Earnings Call Transcript - LAKE Q2 2024

Operator, Operator

Good day, and welcome to the Lakeland Industries Fiscal 2024 Second Quarter Financial Results Conference Call. All lines have been placed on a listen-only mode. And the floor will be opened for questions and comments following the presentation. During today's call, we will make statements relating to our goals and objectives for future operations, financial and business trends, business prospects and management's expectations for future performance that constitute forward-looking statements under federal securities laws. Any such forward-looking statements reflect management's expectations based upon currently available information and are not guarantees of future performance and involve certain risks and uncertainties that are more fully described in our SEC filings. Our actual results, performance or achievements may differ materially from those expressed in or implied by such forward-looking statements. We undertake no obligation to update or revise any forward-looking statements to reflect events or developments after the date of this call. During today's call, we will discuss financial measures derived from our financial statements that are not determined in accordance with U.S. GAAP, including adjusted EBITDA and adjusted EBITDA margin. A reconciliation of each of the non-GAAP measures discussed on this call to the most directly comparable GAAP measure is presented in our earnings release. At this time, I would like to introduce you to your host for this call, Lakeland Industries' Chief Executive Officer, Charlie Roberson. Mr. Roberson, the floor is yours.

Charlie Roberson, CEO

Thank you, Holly. Good morning and thank you all for joining us for our second quarter fiscal 2024 earnings call. Please note that we also have an earnings presentation posted on our IR page of our website at www.lakeland.com. Our second quarter results were very encouraging as we continued to see strong improvements in growth within our strategic product lines and markets. Lakeland delivered net sales of $33.1 million, up 17.3% year-over-year. This growth was driven both organically and by Eagle Technical Products, which contributed $3.4 million in revenue to our results this quarter. Notably, our fire service product category continued to see very significant growth with sales up 202%, compared to last year. This growth highlights the significant momentum that Lakeland is building in our strategic product lines, and our goal to increase penetration in high-value markets is producing positive results. In terms of profitability, our second quarter gross margin remained strong at 42.9%, and importantly, our adjusted EBITDA grew by over 50% to $4.2 million in the quarter. Our Eagle Technical Products acquisition, which makes European Standard Fire Services gear, produced $900,000 of EBITDA in the quarter, helping elevate Lakeland's consolidated adjusted EBITDA margin to 12.6% this quarter, compared to 9% in the prior year. With regard to our key geographic markets, we saw similar demand trends to the first fiscal quarter with strength in the U.S., Europe, and Latin America. The U.S. benefited from continued strength in the oil and gas sector as refinery turnarounds continued well into Q2. Sales of turnout gear into the U.S. market were particularly strong, largely due to the lead time advantage that we have over our competitors as a result of our proactive raw materials planning and manufacturing efficiency improvements. Our European sales strength continued as in Q1 meeting its performance targets and on the strength of the Eagle acquisition. Latin America also experienced strong fire service sales as a result of a large order delivered during the quarter. Despite those markets being strengthened, our Asian markets have been weaker than expected, primarily driven by continued weakness in China. China's economy struggled throughout our fiscal second quarter as exports were at multiyear lows and unemployment increased. China's distribution channels for PPE remain in an overstock position, as China works through its overstock of disposables; we are focusing on new end users to grow sales. Biopharma, semiconductors, and batteries are among our targeted applications. As I already mentioned, Eagle contributed very positively to our results during the quarter. Our integration efforts continue to generate significant cross-organizational synergies, and we expect the Eagle platform to continue to enhance our adjusted EBITDA performance going forward. Eagle's fire glove and particle-blocking hood are progressing through the certification process and we will soon be including Eagle's designers in the development of our next-generation NFPA turnout gear. Additionally, samples of Eagle products have been produced in Lakeland facilities and are being used to certify those facilities to make some of Eagle's products. Shifting gears to our capacity expansion initiatives, as we have previously communicated, we currently have an expansion project underway in Monterey, Mexico. Due to damage experienced during the second quarter at our newly leased Monterey site, we are currently evaluating our leasehold improvement build-out schedule, which may impact our go-live production timing. This evaluation is still underway. However, and importantly, we do not anticipate an adverse impact to our financial results and operations or our ability to meet our forecast. We believe our expectations going forward are not at risk. As it relates to our strategic priorities for the remainder of the fiscal year, we remain committed to driving revenue growth in key strategic markets, while executing a shift in our sales resources towards higher value products. Our shorter lead times are resulting in market gains in our fire service and woven products, and we are utilizing our core strength in disposables and chemical garments, combined with our manufacturing flexibility to attract new end users to our container program and higher-value strategic products. The fact that we can supply a full range of safety and PPE products from a single manufacturing facility is attractive to our large customers. We are leveraging our core products to help our customers fill containers more easily, which increases the frequency with which they can order high-value products by container. This improves customer planning and reduces their freight and inventory costs. Moving forward, our leadership team is committed to identifying and maintaining a robust acquisition pipeline with opportunities that enhance Lakeland's strategic product portfolio and expand our geographic reach. Our M&A efforts are focused on finding opportunities like Eagle that meet our SSQ: small, strategic, and quick acquisition strategy by identifying targets that are similar in size, highly strategic, and accretive to our bottom line in a short period of time. I will now pass the call to Roger to provide an overview of our financial results.

