lining in the situation. One more if I could. Again, last quarter, you talked about full capacity through December, still saying full capacity through December. Am I reading too much into that, that feels a little negative to me. In other words, the capacity, you haven't been able to book out any more than you were 2 months ago. Or am I interpreting that wrong?

Gilbert Lee, CFO

Well, right now, we're still confident that we will be running at full capacity through December. However, the mix will change, the product mix will change. We're going to bring in more local orders, and we want to use any extra capacity to fulfill orders that are from customers with lower ASP and with lower margins. So yes, in terms of volume, we will use up all the capacity, but it's just that the ASP and the margin will suffer. That's why we're not going to guide anything beyond this current quarter because things are changing, but we're going to keep running our capacity at full speed.

Michael Baker, Analyst

Understood. And one more, I guess, point, maybe question, just remind us. So in terms of using this as an opportunity, historically, those new businesses do typically come on with lower runs and lower margins, which is what you're seeing now. But over time, because I believe that's an opportunity for that to build and so take advantage of having a little bit more capacity from new customers. Now you come into low margin, low run businesses, but over time, that grows. Is that the right way to think about this opportunity?

Gilbert Lee, CFO

Yes, absolutely. Just for instance, three years ago, when we brought New Balance to our family, at that time, they were just sending us lower ASP and lower margin products. And within the first three to six months, we had to learn how to run their products, and orders were smaller. So at that time, our margin took a hit. But now they are growing very strongly, and the margin with New Balance has been improving over the past year or two.

Operator, Operator

And the next question is coming from Mark Argento from Lake Street.

Mark Argento, Analyst

And yes, just a couple of quick questions. First off, on obviously, kind of cyclically a little bit of a soft period right now, just given the glove inventory out in the channel post-COVID, kind of having to work itself through, which I'm sure it would. But when you think about the opportunity longer term to add capacity, does this create an opportunity for you, i.e., I think I'm sure probably some of your competitors in the market, Jordan in particular, are probably feeling the pinch a little bit as well. Any thoughts on cranking up the M&A strategy again? It seems like the macro trend towards moving away from Asia to other manufacturing venues is one that sticks around a lot longer than just the cyclical ups and downs that you're experiencing right now. But I just want to get your thoughts on more permanent and substantial capacity opportunities out there.

Gilbert Lee, CFO

You're absolutely correct, Mark. Our competitors and others we know in Jordan are experiencing the same challenges. Eric informed me recently that no factories are operating at full capacity, except for ours, and some are even down to 30% of full capacity. Everyone is feeling the strain. If an opportunity arises for mergers and acquisitions like the one we executed last year with MK, we will certainly pursue it since we have the cash available, and it attracts new customers. If those businesses already serve some of the same clients as we do, that would be even more advantageous. Therefore, we are open to exploring any M&A opportunities, particularly in Jordan or the MENA region. Eric, Sam, do you have anything to add?

Eric Tang, Operations Lead

Yes, I'd say I totally agree with what you are saying. Although as a matter of fact, I mean I was approached by more than 10 to 15 factories in Jordan. They are all facing the problem of buyers cutting down the orders about 25% to 35%, and they also need support from Jerash. In fact, Jerash also faced the same problem that one or two of our major customers also reduced their order. But at the same time, when other brands understand that Jerash has immediate vacant capacity, we are always their top priority. So they may approach us, and then we successfully took some orders from them and fulfilled the capacity, although the profit margin might not be as good as like the jackets that we are doing. But we have a reasonable profit margin, and we can fill up all our capacity by up to the end of December.

Sam Choi, CEO

And Sam Choi here as well. Yes, I think the economic outlook in the coming one or two years may not be good as we just discussed. However, there will be opportunities for Jerash because some branding customers that previously didn't source any garments from a duty-free country like Jordan are now considering it. Our strength lies in being duty-free as well as offering quality products. In fact, we have had very positive discussions with some reputable brand names that didn't source from Jordan before, and now they are seriously considering it instead of sourcing from politically unstable countries. I am optimistic about forming business relationships with them. I believe these reputable brand names will offer margins much higher than those of our regular customers. I hope that by fiscal 2024 or the first quarter of 2024, we can start doing business with them after they complete their specialty certification and other procedures. This will allow us to diversify our customer base with higher margins and capture more opportunities globally.

