LAKELAND INDUSTRIES,

LAKE
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LAKELAND INDUSTRIES : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

06/09/2020 | 04:18pm

This Form 10-Q may contain certain "forward-looking" information within the
meaning of the Private Securities Litigation Reform Act of 1995. This
information involves risks and uncertainties. Our actual results may differ
materially from the results discussed in the forward-looking statements. See
"SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS" at the beginning of Part I,
Item 1.



Overview; Response to COVID-19 Outbreak
We manufacture and sell a comprehensive line of industrial protective clothing
and accessories for the industrial and public protective clothing market. Our
products are sold globally by our in-house sales teams, our customer service
group, and authorized independent sales representatives to a network of over
1,600 global safety and industrial supply distributors. Our authorized
distributors supply end users, such as integrated oil, chemical/petrochemical,
automobile, steel, glass, construction, smelting, cleanroom, janitorial,
pharmaceutical, and high technology electronics manufacturers, as well as
scientific, medical laboratories and the utilities industry. In addition, we
supply federal, state and local governmental agencies and departments, such as
fire and law enforcement, airport crash rescue units, the Department of Defense,
the Department of Homeland Security and the Centers for Disease Control.
Internationally, we sell to a mixture of end users directly, and to industrial
distributors depending on the particular country and market. In addition to the
United States
, sales are made to more than 50 foreign countries, the majority of
which were into China, the European Economic Community ("EEC"), Canada, Chile,
Argentina, Russia, Kazakhstan, Colombia, Mexico, Ecuador, India and Southeast
Asia
.



We have operated facilities in Mexico since 1995 and in China since 1996.
Beginning in 1995, we moved the labor intensive sewing operation for our limited
use/disposable protective clothing lines to these facilities. Our facilities and
capabilities in China and Mexico allow access to a less expensive labor pool
than is available in the United States and permit us to purchase certain raw
materials at a lower cost than they are available domestically. More recently we
have added manufacturing operations in Vietnam and India to offset increasing
manufacturing costs in China and further diversify our manufacturing
capabilities. Our China operations will continue primarily manufacturing for the
Chinese market and other markets where duty advantages exist. Manufacturing
expansion is not only necessary to control rising costs, it is also necessary
for Lakeland to achieve its growth objectives. Our net sales attributable to
customers outside the United States were $22.5 million and $11.8 million for the
three months ended April 30, 2020 and 2019, respectively.



The last two weeks of FY20 and Q1 FY21 were dominated by response to the
COVID-19 outbreak. The virus' progression into a global pandemic will likely
impact our business throughout the entirety of FY21. In the near term, increased
demand for our disposable and chemical lines, combined with our high inventory
levels has produced sales revenues beyond our sustainable manufacturing capacity
on an annualized basis. We anticipate that COVID-19 sales will continue for the
remainder of FY21 however not at the levels experienced in Q1 FY21 as inventory
has been reduced by the high demand and we are limited to our maximum available
manufacturing throughput until we can meaningfully increase sustainable
manufacturing capacity. Our future sales would also be affected should there be
an industry-wide shortage of necessary raw materials in the event of a new rise
in COVID-19 cases; in this respect we did experience significant price increases
for fabric during the first quarter of FY 21 and managed our available
manufacturing capacity to meet customer demand at these higher prices. While we
have not experienced any manufacturing capacity issues due to government
quarantine or shelter-in-place orders, or due to COVID-19 outbreaks in any of
our factories, there can be no assurance that this will continue to be the case.
Potential headwinds to revenue as we emerge from pandemic sales include the
possibility of a recession and consumer stockpiled inventories, as well as a
decline in our oil and gas industrial sector that may temper demand within our
regular markets in the second half of the year. Reference is made to "Risk
Factors" in Part I, Item 1, of our Annual Report on Form 10-K for the fiscal
year ended January 31, 2020. Offsetting these risks are changes to our sales
environment, as a result of COVID-19, that we believe represent considerable
upside to sales. We believe that once the pandemic subsides, there will likely
be secondary government-based pandemic demand as governments around the world
seek to replenish and perhaps increase their PPE stockpiles prior to a possible
second wave of virus outbreak in the fall. This stockpiling will be filled in
part by inventory that is in the distribution channels as the pandemic ends.
When specific governments will issue RFQs for additional product is unknown, but
some RFQs are already pending release, others may take up to a year.
Additionally, we believe the private sector will also engage in stockpiling of
PPE as supply channels catch up to demand. And finally, we are seeing the
emergence of institutional cleaning as a new market segement as countries and
states reopen and seek to prevent further infections. For these reasons we are
maximizing our manufacturing capacity in the near-term and preparing for a
slower second half to last quarter of the year.



