Lakeland Industries Inc (LAKE) 2007 Q3 法說會逐字稿

Good afternoon. My name is Edwardo, and I will be your conference operator today. At this time, I would like to welcome everyone to the Lakeland Industries third quarter fiscal year 2006 results conference call. [OPERATOR INSTRUCTIONS]

Before we begin, parties are reminded that statements made during this call contain forward-looking information within the meaning of the Securities Act of 19 33 and the Securities Exchange Act of 1934. Forward-looking statements are all statements other than statements of historical facts which reflect management's expectations regarding future events and operating performance and speak only as of today, December 7, 2006. Forward-looking statements are based on current assumptions and analysis made by the Company in light of its experience and its perception of historical trends, [inaudible] conditions, expected future developments and other factors they believed are appropriate due to circumstances. These statements are subject to a number of assumptions, risks, and uncertainties, and factored in the Company's filings with the Security and Exchange Commission: General, economic, and business conditions; the business opportunities they may present to you and pursued by the Company; changes in law or regulations; and other factors, many of which are beyond the control of the Company.

Listeners are cautioned that these statements are not guarantees of future performance and the actual results or developments may differ materially from those projected in any forward-looking statements. All subsequent forward-looking statements attributal to the Company, or persons acting on its behalf, are expressly qualified in their entirety by these cautionary statements.

At this time I would like to introduce your host for this call, Lakeland Industries President and Chief Executive Officer, Christopher Ryan. Mr. Ryan, you may begin.

Thank you. Good evening, gentlemen. The last time we had this was three months ago and at that time I let everybody know that the third quarter was not going to be a particularly promising quarter. However, I also said that, after the third quarter was out, we would certainly improve our sales and earnings and that's what I think is going to happen. So to begin with, sales growth in our third quarter ended October 31, 2006, FY '07, which increased in a number of areas from last year, being Tyvek® disposables and international sales of $1.1 million, somewhat offset by a decrease in fire products and high-visibility clothing and domestic U.S. glove sales of $585,000. That leaves us with a 2.4% increase in sales in this quarter over last year. Chemical sales were flat due to a continuing lull in spending in our homeland security chemical suit business, which is highly dependent on federal, state and municipal spending patterns, which are quite difficult to predict.

The 2002 fire act grants have been consistently spent by fire departments since the first [accreants] were dispersed beginning in early 2003 on our chemical suit products. However, the spending decreased in the beginning of 2005, as pipelines filled and large portions of the new fire act cash grants were delayed in this calendar year. Nonetheless, we do expect replacement sales starting in 2007, as the suits have a shelf life of five years and some 25 million of these suits were sold between FY 2003 and 2005. [inaudible] prior purchases will be placed on a timely basis; However we do expect incremental sales in this area in calendar 2007, '08, and '09. However, the most significant shortfall in anticipated governmental spending comes from the bioterrorism act of 2002 grant and spending programs, which more money are largely still [inaudible] in state geographies. Our gross margins is decreased by 0.8% to 24.2% from 25% last year, mainly due to start-up costs in India, different mix of chemical suits which carry various margins and higher cost of raw materials for August and September, partially offset by the ongoing cost reduction programs in component and service purchasing and shipping production from the U.S. to China.

Sales of our Tyvek® disposable garments have firmed up, as the previous surplus of Tyvek® in the distribution channels has worked its way through the market. Tychem® chemical suit sales are flat as mentioned above, because government spending on these products has been down for the last six months. Unlike fashion apparel, our protective garments do not change in fabric content or parel -- or pattern style, and as mentioned before have a five-year shelf life. So obsolescence is not a risk factor in running down inventories. Our disposable inventory reduction is more of a timing challenge, and adjusting raw material buying and garment production to market demand, not obsolescence or write-down problem. The only negative is in interest carry cost on these higher inventory levels. Thus, we have adjusted downwardly our finished goods inventory from the July 2006 levels toward more normal levels with further reductions, planned throughout the next seven months in overall inventory levels.

Bank debt as of October 31, 2006 was $7.8 million, but as of today it's about $5 million. We're down some $2.9 million. This debt level includes the $3.4 million purchase price for India and a resumption of raw material purchasing in September. We expect these inventory levels to decrease markedly by the end of our second quarter ended July 31,2007. In addition, the decrease in gross margins we just discussed above, operating margins also decreased for the nine months and three months ended October 31, 2006, as clearly outlined by the lidie -- line items in the press release issued earlier today.

