Lakeland Industries Inc Q1 FY2020 Earnings Call

Good day, ladies and gentlemen, and welcome to the Lakeland Industries Report on Fiscal 2020 First Quarter Financial Results and Conference Call. All lines have been placed on a listen-only mode and the floor will be opened for your questions and comments following the presentation.

Thank you, and good afternoon to you all and thank you for joining us on our fiscal 2020 first quarter financial results conference call. I am joined here today with Lakeland's Chief Operating Officer, Charles Roberson. We are first going to discuss the status of operations on our financial results. Then the call will be opened up, so that we may respond to your questions. Now onto the formal remarks. Our first quarter fiscal 2020 results show meaningful progress from the fourth quarter of last year, while setting the stage for important business decisions and continued execution toward achieving our growth objectives. Most notable for quarterly performance sequentially, we did deliver an improvement in gross margin, a reduction in operating expenses, lower operating and net losses and a return to adjusted EBITDA profitability. The company continues to work toward the completion of the enterprise resource planning solution, or ERP restructuring, and business development on a global scale, to support our ERP installation, which largely commenced last year. With the sequential performance measures providing perspective on the headway we have been making, we believe we are now past the most challenging aspect of our initiatives, although work remains to be done to fully capitalize on the many opportunities available in the markets in which we operate. A critical component of our plan has included the implementation of an ERP. Today, the ERP costs us $0.9 million for the technology suite, licensing and installation. There was an estimated $1.3 million in additional non-recurring expenses in fiscal 2019 relating to the installation and an estimated $0.1 million in the first quarter of fiscal 2020 this past quarter. This does not include the business disruption, which is very difficult to quantify, but I can say that we believe it to be a material impact including the resignation of our Chief Financial Officer. We expect the domestic installation to be completed by the end of calendar 2019, with installation in our foreign subsidiaries to begin in the first half of fiscal 2020, beginning with our Mexico and Canada facilities. Thanks to our deep senior management bench, we have been able to drive forward in the face of these challenges. In the absence of the CFO on today's call, here are some key financial performance data for the first quarter. Net sales for Q1 FY 2020 were $24.7 million, compared with $24.3 million in quarter one FY 2019 and $25 million in Q4 FY 2019. Gross profit for Q1 FY 2020 of $7.5 million compared with $9.5 million in Q1 FY 2019 and $6.9 million in Q4 FY 2019. Since we are required to report all of our sales and earnings in USD, it should be no surprise that both these line items were hurt when translated back to USD from the approximately 10 material foreign currencies we deal in. Gross margin as a percentage of net sales in Q1 FY 2020 was 30.6% compared to 30.90% in Q1 FY 2019 and 27.7% in Q4 FY 2019. Operating expenses of $7.9 million in Q1 FY 2020, up from $7.1 million in Q1 FY 2019, but down from $8.4 million in Q4 FY 2019. Net loss of $465,000 or $0.06 per basic share for the Q1 FY 2020 quarter compared with net income of $1.9 million, or $0.23 per basic share in Q1 FY 2019 and net loss of $1.9 million or $0.24 per share in Q4 FY 2019. Adjusted EBITDA of $242,000 as compared to $2.1 million in Q1 FY 2019 and a loss of $932,000 in the last quarter. So what's really obvious here is that we've picked up from last quarter in the first quarter. We are making some progress here. Similar to the fourth quarter, the ERP system in the U.S. led to lower domestic sales and gross margins due to order processing issues and the significant expense incurred to ensure our customers received their shipments on time. This was particularly true in the first quarter. The fact that our gross margins increased for the fourth quarter amid these challenges and other macroeconomic concerns demonstrates the potential for revenue growth and profitability expansion once conditions normalize. On our year-end conference call, we mentioned that our investments in product development, quality control and market positioning are paying off as evidenced by fiscal 2020 starting with a global order backlog of $10.5 million with U.S. backlog going from $5.5 million at the beginning of the fourth quarter and ending at $4 million. Our backlog at the end of Q1 2020 was $8.9 million, of which $4 million was from the U.S. We made certain improvements here because our customers needed it. But as I discussed herein, it was at the expense of margins. The other critical change to our business has been the ramping up of our Vietnam manufacturing and associated operations along with our new facility in India. We have been investing in these facilities for more than a year, while adding in-country sales and warehousing capabilities. Capital expenditures for equipment peaked last year. So we are now spending less in 2020. CapEx for fiscal 2020 first quarter was $200,000 compared with approximately $300,000 in fiscal 2019 period. Capital expenditures for all of fiscal 2019 were $3.1 million and are expected to decline to approximately $2 million for fiscal 2020, with most spending in the current year allocated toward the phased global rollout of ERP system and additional manufacturing capacity in both Vietnam and India. Staffing in Vietnam has been elevated to near capacity and we are training the staff while transitioning some of the production headcount from China to the new facility. Manufacturing staff in Vietnam and India combined for 819 employees, while our manufacturing staff in China is now 542 employees, down from 560 a year ago. Following the training regimen to yield more efficient output over the next few quarters, we expect a much lower cost and tariff remanufacturing platform in Vietnam to further bolster our financial performance. Sales activities within Vietnam and India are gaining traction. Our efforts to strengthen our global marketing channels, manufacturing capabilities, and improve our overall financial performance are moving forward. At the same time, by the end of Q1 fiscal 2020, we increased our cash position by $1.5 million from the beginning of the fiscal year and modestly reduced the little debt that remains on our balance sheet. We now have under $1.3 million in debt. Our cash position now at $14.3 million has increased for two consecutive quarters, even though we have elevated our inventories to $46.8 million at the end of Q1 from $42.4 million at the start of the year. Approximately 75% of this increase was in work in process and raw materials as we seek to continue delivering improvements to our customers, scale up our high-value utility product line and support our new manufacturing facility. Our cash flow and profitability should also be assisted by efficiency improvements in our new manufacturing facilities in Vietnam and India and the corresponding alignment of cost as capacity is allocated accordingly. Depending on product mix, our run rate of revenue from a normalized and efficient manufacturing standpoint could be in the range of $130 million to $150 million today, up from our current Q1 annualized revenues of about $115 million. With our share price at the current levels and our outlook for improving cash levels, we will certainly be looking closely at our stock repurchase program. This program was approved on July 19, 2016. And to-date we spent $1.2 million to acquire 105,648 shares, although no shares were purchased in the first quarter. We are encouraged by the company's direction and progress. With the strategic advantage through diversified manufacturing operations in Argentina, China, India, Mexico, the U.S. and Vietnam that affords us significant flexibility in the uncertainty of the current international trade environment and sales into 65 countries, we remain excited by our strong position in the market. As we move through fiscal 2020 and beyond, we look forward to capitalizing on the progress we have made and will continue to make in our efforts to drive sustainable improvement in longer-term topline results as well as bottom-line performance. That concludes my remarks. I will turn the call back to the operator to begin the Q&A.