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Lakeland's strategy for response to these "black swan" events is to remain
focused on our long term growth strategies and tailor our response to these
events so as to accelerate our strategic plans. We believe that focusing on our
long-term growth strategy is also a solid strategy for minimizing the impact of
any post-pandemic recession. In this particular case, our long-term strategy for
revenue and margin improvement is to increase market penetration into markets
that use higher value, higher margin products, that are recession resistant. Our
manufacturing flexibility allows the company to maximize the manufacture of
disposable and chemical garments without degrading its ability to supply higher
end, flame resistant and arc flash resistant garments. In order to maximize our
response to pandemic demand, we have increased the daily working hours for our
disposables and chemical manufacturing product lines, and we have significantly
reduced the number of SKUs in these product lines in order to maximize
efficiencies. This will have the effect of increasing throughput and reducing
manufacturing costs to help mitigate any raw materials prices increases.
Additionally, by focusing on a few core styles, we believe we can minimize the
impact on inventory of any production over run when the pandemic subsides. We
are not deviating from our growth strategy, rather we are looking to utilize the
short-term, increased demand as a catylast to accelerate attainment of growth
objectives.



Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations
are based upon our unaudited condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of our unaudited condensed
consolidated financial statements in conformity with accounting principles
generally accepted in the United States requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, net sales and
expenses and disclosure of contingent assets and liabilities. We base our
estimates on the past experience and on various other assumptions that we
believe to be reasonable under the circumstances, and we periodically evaluate
these estimates.



We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our unaudited
condensed consolidated financial statements.



Revenue Recognition. Substantially all of the Company's revenue is derived from
product sales, which consist of sales of the Company's personal protective wear
products to distributors. The Company considers purchase orders to be a contract
with a customer. Contracts with customers are considered to be short-term when
the time between order confirmation and satisfaction of the performance
obligations is equal to or less than one year, and virtually all of the
Company's contracts are short-term. The Company recognizes revenue for the
transfer of promised goods to customers in an amount that reflects the
consideration to which the Company expects to be entitled in exchange for those
goods. The Company typically satisfies its performance obligations in contracts
with customers upon shipment of the goods. Generally, payment is due from
customers within 30 to 90 days of the invoice date, and the contracts do not
have significant financing components. The Company elected to account for
shipping and handling activities as a fulfillment cost rather than a separate
performance obligation. Shipping and handling costs associated with outbound
freight are included in operating expenses. For the three months ended April 30,
2020
and 2019 shipping and hadling costs aggregated approximately $1.6 million
and $0.8 million, respectively. Taxes collected from customers relating to
product sales and remitted to governmental authorities are excluded from
revenue.



The transaction price includes estimates of variable consideration related to
rebates, allowances, and discounts that are reductions in revenue. All estimates
are based on the Company's historical experience, anticipated performance, and
the Company's best judgment at the time the estimate is made. Estimates for
variable consideration are reassessed each reporting period and are included in
the transaction price to the extent it is probable that a significant reversal
of cumulative revenue recognized will not occur upon resolution of uncertainty
associated with the variable consideration. All the Company's contracts have a
single performance obligation satisfied at a point in time and the transaction
price is stated in the contract, usually as quantity time's price per unit.



The Company has seven revenue generating reportable geographic segments under
ASC Topic 280 "Segment Reporting" and derives its sales primarily from its
limited use/disposable protective clothing and secondarily from its sales of
reflective clothing, high-end chemical protective suits, firefighting and heat
protective apparel, reusable woven garments and gloves and arm guards. The
Company believes disaggregation of revenue by geographic region best depicts the
nature, amount, timing, and uncertainty of its revenue and cash flows (see table
below).