Roger Shannon, CFO

Thanks, Charlie, and good morning, everyone. Lakeland delivered sales of $33.1 million in the second quarter ended July 31, 2023. Domestic sales were $15.2 million or 46% of total revenues, and international sales were $17.9 million or 54% of total revenues. This compares with domestic sales of $11.9 million or 42% of the total and international sales of $16.3 million or 58% of the total in the second quarter of fiscal 2023. As we noted in our earnings press release issued yesterday afternoon, we continue to see very strong growth within our fire service product category with sales up 202% year-over-year. In terms of product mix for the quarter, fire service increased to 27% of sales for the quarter, up from 11% in the same quarter of last fiscal year. As a reminder, our fire service product category was up 101% last quarter. Disposables continued to decrease as a percentage of Lakeland sales and represented 38% of total revenues, compared to 45% in the year-ago period. This reflects the efforts we've made to shift our product mix toward higher value, higher margin, and less commoditized products as we've discussed in prior calls. From a segment reporting standpoint, Lakeland saw strong sales growth in our U.S., European, and Latin American markets. This growth was partially offset by softer Asian sales, particularly in China, which is a continuation of what we saw last quarter. Gross profit as a percentage of net sales was 42.9% for the fiscal 2024 second quarter, as compared with 41.3% a year ago. As Charlie already highlighted, our gross margin improvement has been driven primarily by a deliberate sales focus on strategic products, supported by manufacturing efficiencies that have resulted in reduced lead times, as well as decreases in transportation costs. Lakeland reported operating profit of $3.7 million in Q2 ’24, as compared to $1.8 million in the second quarter of last year. As a result, operating margins were 11.3% in the second quarter, up from 6.4% in the second quarter of last year. Our operating profit benefited from improved gross margins resulting from our product mix shift and operating leverage resulting from higher revenue, as previously discussed. This was partially offset by an increase of approximately $600,000 in operating expenses compared to last year. The increase in OpEx is attributable to currency fluctuations, one-time expenses related to severance and startup costs, increased depreciation and amortization, and OpEx related to the Eagle acquisition and year-over-year labor cost increases. Currency fluctuations, primarily related to the Chinese yuan and Argentinean peso, totaled approximately $600,000. One-time expenses related to severance and startup costs were approximately $500,000, and increased D&A and OpEx related to Eagle totaled approximately $300,000. These increases were partially offset by a reduction of $700,000 in the earnout consideration accrual related to the Eagle acquisition, which was recorded as a reduction in operating expenses. Lakeland delivered net income of $2.5 million or $0.33 per basic share and $0.32 per diluted share during the quarter. This compares to a net loss of $900,000 or $0.11 for basic and diluted share in the prior year period. Adjusted EBITDA was $4.2 million in Q2 ‘24, compared to $2.5 million in the second quarter of ‘23. Lakeland delivered operating cash flow during the quarter of approximately $200,000. Our robust balance sheet provides us with significant flexibility as we continue to explore acquisition opportunities, organic growth investments, and returning capital to our shareholders. Lakeland ended the quarter with cash and cash equivalents of approximately $24.3 million, compared to our FY ’23 year-ended cash balance of $24.6 million. The company continued to have no debt at the end of the quarter and has up to $25 million available from bank credit facilities. Capital expenditures for the three months ended July 31, 2023, were $400,000. For the full fiscal year, we now expect capital expenditures to be approximately $2 million, down from our previous estimate of $3 million as we replace existing equipment in the normal course of operations and pause the Monterey expansion to assess the damage to our leased building, as Charlie previously discussed. We expect to fund capital expenditures from our cash flow from operations. Inventories declined slightly quarter-over-quarter from $57.9 million to $57.4 million at the end of the second quarter of fiscal 2024. Raw materials inventory increased by approximately $990,000, while finished goods inventories decreased by approximately $360,000. The increase in raw material inventory is driven by growth in our higher-value strategic products as we continue to strategically position ourselves to take market share from competitors. More specifically, much of our success in these end markets can be attributed to having more favorable lead times compared to our competition, and having raw materials on hand is key to the strategy. While the overall decrease in inventory during the quarter was minimal, we remain committed to accelerating the reduction of our finished goods inventory this year as previously communicated. We are aggressively pursuing additional sales channels, marketing programs, and price deviations on excess inventory to drive these reductions. We expect these efforts to accelerate in the second half of this fiscal year. With that overview, I’d now like to turn the call back over to the operator to open up for questions.