We'll take our first question from Dave King with Roth Capital.

Hi. This is Andrew stepping on for Dave. I guess, just first on the ERP system. We're trying to quantify how much of that has weighed on the quarter. Do you have the dollar amount in cost of goods sold for the ERP impact?

I'll turn that one over to Charlie who's also on the line and indicate where this is all going on.

Trying to quantify that, Andrew, as we had in the written comments earlier, is very difficult to determine. We have some legacy issues, but the best I can estimate that number is about $300,000.

Great. That's helpful. Thank you. And then, I guess, maybe turning to the revenue side, how much do you think may be the ERP implementation weighed on revenue? And how much of an impact do you think you might have in subsequent quarters? And then I’ll follow up with that, how are you feeling about your ability to meet demand as well?

Well, that's one of the things about the ERP; we're seeing our revenues remain pretty consistent through all of the quarters and we're even seeing our backlogs grow, though in Q1 we did begin to pull those backlogs down. We still have a high backlog compared to what we're ordinarily used to seeing and we're continuing to work to pull that number down. So I think we're benefiting from a good business environment. And our manufacturing installation is primarily in the U.S. so it is not impeding our manufacturing processes at our foreign subsidiaries. So we're still able to service our customers.

Great. Thanks.

One of the other things affecting revenues is a lot of the currencies we operate in were severely impacted this quarter. I mean, up until recently the Mexican peso, the Chinese RMB, and the British pound were really hit hard with saber rattling by certain individuals in this country.

That's helpful. Thank you. And then I guess just lastly for me, how are some of your oil and gas customers holding up given some of the recent weakness there? And then similarly, how's demand been in China with some of the concerns we're seeing?

China has been relatively stable for us. Currently, we've experienced some weakness with certain customers, including one that has chosen to exit the protective clothing sector. This was a major client. I believe our situation in China does not mirror the overall state of their economy. We're lagging a bit, but definitely not to the extent that their economy is suffering at this moment. What was the first part of your question? Oh, right, it was about oil and gas. That area has not affected our back orders. We are still in a backorder situation in those markets.

Great. That's helpful. Thank you for taking my questions.

Thank you.

We'll go next to Mark Rosenkranz with Craig-Hallum.

Hello, Mark.