Gilbert Lee, CFO

Yes, you're right, Sam. Actually, we have put in place our MENA sourcing team in Jordan. Previously, we really focused on sourcing from Asia and our Hong Kong and China sourcing team have been really just in the lead in terms of sourcing. But now we have put a team together in Jordan to source from the Middle East and North Africa region. We have already started sourcing our materials from Turkey, from Egypt, and that is going to give us a significant competitive advantage going forward. In addition, we have also strengthened our merchandising and sample development capability in Jordan. That will give us a lot of opportunities to work with any new customers, any new brands because we are right there to do the product development and pricing with them. So with just these two, I believe we're going to be very successful in bringing in new customers.

Mark Argento, Analyst

That's helpful. Just one housekeeping item. Did you mention, Gilbert, if you guys bought some stock back in the quarter? Can you refresh that for me?

Gilbert Lee, CFO

Yes. We started our repurchase program I think back in July. Yes. I think we started buying in July. And so far, we have purchased about 24,000 shares. Well, we have to stop because of the quiet period. But as soon as we file the 10-Q, we will begin buying again.

Operator, Operator

And the next question is coming from Peter Sidoti from Sidoti & Company.

Peter Sidoti, Analyst

Just one quick question. For the rest of the year, do you see yourself generating cash, using cash? How do you see the cash flow going to the year?

Gilbert Lee, CFO

We will be very cautious with our cash flow situation. We consistently generate enough operating cash flow, and we expect to remain profitable for the rest of the fiscal year. We always have access to adequate credit facilities and are collaborating with our two largest customers on a financing program that allows us to receive payment faster if we require cash more quickly. We do need to allocate some capital for purchasing the building and land for the MK factory, which involves approximately $2.2 million to finalize the deal. Additionally, we plan to acquire the office building in Hong Kong for about $5 million. We also need to complete the dormitory construction. Therefore, while we anticipate significant capital expansion expenses, we expect to maintain sufficient cash flow for the upcoming year.

Peter Sidoti, Analyst

I'm sorry, you're purchasing a building in Hong Kong for $5 million you said?

Gilbert Lee, CFO

It's not an entire building. It's just the office space that we have been using for the past I don't know how many years. But in order to take advantage of the, I guess, after COVID, the real estate price has dropped, and we also want to save the rent. So that's why the Board decided to purchase the property.

Operator, Operator

The next question is coming from an unidentified analyst.

Unidentified Analyst, Analyst

I just have one quick question regarding the operating expenses and the increase in that. I saw that you mentioned that part of this is due to increased headcount from the MK acquisition along with some other expenses. Can you highlight like what is a one-time expense out of that and what will be recurring?

Gilbert Lee, CFO

I believe the one-time expense is primarily due to the recruitment of additional overseas workers. A year ago, when COVID restrictions were lifted, our headcount was around 4,500 or 4,200, and now it has increased to nearly 5,800. Over the past year, we have brought in approximately 1,000 new workers. Is that correct, Eric?

Eric Tang, Operations Lead

Yes, yes, you're right.

Gilbert Lee, CFO

Bringing in 1,000 workers requires significant financial resources. We need to apply for visas and obtain permits from the Jordanian Government, as well as arrange their flights. We also took on the MK factory's 500 workers, which has now increased to around 600 with the potential to reach 800. The expenses related to recruiting and human resources are likely one-time costs. We are looking for ways to lower our selling, general, and administrative (SG&A) expenses since we do not expect significant growth in the coming year. For now, we will begin to recruit additional foreign workers, and we still have the necessary permits to bring them in, but we will hold off on that for the moment. We also have workers whose contracts are ending and need to return home, and we will not replace them, opting instead to reduce our headcount through attrition. Although this doesn’t significantly impact SG&A since these workers are more associated with the cost of goods sold, we will at least save on recruitment costs. Over the past year, there has been an increase in SG&A expenses, including a separate line for stock-based compensation exceeding $1 million. Sales have also risen compared to last year, and costs associated with sales, including shipping and freight, have increased not only due to higher volumes but also because oil prices have risen, driving transportation costs up.

