LAKE Lakeland Industries Inc

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

The following discussion and analysis should be read in conjunction with the historical financial statements and other financial information included elsewhere in this quarterly report on Form 10-Q. This Form 10-Q may contain certain forward-looking statements. When used in this Form 10-Q or in any other presentation, statements which are not historical in nature, including the words “anticipate,” “estimate,” “should,” “expect,” “believe,” “intend,” “project” and similar expressions, are intended to identify forward-looking statements. They also include statements containing a projection of sales, earnings or losses, capital expenditures, dividends, capital structure or other financial terms.

The forward-looking statements in this Form 10-Q are based upon our management’s beliefs, assumptions and expectations of our future operations and economic performance, taking into account the information currently available to us. These statements are not statements of fact. Forward-looking statements involve risks and uncertainties, some of which are not currently known to us that may cause our actual results, performance or financial condition to be materially different from the expectations of future results, performance or financial condition we express or imply in any forward-looking statements. Some of the important factors that could cause our actual results, performance or financial condition to differ materially from expectations are:

We believe these forward-looking statements are reasonable; however, you should not place undue reliance on any forward-looking statements, which are based on current expectations. Furthermore, forward-looking statements speak only as of the date they are made. We undertake no obligation to publicly update or revise any forward-looking statements after the date of this Form 10-Q, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Form 10-Q might not occur. We qualify any and all of our forward-looking statements entirely by these cautionary factors.

Overview

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 $18.4 million and $22.5 million for the three months ended April 30, 2021 and 2020, respectively.

Response to COVID-19 Outbreak

Our strategy for responding to the COVID-19 outbreak evolved from prior “black swan” events. These events have been very disruptive for the users of our products and contributed little in terms of sustainable business improvement or growth for the suppliers. Any gains attributable to these events were limited to short-term increases in sales volume and price increases associated with capacity expansion and expedited deliveries. In responding to COVID-19 Lakeland sought a new approach. We decided to focus on our existing business, adding new customers, and increasing market penetration by prioritizing service to our existing industrial end users and seeking new customers who were experiencing supply shortages. We decided to service the COVID-19 market to the extent that Lakeland had excess capacity after servicing existing and new industrial customers. We believe that focusing on the industrial market first and the pandemic market second, is a sound strategy for diminishing the impact of any post-event recession and loss of COVID-19 related sales while accelerating our growth by developing new, permanent business that will remain after the “black swan” event passes.

Our manufacturing flexibility allows us to rapidly shift capacity between product lines and alter our product offering so that we can maximize throughput of critical products.  In the case of COVID-19 we shifted our sewing capacity heavily to disposable and chemical garments; increased daily working hours; and ran a 7-day work week until market supply caught up with demand.  We rationalized our product offerings and eliminated SKUs that did not meet our profitability goals, did not create a competitive advantage or were detrimental to manufacturing efficiencies due to change over times.  Because we own our manufacturing facilities, Lakeland was able to make these changes within the first couple of months of the pandemic.

The last two weeks of FY20, all of FY21, and Q1 FY22 were impacted by our COVID-19 response strategy.  As the pandemic progressed in FY21, we saw reductions in industrial activity due to lockdowns and work restrictions that resulted in diminished sales into petrochemicals, the utility sector, and industrial segments like automotive and airlines.  Our second and third quarters of FY21 were the peak quarters for Personal Protective Equipment (PPE) pandemic sales.  In Q4FY21 we began to see a softening in demand for COVID-19 related sales, and a return of general industrial demand that continued into Q1 FY22.  As the COVID-19 pandemic wanes, demand for associated PPE is falling, but the decline is being offset in part by an increase in industrial activity and associated industrial demand for PPE.  COVID-19 related demand was estimated to be approximately 30% to 35% of FY21 revenue and accounted for an estimated 13% of Q1 FY22 sales.  As this demand continues to decrease, we anticipate a continuation of an increase in our industrial core businesses that began in Q2 FY21 and continued through Q1 FY22 with our sales also benefitting from repeat orders by new industrial customers that began using Lakeland during the pandemic. The negative impact of lock downs and stay at home orders peaked in Q2 FY21 with industrial business sales down by approximately 25%. Through the second half of Q2 FY21 and through Q1 FY22 our core business sales have been recovering steadily. At present, we anticipate our core industrial sales will not only return, but as a result of our focus on increased market penetration and new product offerings we believe revenues will attain levels higher than pre-pandemic revenue levels. 

We are not deviating from our growth strategy, rather we are looking to utilize the short-term, increased demand as a catalyst to accelerate attainment of growth objectives. The success of this strategy is clearly exemplified by our Q1 FY22 new customer order rate of approximately 68% of the more than 500 new customers we have developed.