Hi. Good afternoon. Hi. Good afternoon, everyone. Thanks for taking my questions. I wonder if you could discuss the sourcing of your raw materials and maybe some of the labor costs you're seeing in India and Vietnam, and compare that to the current setup in China. Just how do you see those expectations for those regions versus China going forward?

Well, I'll interject here and Charlie can close up, but this is the one place where the weakening foreign currencies help us because we're buying a lot of our fabrics in China and some in India. To the extent that those currencies weaken, that makes our collection of raw materials much cheaper. The RMB has been hit pretty hard in the last two quarters. So that's the positive side of the currencies being weak. And if Charlie has anything more to say I'll let him.

Yes. As I mentioned earlier, our backlogs remain high. Our strategy with India, Vietnam, and China has been to open up our operations in Vietnam as a bridge to India, which is a long-term strategy, while gradually reducing our capacities in China. Given our current backlog and barring any trade issues, we are not reducing our operations in China as quickly as anticipated. This is a positive development and is currently working in our favor. We need the labor and we have sufficient capacity for it, although the costs are somewhat higher. When comparing labor costs among these markets, India is the most affordable. If we assign a value of 1 to Indian labor, then labor in Vietnam is approximately 1.5 times that, and in China, it's about four times India. This gives you an idea of our labor cost structure and explains why we will gradually shift our production to Vietnam and India. One of the controlling factors in the rate at which we can do that is of course raw material availability. Currently, Vietnam serves us very well because it’s such a short sail and can be serviced from China. We have manufacturers now coming online in Vietnam at the lower end of our product lines, and we also have those growing and maturing or developing in India. And that's going to take place over time. Vietnam is first; India is going to follow and we're prepared to just move that direction around Southeast Asia as that occurs. And especially in terms of the uncertainty of the current trade environment that's something our customers are quite happy to see us prepare to do.

And I would also add to that that we buy a lot of fabrics in the United States from major manufacturers in the United States. They have all raised their prices significantly. And we can usually pass on that amount or sometimes a little bit more when this occurs because these are the last remaining textile suppliers in the United States, so they usually have a virtual monopoly by the fact that they have patents on their fabrics. They're very expensive and we buy them in USD so at least that doesn't affect us on a currency basis. But those prices are going up, but it shouldn't be too difficult to pass the increases on. Because as I said, these are sort of monopoly-type fabrics.

Thank you for the information; it's appreciated. Now, regarding the ERP issue you previously mentioned, there were challenges that impacted the salesforce, particularly with some new hires feeling hesitant to engage with new clients or develop markets during difficult backend situations. Have you noticed any improvement in the salesforce trend?

That's for Charlie.

Yes. The answer to that question, yes. The very worst of our delivery issues were in Q3 and Q4. We still have some legacy problems remaining because of planning issues and our lead times. But I think our salesforce has held up very well through this, and they continue to move forward. They've been very good.

I would add, yes, the salesmen are probably in a holding pattern until they see better delivery.

Okay, great. That's helpful. Good luck for August.

Okay.

We'll go next to Pete Muckerman with Raymond James.

Good afternoon. I have a couple of questions. First, could you provide an update on your cleanroom initiative that you've mentioned in earlier calls? Any progress on that? Additionally, I've read about some hotspots globally, including the swine flu situation in China and a report from the WHO stating that the Ebola situation could take another two years to resolve. Are you seeing any business impacts from those hotspots, and can you also give an update on the cleanroom initiative?

That's you Charlie.

Okay. With regard to our cleanroom business we are seeing that it is meeting our expectations for growth and actually pushing the upper edges of that. We're very pleased with the orders that we've seen there and with some of our chemotherapy products. So, as for the outbreaks of swine flu and Ebola and that kind of thing, we've had some phone calls, so far no orders. In the case of Ebola, it's in a place that is largely unserviceable even by medical staff because of revolutionary activity and other issues. So, there's no consumption, but I think people are looking to find out what's available in case it winds up going into less contentious territory. But I think that the vaccines are actually working pretty well there at this point. If it goes two years, who knows because it's going to mutate several times and the vaccine will need to account for that mutation. As for swine flu, we haven't seen anything yet.

Got you. Thank you.

Mr. Ryan, there are no further questions at this time, I'd like to turn the call back over to you for any additional or closing comments.

Okay. Thanks, Tom. We appreciate your participation in Lakeland's fiscal 2020 first quarter financial results conference call. As we close out the first quarter this fiscal year, we believe we are on track with the right mix of products and manufacturing processes around the world, financial health, and a growing global team to capitalize on the opportunities ahead. We continue to be very well-positioned for continued growth in sales, market share, and profitability in fiscal 2020, which we believe will deliver value for our shareholders. Thank you for joining us today on today's conference call. Goodbye.