Unidentified Analyst, Analyst

So out of the increase year-over-year for the operating expenses was about $1.1 million. If you exclude the stock-based compensation, that leaves about $800,000. So how much of that do you think is one-time?

Gilbert Lee, CFO

I don't have the detail in front of me, but I would believe about $300,000 or $400,000 is one-time, that will be my guess.

Unidentified Analyst, Analyst

Okay. And with regards to the acquisition of the office in Hong Kong, you mentioned it's about $5 million. How much in rent are you paying for that? Like so how much spend savings will come out of the acquisition?

Gilbert Lee, CFO

I don't remember exactly how much rent we're paying for the Hong Kong office. I think it's like $600,000 a year. Is that right, Sam?

Sam Choi, CEO

Okay. In fact, the reason why we purchased the property is we have been using that with some decoration expenses have been spent on that. So definitely, we will move out with a new office, more decoration expenses of that. And also, for the purchase of the property of our own office, taking into account the depreciation of the office over 10 to 25 years, the existing rent is around close to $13,000 per month, which will be around $360,000 per year. So after the calculation, there will be some savings considering depreciation into account because depreciation will be 20 to 30 years for that. Yes. So that's why we purchased the property. Taking the COVID situation into account, the property price, we believe is below market a bit. If we use the office for long, definitely, the office value will be increasing. Yes. So that's why we purchased that.

Operator, Operator

And the next question is coming from Michael Wu, who’s also a Private Investor.

Unidentified Analyst, Analyst

First question is about your jacket orders. So could you just give me more color on that, and the amount that reduced the order on jacket, incurred on that?

Gilbert Lee, CFO

Eric, can you answer this one, the reduction in jacket orders?

Eric Tang, Operations Lead

Okay. Our major customer is giving us a monthly jacket order of around 800,000 pieces. So we already relayed this message just now that they have reduced, I mean, around 200,000 pieces to 250,000 pieces a month, because of the excess inventory. So that means we have to find replacement orders in order to fill up our weakened capacity. We have successfully done so during the past couple of months, and that's why we are still booked through our capacity, still booked through the end of December.

Unidentified Analyst, Analyst

So is this just like a quarter for you? Is that for the whole year? Like this is monthly, then up to which month for a reduction?

Eric Tang, Operations Lead

Actually, the buyers indicated that when they will resume the extra 200,000 or 250,000 pieces. But it depends on the market situation, especially the sales during this year, particularly during the Christmas and New Year. So they will keep us posted as they progress.

Unidentified Analyst, Analyst

Okay. Great. Can you just clarify what is the New Balance and North Face sales on this quarter?

Eric Tang, Operations Lead

Gilbert, you have this, right?

Gilbert Lee, CFO

No, no, no.

Unidentified Analyst, Analyst

Yes, the dollar amount. Last quarter, I mean last year, you had $10 million, $20 million or something like that.

Gilbert Lee, CFO

Well, North Face this quarter is about $21 million, and New Balance is about $8.5 million.

Operator, Operator

Thank you, and that's all the time we have for questions today. I would now like to hand the call back to Sam Choi for closing remarks.

Sam Choi, CEO

Okay. Thank you, operator. And thanks again to all of you for joining us today. Our prospects remain healthy as we traverse the current environment. We appreciate your support and interest in our company, and we look forward to speaking with you again soon on our fiscal 2023 second quarter call. Thank you very much.

Operator, Operator

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

Sam Choi, CEO

Thank you very much.

Gilbert Lee, CFO

Thank you.