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Net sales by geographic region and by product line are included below:





Three Months Ended
April 30,
(in millions of dollars)


2020 2019



External Sales by geographic region:
USA $23.11 $12.87
Other foreign 2.30 0.78
Europe (UK) 3.01 2.39
Mexico 1.37 0.60
Asia 9.05 3.83
Canada 4.31 2.49
Latin America 2.43 1.72
Consolidated external sales $45.58 $24.68




Three Months Ended
April 30,
(in millions of dollars)


2020 2019



External Sales by product lines:
Disposables $31.21 $12.36
Chemical 8.88 5.06
Fire 1.45 1.40
Gloves 0.78 0.75
High Visibility 1.35 2.12
High Performance Wear 0.29 0.23
Wovens 1.62 2.76
Consolidated external sales $45.58 $24.68




Accounts Receivable, Net. Trade accounts receivable are stated at the amount the
Company expects to collect. The Company maintains allowances for doubtful
accounts for estimated losses resulting from the inability of its customers to
make required payments. The Company recognizes losses when information available
indicates that it is probable that a receivable has been impaired based on
criteria noted above at the date of the consolidated financial statements, and
the amount of the loss can be reasonably estimated. Management considers the
following factors when determining the collectability of specific customer
accounts: Customer creditworthiness, past transaction history with the
customers, current economic industry trends and changes in customer payment
terms. Past due balances over 90 days and other less creditworthy accounts are
reviewed individually for collectability. If the financial condition of the
Company's customers were to deteriorate, adversely affecting their ability to
make payments, additional allowances would be required. Based on management's
assessment, the Company provides for estimated uncollectible amounts through a
charge to earnings and a credit to a valuation allowance. Balances that remain
outstanding after the Company has used reasonable collection efforts are written
off through a charge to the valuation allowance and a credit to accounts
receivable.



Inventories. Inventories include freight-in, materials, labor and overhead costs
and are stated at the lower of cost (on a first-in, first-out basis) or net
realizable value.



Impairment of Long-Lived Assets. The Company evaluates the carrying value of
long-lived assets to be held and used when events or changes in circumstances
indicate the carrying value may not be recoverable. The Company measures any
potential impairment on a projected undiscounted cash flow method. Estimating
future cash flows requires the Company's management to make projections that can
differ materially from actual results. The carrying value of a long-lived asset
is considered impaired when the total projected undiscounted cash flows from the
asset is less than its carrying value. In that event, a loss is recognized based
on the amount by which the carrying value exceeds the fair value of the
long-lived asset.





30



Income Taxes. The Company is required to estimate its income taxes in each of
the jurisdictions in which it operates as part of preparing the consolidated
financial statements. This involves estimating the actual current tax in
addition to assessing temporary differences resulting from differing treatments
for tax and financial accounting purposes. These differences, together with net
operating loss carryforwards and tax credits, are recorded as deferred tax
assets or liabilities on the Company's consolidated balance sheet. A judgment
must then be made of the likelihood that any deferred tax assets will be
recovered from future taxable income. A valuation allowance may be required to
reduce deferred tax assets to the amount that is more likely than not to be
realized. In the event the Company determines that it may not be able to realize
all or part of its deferred tax asset in the future, or that new estimates
indicate that a previously recorded valuation allowance is no longer required,
an adjustment to the deferred tax asset is charged or credited to income in the
period of such determination.



The Company recognizes tax positions that meet a "more likely than not" minimum
recognition threshold. If necessary, the Company recognizes interest and
penalties associated with tax matters as part of the income tax provision and
would include accrued interest and penalties with the related tax liability in
the consolidated balance sheets.



Foreign Operations and Foreign Currency Translation. The Company maintains
manufacturing operations in the People's Republic of China, Mexico, Vietnam,
India, and Argentina and can access independent contractors in China, Vietnam,
Argentina, and Mexico. It also maintains sales and distribution entities located
in China, Canada, the U.K., Chile, Argentina, Russia, Kazakhstan, India, Mexico,
Uruguay, Australia, and Vietnam. The Company is vulnerable to currency risks in
these countries. The functional currency for the United Kingdom subsidiary is
the Euro; the trading company in China, the RMB; and the Russian operation, the
Russian Ruble, and the Kazakhstan operation the Kazakhstan Tenge. All other
operations have the US dollar as its functional currency.



Pursuant to US GAAP, assets and liabilities of the Company's foreign operations
with functional currencies other than the US dollar, are translated at the
exchange rate in effect at the balance sheet date, while revenues and expenses
are translated at average rates prevailing during the periods. Translation
adjustments are reported in accumulated other comprehensive loss, a separate
component of stockholders' equity. Cash flows are also translated at average
translation rates for the periods, therefore amounts reported on the
consolidated statement of cash flows will not necessarily agree with changes in
the corresponding balances on the consolidated balance sheet. Transaction gains
and losses that arise from exchange rate fluctuations on transactions
denominated in a currency other than the functional currency are included in the
results of operations as incurred.