Operator, Operator

Certainly. At this time, we will be conducting a question-and-answer session. Your first question for today is coming from Gerry Sweeney at Roth Capital.

Gerry Sweeney, Analyst

Good morning, Roger and Charlie. Thanks for taking my call.

Charlie Roberson, CEO

Please, Jerry.

Gerry Sweeney, Analyst

I want to start on the high-value products and even a little bit on the fire products and wovens. But to start off, obviously, you're getting some great momentum there. Can you give a little bit more explanation? You talked about lead times and raw materials that give you an advantage. But what can you do to keep this momentum going, or can you accelerate it to some degree in terms of maybe sales resources or things along those lines? Or are we looking at sort of a steady state and you are in good shape from the momentum standpoint?

Charlie Roberson, CEO

Let me start by saying this market differs from our core markets and disposable and chemical in that it has its own distribution channels. A number of those distributors are exclusive to a specific manufacturer of turnout gear, right? This is true not just in North America but globally as well. Our operations, people, planning, and sales have done a very good job over the last three quarters of managing raw materials availability; that's kind of the long pole in the tent for lead time in this market. Our lead times will continue to be below our competition, even though early lead times are coming down. Thanks to our operations, planning, and salespeople, we're committed to maintaining our lead time advantages. As a result of that, competitors' lead times have been extended now for over a year in some cases. A number of large distributors who were exclusive to other competitors are now taking Lakeland products. That’s one of the advantages of lead time reduction. As long as you have a quality product, which we had before, they just wouldn’t break the relationship. Now they have a reason to do that, and we have our foot in the door. I think the main avenue for growth comes from maintaining what we've done, which will continue to yield growth in the U.S. but expanding this and replicating it with Eagle internationally presents a great opportunity for us.

Roger Shannon, CFO

Hey Gerry…

Gerry Sweeney, Analyst

On Eagle, yes sorry go ahead. Sorry about that.

Roger Shannon, CFO

Yes, we just have briefly referenced Eagle, and that really was the strategic rationale behind that acquisition. We see a significant addressable market but a market that is very fragmented. Although we are seeing advantages versus the major competitors on lead time, the major competitors still make up a fairly small part of the overall addressable market. So we see globally the opportunity to increase our market share, and that really was the strategic rationale. We're pleased to see execution on that and we do expect that to continue. Taking Eagle as an example, it’s a tremendous product that we acquired with the European standard that we're able to add to our portfolio, which is the NFPA standard. We’re adding that into our global sales distribution channel and increasing that opportunity around the world. We've found products within the Eagle portfolio, Charlie mentioned, gloves, and particulate hoods, that we're running through qualification and certification now. That validates our acquisition strategy.

Gerry Sweeney, Analyst

Actually, the Eagle acquisition was what I wanted to ask next about. On the last call, you really talked about ramping up some of the cross-selling or some of the sales on the Eagle Product and vice versa. I'm curious as to how that's going and if you could touch upon that.

Charlie Roberson, CEO

We have some of the Eagle products already being offered in South America through Eagle's current manufacturing channel. Those opportunities should really accelerate once we have certification of our own facilities to make those products. We're also getting some traction in Europe with Eagle products; meanwhile, we are still in our infancy in North America regarding bringing in the gloves and hoods, but that is moving forward. We should see results from that within the next six to 12 months.

Gerry Sweeney, Analyst

Got it. So the North America hoods and gloves, that’s still yet to come, which is a positive.

Charlie Roberson, CEO

As I mentioned in the call, another important part, while it's not quick cross-selling, the involvement of Eagle's designers in the development of our next-generation NFPA gear will provide a different perspective on our next-gen gear. That is a huge synergy for us.

Roger Shannon, CFO

Hey Gerry, just a specific example, during the past quarter, we had a sales trading conference with Eagle products and Eagle personnel for our Latin American team in country. So that was very well received.