Over the course of FY21, raw materials supply appears to have caught up with demand. Prices have declined, but remain above pre-COVID-19 pricing as we anticipated. We believe that raw materials prices will continue at inflated levels through FY22. Our future sales would be affected should there be an industry-wide shortage of necessary raw materials in the event of another rise or surge in COVID-19 cases. As previously noted, we did experience significant price increases for fabric during FY21 and managed our available manufacturing capacity to lower costs, and increased prices, to meet customer demand at these higher prices. With the exception of our India export manufacturing operation, which did not qualify for “essential status” due to its export only restrictions, and where a recent surge has led to government imposed lockdowns, we have not experienced any manufacturing capacity issues due to inability to source raw materials, government quarantine, or shelter-in-place orders, or due to COVID-19 outbreaks in any of our factories, however there can be no assurance that this will continue to be the case. While current economic indicators and industry data indicate a robust industrial market recovery, potential headwinds to revenue as we emerge from pandemic sales include the possibility of a recession and consumer stockpiled inventories that may temper demand within our regular markets in the second half of FY22.

Reference is made to “Risk Factors” in Part I, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended January 31, 2021 and to “Forward-Looking Statements” above in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”.  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 be continued demand for establishing PPE stockpiles for the long-term.  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 are expected to be released over the next several months. 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 segment as countries and states reopen and seek to prevent further infections.  More recently we are seeing increased demand related to COVID-19 surges in Vietnam and India.  For these reasons we are maximizing our manufacturing capacity in the near-term and evaluating expansion opportunities to allow us to further increase our industrial market penetration as our competitors abandon their industrial customers as they seek to maximize COVID-19 related sales. This strategy combined with new product development, manufacturing expansion, and the addition of key senior personnel also serves to  prepare us  for any economic slowdown that may occur as COVID-19 business ends and our industry transitions to a more traditional product mix.

Having successfully implemented the above strategy, as evidenced by significantly increased market penetration in international markets, the addition of new customers, and realizing efficiency gains that we intend to make permanent, we are now focused on adding human and IT resources required to accelerate our growth rate in a post-COVID-19 environment. We believe that we emerged from FY21 a full year ahead of our pre-COVID-19 growth plan, and we are committed to leveraging our position to accelerate growth in Critical Environment Markets such as pharmaceutical cleanrooms, isolation gowns, and Chemo-gowns; the Electric Utility Market; and to continue improving efficiencies by rationalizing our product offering in non-Covid product lines. To do this we will be acquiring additional senior and middle managers with specific skills in Sales and Marketing, Quality Control, Supply Chain Management, and Industrial Engineering. These personnel will facilitate future manufacturing expansion.by assuring that we have the skill sets necessary to meet our growth targets. In addition, we may pursue growth through acquistions.

Significant Balance Sheet Fluctuation April 30, 2021, Compared to January 31, 2021

Cash increased by $7.7 million, primarily as a result of continued profitability and improved accounts receivable collection efficiency. Accounts receivable decreased due to improved collections and lower sales compared to the previous quarter. Inventory increased less than $0.1 million. Accounts payable, accrued compensation, and other accrued expenses increased $0.1 million. Capital expenditures for the three months ended April 30, 2021 were $0.1 million.

Three Months ended April 30, 2021, Compared to the Three Months Ended April 30, 2020

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

Net Sales. Net sales were $34.1 million for the three months ended April 30, 2021 a decrease of $11.5 million or 25.2% compared to $45.6 million for the three months ended April 30, 2020, Sales of our disposable and chemical product line were impacted in the first quarter due to reduction in direct container sales that were COVID-19 driven demand. As noted, it is anticipated that COVID-19 demand will continue to diminish. Other product lines such as fire, high performance, and wovens, which are primarily used by industrial customers, increased during the period due to strengthening in those markets.

Gross Profit. Gross profit for the three months ended April 30, 2021 was $14.4 million, a decrease of $7.8 million, or 35.0%, compared to $22.1 million for the three months ended April 30, 2020. Gross profit as a percentage of net sales decreased to 42.2% for the three month period ended April 30, 2021, from 48.6% for the three months ended April 30, 2020. Major factors driving gross margins were:

Operating Expense.  Operating expenses decreased 17.3% from $9.8 million for the three months ended April 30, 2020 to $8.1 million for the three months ended April 30, 2021. Operating expenses as a percentage of net sales was 23.9% for the three months ended April 30, 2021, up from 21.4% for the three months ended April 30, 2020. Selling expenses were decreased, with decreases in sales compensation and commissions and freight out due to the decrease in sales. General and administrative expenses in total were essentially the same for each period which included a gain in currency fluctuations of $0.5 million in Q1 FY22 as compared to currency losses of $0.2 million in Q1 FY21.  This currency gain was offset by compensation costs and licensing and depreciation associated with our ERP investment.