Looking to the future. We expect our fourth quarter gross margins to be significantly higher due to the gyrating costs of raw materials, as they float through our FIFO-based inventory. As lower cost raw materials aggressively purchased from March to June roll through our sales process, they should result in higher margins in the coming fourth quarter. So we are looking for a decent recovery in sales in the fourth quarter combined with better margins for the fourth quarter due to lower raw material costs. We believe that sales will firm up in FY '08 in all divisions. We expect that the growth on [Chemlan] will be squeezed somewhat, and what I mean by Chemlan is our high-end chemical suit division. They will be squeezed somewhat by competitive pressures and different sales mix. We expect the overall cost of raw materials will stabilize and soften with the softening oil prices in 2008 -- '07, or FY '08. The impact of the start-up costs should be lessened and the SG&A cost should hold steady.

Our long-term plans, which span the next three years, in which, in a large part are responsible for the current increased operating expenses, cannot be sacrificed for an obsession with this or next quarter's results. Many CEOs I talk with contend that they have no choice but to adopt a short-term orientation, given that the origin holding period for stocks and professionally managed funds has dropped from about seven years in the 1960's to less than a year today. They tell me, why consider the interest of long-term shareholders when there are none? We at Lakeland believe this reasoning is deeply flawed. What matters is not investor holding periods, but rather the market's valuation horizon; i.e., the number of years of expected cash flows required to justify the stock price.

While hedge funds may focus unduly or near term -- on near term goals and hold shares for a relatively short period of time, stock prices reflect the markets long view. We would suggest that it takes five to ten years of value-creating cash flows to justify the stock prices in most companies. Therefore, we feel our responsibility is to deliver those flows. That is, to perserve -- pursue long-term valuation, regardless of the mix of high and low turnover shareholders. We do not think that it is reasonable to argue that an absence of long-term shareholders gives management the license to maximize short-term performance and risk endangering the Company's future. Lakeland's competitive landscape, not the shareholder list should shape our business strategies. Our long-term value maxima -- maximization strategies include expanding our international sales line. This resulted in expense increases tied to opening new sales offices in Japan, Chile and, more importantly, the development of our new Indian glove manufacturing of $350,000 net of taxes in this quarter. Indeed the nonrecurring Indian expense alone cuts $0.07 in earnings off of EPS this third quarter.

Develop new project -- new proprietary products. The cost of $510,000 for the year-to-date nine months is reflected in the increase in sales salaries and commission expenses to support the introduction of these new lines over the next three years. The implementation of these long-term strategies is why we resist the temptation to manage earnings or give earnings guidance. What we seek to do and more importantly execute on is to make strategic long-term decisions that maximize long-term expected value, even at the expense of lowering near-term earnings.. This also means making acquisitions that maximize expected long-term value, even at the expense of lowering near-term earnings, the Indian glove acquisition and the international sales investments being the prime examples here.

As an example of similar international investments, we lost $552,000 in our British subsidiary over a three-year period at which point it turned profitable and has contributed $218,000 to earnings in the last nine months. Management expects such cash flows in the UK not only to continue, but more importantly to increase in the foreseeable future. Foreign sales offices take two to three years to mature and then sales and earnings growth is very rapid. The reason for this is that most customers are hesitant to do business with a start up. They want to see staying power. Their country's market acceptance of our products and trade name is where they buy. Once a reputation has been earned for quality, on-time delivery market acceptance, then and only then do the big customers jump on board. And we expect our fourth quarter earnings ending January 31, 2007 to improve significantly over this October 31, 2006 quarter, due to lower losses in India and stabilizing to lower raw material prices as we reap the benefit of our earlier aggressive buying, while the outlook for raw material prices is softened somewhat with the worldwide prices of oil.

As the Chinese R&D increases against the dollar, we have to look to other low wage countries with weaker currencies like India. Not only does such an investment diversify our labor and currency risks, but it also opens up new platforms to sell our products into the fastest growing large economies such as China and India. Another example of this is that we opened our Beijing sales office in the beginning of 2006 and aggregate sales today are $275,000, at above average margins. This performance, with an approximate $60,000 of start-up expenses, dictates that we will take on two new sales personnel in China -- in the China domestic market shortly. An investment in sales force proceeds actual sales growth. Increased sales just do not happen themselves, particularly in our industry, where end-users require a lot of hand holding and technical proof and support before switching to a new product. Although our stock has dipped and rallied countless times over the last 15 years, nonetheless long-term trend has been from approximately $0.50 a share 15 years ago to today's price, and our goal is to repeat that performance over the next ten to 15 years.

So with that, I'll turn it over to Gary Pokrassa, our CFO.