Gerry Sweeney, Analyst

Got it. And then final question, acquisitions, you had the SSQ strategy. You touched upon the Eagle. You have a global distribution footprint. I'm curious about what that acquisition pipeline looks like? Is it more gear or product-driven or is it perhaps more geographical expansion focused? Could you touch upon that?

Charlie Roberson, CEO

You are correct that it is more product focused. We do have companies where our primary interest may be geographic. We have a healthy pipeline. I won’t quantify it, but there are plenty of opportunities out there in the Eagle size range, particularly in the fire market, which is very fragmented. Our estimation is that the largest player globally in the market only has a 10% market share. The next one after that’s down to five, so that gives you some idea of how fragmented it is.

Roger Shannon, CFO

That's exactly right. We currently have no debt, and we saw the contribution that Eagle made to EBITDA, which supports our ability to build on that strategy.

Gerry Sweeney, Analyst

How much competitive advantage do you have in the fire and turnout gear? Obviously, you talked about the hood and gloves for Eagle, but if you start building out additional products, how much advantage does that give you?

Charlie Roberson, CEO

Good question. One of the issues that end users deal with is selection of the garment and what certification to go with. Currently, there are only two other companies offering, European certified gear and North American certified gear globally. Having that global reach and the ability to offer both product lines and explain the features and benefits of both is a tremendous service to the end users. There is confusion, for instance, in EMEA: there's a lot of use of NFPA gear, but CE is also coming in. It’s mixed, and people don’t understand the trade-offs they are making. The differences in pricing of the gear can be as much as 30% or 40%. So what are you giving up for the savings in CE? That is a tremendous amount of credibility within individual markets, and the ability to supply from a global manufacturing base makes us cost competitive. We have many advantages.

Roger Shannon, CFO

What I would add to that, it’s intuitive as well. We talked about what Charlie referred to, gaining additional distribution channels due to our lead times. Having that full suite of products, both NFPA and CE, and being able to be head-to-toe just kind of strengthens our position with distributors. We've seen advantages in RFPs, as these smaller to medium-sized customers will favor someone who's able to deliver the full ensemble.

Gerry Sweeney, Analyst

Got you. Super helpful. I appreciate it. I'll jump back in queue. Thanks, guys.

Operator, Operator

Your next question for today is coming from George Melas at MKH Management.

George Melas, Analyst

Good morning, Charlie and Roger. Congratulations, looks like a great quarter. Quick question on operating leverage; it seems like you had really nice leverage this quarter, and your breakdown of the OpEx increase was quite interesting since there's a lot of one-time expenses. Of course, there was a reduction in the year-on-year as well, but it seems like you're maintaining control over OpEx? Do you see that continuing to the future? Or do you feel like you will have to spend more money as you try to expand share?

Roger Shannon, CFO

Great question, George, and thank you for the question. We’ve previously alluded to having operating leverage. It was very good to see that be the case. A significant amount of the OpEx we saw in the quarter was either one-time or currency-related, and we are obviously taking measures to manage currency risk. We believe we have operating leverage. Our platform is currently scaled well to manage this growth. So we are focused on OpEx and OpEx reduction. As we've said before, we're focused on free cash flow and are looking to make improvements across the company.

George Melas, Analyst

Okay, great. That's good to hear. Maybe can you tell us a little something on the issues with the Monterey clients? I don't know how much you can share, but can you explain a little bit about what happened, where you stand, and what options you are considering?

Charlie Roberson, CEO

Yes. George, we're very early in this process. As we said, there’s not much that we can add because we're still investigating and have many questions ourselves. Suffice it to say, while we are delayed, we don't see an impact on future earnings or our operations or our ability to meet our forecast. That was our first concern, and we believe that we have handled that. There was a startup time associated with that business anyway, so it’s not an immediate impact to our projections. Unfortunately, we are waiting on some engineering reports, and once we have those, we'll know more, but there’s not much else we can share.

George Melas, Analyst

Thank you.

Charlie Roberson, CEO

Thank you, George.

Operator, Operator

We have reached the end of the question-and-answer session. I will now turn the call over to Charlie for closing remarks.

Charlie Roberson, CEO

Thank you, Holly, and thank you all for joining us on today's call. I would also like to thank our employees for their commitment and hard work to execute on our strategic vision, which has helped drive strong results in the fiscal second quarter. We look forward to capturing the large opportunity ahead of us and building on the momentum we have achieved so far this year. Have a great day.

Operator, Operator

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.