Fair Value of Financial Instruments. US GAAP defines fair value, provides
guidance for measuring fair value and requires certain disclosures utilizing a
fair value hierarchy which is categorized into three levels based on the inputs
to the valuation techniques used to measure fair value. The following is a brief
description of those three levels:




Level 1:
Observable inputs such as quoted prices (unadjusted) in active markets for
identical assets or liabilities.
Level 2:
Inputs other than quoted prices that are observable for the asset or liability,
either directly or indirectly. These include quoted prices for similar assets or
liabilities in active markets and quoted prices for identical or similar assets
or liabilities in markets that are not active.
Level 3:
Unobservable inputs that reflect management's own assumptions.


Foreign currency forward and hedge contracts are recorded in the consolidated
balance sheets at their fair value as of the balance sheet dates based on
current market rates.



The financial instruments of the Company classified as current assets or
liabilities, including cash and cash equivalents, accounts receivable,
short-term borrowings, borrowings under revolving credit facility, accounts
payable and accrued expenses, are recorded at carrying value, which approximates
fair value based on the short-term nature of these instruments.



The Company believes that the fair values of its long-term debt approximates its
carrying value based on the effective interest rate compared to the current
market rate available to the Company.



Recent Accounting Pronouncements
See Note 3 in the unaudited condensed consolidated financial statements for
management's periodic review of new accounting standards that were issued.



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Significant Balance Sheet Fluctuation April 30, 2020, Compared to January 31,
2020



Cash increased by $8.9 million, primarily as a result of increased
profitability, improved accounts receivable collection efficiency, and a
decrease in inventory, offset by the payoff of the term loan outstanding at
January 31, 2020. Accounts receivable increased due to the increase in sales.
Inventory decreased $6.8 million due to the increase in sales. Accounts payable,
accrued compensation, and other accrued expenses increased $0.9 million. Capital
expenditures for the three months ended April 30, 2020 were $0.2 million.



Three Months ended April 30, 2020, Compared to the Three Months Ended April 30,
2019



Reference is made to "Overview; Response to COVID-19 Outbreak" above which
should be read in conjunction with this Section.



Net Sales. Net sales increased to $45.6 million for the three months ended April
30, 2020
compared to $24.7 million for the three months ended April 30, 2019, an
increase of 84.7%. Sales globally were driven by COVID-19 demand, as we realized
significant increases in all markets for our disposable and chemical product
lines. In addition to the increased volumes, sales were also impacted by price
increases based on our normal, annual adjustments, special price increases due
to increases in raw material costs, which we expect will be temporary, and
increased sales to new customers, which are typically at prices above those for
our recurring customers. We were able to meet this demand with inventory on hand
(which has been significantly reduced) and by increasing our manufacturing
capacity with expanded operating hours. Other product lines such as wovens,
which are primarily used by industrial customers, declined during the period due
to various global shutdowns and quarantines.



Gross Profit. Gross profit increased $14.6 million, or 193.1%, to $22.1 million
for the three months ended April 30, 2020, from $7.6 million for the three
months ended April 30, 2019. Gross profit as a percentage of net sales increased
to 48.6% for the three-month period ended April 30, 2020, from 30.6% for the
three months ended April 30, 2019. Major factors driving gross margins were:




?
Significant increases in volumes driven by COVID-19 demand.
?
Price increases described above.
?
Improved manufacturing efficiency in substantially all locations as we increased
the number of hours per shift and number of days per week.
?
Reduction in SKUs led to increased run size that increased manufacturing
throughput and improved efficiency.
?
Sales of reserved inventory into COVID-19 applications.


Operating Expense.Operating expenses increased 24.2% from $7.9. million for the
three months ended April 30, 2019 to $9.8 million for the three months ended
April 30, 2020. Operating expenses as a percentage of net sales was 21.4% for
the three months ended April 30, 2020, down from 31.9 % for the three months
ended April 30, 2019. Selling expenses increased $1.4 million, including sales
compensation and commissions, freight out, advertising and marketing. General
and administrative expenses were increased due to increases in salaries and
compensation (including bonuses), and currency fluctuations.



Operating Profit (Loss). Operating profit increased to $12.4 million for the
three months ended April 30, 2020 from an operating loss of $(0.3) million for
the three months ended April 30, 2019, due to the impacts detailed above.
Operating margins were 27.1% for the three months ended April 30, 2020, as
compared to (1.3%) for the three months ended April 30, 2019.



Interest Expense. Interest expense decreased slightly to $0.02 million for the
three months ended April 30, 2020 from $0.03 million for the three months ended
April 30, 2019 as a result of very little borrowings for each quarter.