Operating Profit. Operating profit declined to $6.2 million for the three months ended April 30, 2021 from $12.4 million for the three months ended April 30, 2020, due to the impacts detailed above. Operating margins were 18.3% for the three months ended April 30, 2021, as compared to 27.1% for the three months ended April 30, 2020.

Interest Expense. Interest expense decreased slightly to less than $0.01 million for the three months ended April 30, 2021 from $0.02 million for the three months ended April 30, 2020 as a result of reduced borrowings.

Income Tax Expense. Income tax expense consists of federal, state and foreign income taxes. Income tax expense was $1.6 million for the three months ended April 30, 2021, compared to $3.7 million for the three months ended April 30, 2020, due to the reduction in operating profit.

Net Income. Net income decreased by $4.0 million to $4.6 million for the three months ended April 30, 2021 from income of $8.6 million for the three months ended April 30, 2020.

Liquidity and Capital Resources

At April 30, 2021, cash and cash equivalents were approximately $60.3 million and working capital was approximately $112.7 million. Cash and cash equivalents increased $7.7 million and working capital increased $4.5 million from January 31, 2021, due to continued profitability and a focus on working capital efficiencies.

Of the Company’s total cash and cash equivalents of $60.3 million as of April 30, 2021, cash held in Latin America of $2.7 million, cash held in Russia and Kazakhstan of $0.7 million, cash held in the UK of $1.7 million, cash held in India of $1.2 million and cash held in Canada of $4.7 million would not be subject to additional US tax in the event such cash was repatriated 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 $26.6 million balance at April 30, 2021 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.

Net cash provided by operating activities of $8.3 million for the three months ended April 30, 2021 was primarily due to net income of $4.6 million, non-cash expenses of $1.1 million for deferred taxes, depreciation and amortization and stock compensation, and decrease in accounts receivable of $2.3 million. Net cash used in investing activities of $0.1 million for the quarter ended April 30, 2021 reflects equipment purchases. Net cash used in financing activities was $0.5 million for the quarter ended April 30, 2021, was due to shares returned to pay income taxes on shares vested under our restricted stock program.

We believe our current cash balance and cashflow from operations will be sufficient to satisfy our projected working capital and planned capital expenditures for the foreseeable future.

On June 25, 2020, we entered into a Loan Agreement (the “Loan Agreement”) with Bank of America (“Lender”). The Loan Agreement provides the Company with a secured $12.5 million revolving credit facility, which includes a $5.0 million letter of credit sub-facility. The Company may request from time to time an increase in the revolving credit loan commitment of up to $5.0 million (for a total commitment of up to $17.5 million). Borrowing pursuant to the revolving credit facility is subject to a borrowing base amount calculated as (a) 80% of eligible accounts receivable, as defined, plus (b) 50% of the value of acceptable inventory, as defined, minus (c) certain reserves as the Lender may establish for the amount of estimated exposure, as reasonably determined by the Lender from time to time, under certain interest rate swap contracts. The borrowing base limitation only applies during periods when the Company’s quarterly funded debt to EBITDA ratio, as defined, exceeds 2.00 to 1.00. The credit facility will mature on June 25, 2025. Borrowings under the revolving credit facility bear interest at a rate per annum equal to the sum of the LIBOR Daily Floating Rate (“LIBOR”), plus 125 basis points. LIBOR is subject to a floor of 100 basis points. All outstanding principal and unpaid accrued interest under the revolving credit facility is due and payable on the maturity date. On a one-time basis, and subject to there not existing an event of default, the Company may elect convert up to $5.0 million of the then outstanding principal of the revolving credit facility to a term loan facility with an assumed amortization of 15 years and the same interest rate and maturity date as the revolving credit facility. The Loan Agreement provides for an annual unused line of credit commitment fee, payable quarterly, of 0.25%, based on the difference between the total credit line commitment and the average daily amount of credit outstanding under the facility during the preceding quarter.

Stock Repurchase Program. On February 17, 2021, the Company’s board of directors approved a stock repurchase program under which the Company may repurchase up to $5,000,000 of its outstanding common stock. The new program replaces the prior program which had approximately $800,000 remaining for repurchases. There were no shares repurchased in Q1 FY22.

Capital Expenditures. Our capital expenditures for first three months of FY22 of $0.1 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 FY22 capital expenditures to be approximately $3.0 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.  The Company may also seek to expend funds in connection with acquisitions.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. A summary of our significant accounting policies is included in Note 1 to our consolidated financial statements in our fiscal year 2021 Annual Report. Certain of our accounting policies are considered critical, as these policies are the most important to the depiction of our financial statements and require significant, difficult or complex judgments, often employing the use of estimates about the effects of matters that are inherently uncertain. Such policies are summarized in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section in our 2021 Annual Report. There have been no significant changes in the application of our critical accounting policies during the Q1 FY2022.