Income Tax Expense. Income tax expense consists of federal, state and foreign
income taxes. Income tax expense was $3.7 million for the three months ended
April 30, 2020, compared to $0.1 million for the three months ended April 30,
2019
, due to the increase in operating profit.



32



Net Income (loss). Net income increased by $9.1 million to $8.6 million for the
three months ended April 30, 2020 from a $(0.5) million loss for the three
months ended April 30, 2019.



Liquidity and Capital Resources



At April 30, 2020, cash and cash equivalents were approximately $23.5 million
and working capital was approximately $77.9 million. Cash and cash equivalents
increased $8.9 million and working capital increased $11.0 million from January
31, 2020
, due to increased profitability and a focus on working capital
efficiencies.



Of the Company's total cash and cash equivalents of $23.5 million as of April
30, 2020
, cash held in Latin America of $1.3 million, cash held in Russia and
Kazakhstan of $1.4 million, cash held in the UK of $0.5 million, cash held in
India of $0.9 million and cash held in Canada of $1.7 million would not be
subject to additional US tax due to the change in the US tax law as a result of
the December 22, 2017 enactment of the 2017 Tax Cuts and Jobs Act (the "Tax
Act"). In the event the Company repatriated cash from China, of the $12.9
million
balance at April 30, 2020 there would be an additional 10% withholding
tax incurred in that country. The Company has strategically employed a dividend
plan subject to declaration and certain approvals in which its Canadian
subsidiary sends dividends to the US in the amount of 100% of the previous
year's earnings, the UK subsidiary sends dividends to the US in the amount of
50% of the previous year's earnings, and the Weifang China subsidiary sends
dividends to the US in declared amounts of the previous year's earnings. No
dividends were proposed by management or declared by our Board of Directors for
our China subsidiary in the quarter ended April 30, 2020.



Net cash provided by operating activities of $10.3 million for the three months
ended April 30, 2020 was primarily due to net income of $8.6 million, non-cash
expenses of $2.9 million for deferred taxes, depreciation and amortization and
stock compensation, offset in part by a $1.3 million increase in net working
capital accounts. Net cash used in investing activities of $0.2 million for the
three months April 30, 2020 reflects purchases of property and equipment. Net
cash used in financing activities of $1.0 million for the three months ended
April 30, 2020, was due to the repayment of a term loan.



We currently have a $20 million revolving credit facility which commenced May
10, 2017
, and which will expire on August 10, 2020., This facility currently
carries an interest rate of 3.3% per annum. There are no borrowings outstanding
under this facility at April 30, 2020. Maximum availability under this facility
at April 30, 2020 was approximately $15.7 million. Our current credit facility
requires, and any future credit facilities may also require, that we comply with
specified financial covenants relating to fixed charge coverage ratio and limits
on capital expenditures and investments in foreign subsidiaries. Our ability to
satisfy these financial covenants can be affected by events beyond our control,
and we cannot guarantee that we will meet the requirements of these covenants.
These restrictive covenants could affect our financial and operational
flexibility or impede our ability to operate or expand our business. Default
under our credit facilities would allow the lenders to declare all amounts
outstanding to be immediately due and payable. Our primary lender, SunTrust
Bank
, has a security interest in substantially all of our US assets and pledges
of 65% of the equity of the Company's foreign subsidiaries. If our lender
declares amounts outstanding under the credit facility to be due, the lenders
could proceed against our assets. Any event of default, therefore, could have a
material adverse effect on our business. We are currently negotiating with
another prospective lender to provide a revolving credit facility agreement
which would replace the existing agreement with SunTrust.



The Company has experienced increased sales and order activity as a result of
the COVID-19 pandemic and may need to increase inventories in order to continue
to respond to this increased demand. Additionally, the Company may accelerate
investments in capacity expansion which may require significant capital
expenditures.



Stock Repurchase Program. On July 19, 2016, the Company's board of directors
approved a stock repurchase program under which the Company may repurchase up to
$2,500,000 of its outstanding common stock. During the three months ended April
30, 2020
, the Company repurchased no shares of stock. The Company has
repurchased 152,801 shares of stock under this program as of the date of this
filing which amounted to $1,671,188, inclusive of commissions.



Capital Expenditures. Our capital expenditures for first quarter of FY21 of $0.2
million
principally relate to capital purchases for our manufacturing facilities
in Mexico, Vietnam and India, and the enhancement of our global IT
infrastructure. We anticipate FY21 capital expenditures to be approximately $2.0
million
as we continue to deploy our ERP solution globally, invest in strategic
capacity expansion, and replace existing equipment in the normal course of
operations.



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