Thanks, Chris, and good afternoon, ladies and gentlemen. As you saw last quarter, we changed our conference call format. Rather than my reading off a history of our metrics and droning on, we have expanded our press release to include a detailed table of historic metrics by quarter. I hope everyone's had a chance to at least read through this history. Let me just emphasize that our aggressive materials purchasing will directly result in improved margins in our fourth quarter. The increased cost from the purchases in December through February rolled through cost of goods sold through about mid September. Since then, we have been benefiting from the recent round of discounted purchases, which have and are reducing our cost of goods sold from about mid September, and that should continue through the January year end. I anticipate that our overall effective tax rate will be about 30% for FY '08.

And with that we'll turn it over to questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Brian Butler of FBR. Please go ahead.

Good afternoon, Chris and Gary. How's it going?

Fine.

Good.

Question, just when you think about the swing that the raw inventory -- or raw material costs in the inventory has on margins, does this mean you get back kind of the same level you saw in the second quarter? I'm just trying to gauge in the magnitude of this swing. Without you guys putting in a specific number, is operating margins back to kind of that level reasonable? Or is it going to swing -- you know, the pendulum going to swing past that to a number higher than that?

Well, I think the pendulum still has a couple of swings left in it, Brian. What I would -- what I believe is that in Q4 it actually should swing to an even more favorable than just that quarter. Once we get past that, then we've got another couple humps. We've started a modest amount of purchasing at a somewhat higher price in September, which is why our loan balance went back up a little bit. It's since come down again. That was only a small amount. But that has to run its way through cost of goods sold, also. That amount will run through cost of goods sold sequentially after we run through the discounted amount. The discounted amount will last all the way through January and somewhere into mid February, depending on sales. Once we hit mid February, then the roller coaster goes up the hill again for about a month to a month and a half's worth of purchases, I guess, at a somewhat higher price. And then we should back down again. And going forward, we believe we have a way -- we believe we will rationalize our purchases with our major vendors so that when we get off this roller coaster, we should be more stabilized in terms of the level of purchasing and the pricing going forward. And it should stabilize somewhere about where that second quarter was, yes.

Okay.

But that would be -- that would be maybe towards the end of Q1 of FY '07 going forward from there. Call it Q2 of FY '07 forward it should stabilize at about that level. Probably to Q1 FY '09, literally, the stabilization.

Going forward, right?

Yes.

Yes.

So you get a stabilization essentially a little bit more than a year from now?

No, I'm saying it would last -- it's going to start in Q1 of this coming fiscal year.

Oh. Okay. This fiscal year. Okay.

In other words, just to be clear because this is really important that everybody understands is that we really are on a roller coaster here Just so everybody understands where we are going, we are now in a heavily discounted price period the way the FIFO costs roll through sequentially. Q4 should have extremely higher grosses due to lower raw material costs due to the heavy discount buying. That material, depending on sales, will last through -- certainly through the year end and partially into the month of February. Once we run through that, then sequentially we're back to a higher cost for about a month to six weeks worth of sales, all in Q1 of this coming year.

Okay.

Once we get past that, then the roller coaster should level out from that point forward for at least a good 12 months, you know, going forward from there. So Q1 of this upcoming year should have roller coasters up and down. And near the end of the -- maybe the last month of Q1 going forward from there for about 12 months, we should be stabilized about the level of Q2 of this past year.

Okay. And I guess when you go on the other part of the costs, kind of the international business, especially India and the SG&A costs associated with that, do those kind of flatten out in the fourth quarter? I mean at some point and beyond, I'm guessing that's the case. Or is there a possibility that the SG&A comes down a little bit?

Actually the SG&A in India, we have totally -- as you can see the press -- there was a press release we put out about two weeks I guess, which laid this out a bit in that we are totally revamping the deal with India. And we are proceeding with the same assets we were originally intending, but not the same principals. We are proceeding without the original principals on a different deal. And doing that has necessitated taking some write-offs that we originally thought would be part of the purchase price and taking some other write-offs in terms of some receivables we have with these principals -- from these principals, which we're going to have to work some to collect, due to the nature of this relationship. We all decided it was in our interest not to proceed with these individuals and to -- but we did want the assets and we're proceeding with those assets.

Okay. So you took those write-offs in this quarter?

Correct.

Okay, and that ran through -- okay. And then last question, just you'd focused on talking about the long-term outlook as being the -- kind of the more important focus, which I don't disagree with. Can you give me a sense of, when you look out over the five-year period, what's kind of the numbers in your mind when you look at what reasonable growth is, what margins could be or are you expecting that you might get to over a longer period of time, and what kind of capital spending is required to do that?

Okay. I gave one example of our British subsidiary. We invested roughly $550,000 in it.

In operating losses.

Yes, in operating losses and it returned about $220,000 in the last nine months. What we see there is a company that will probably grow in sales at about 20T to 30%, probably, simply because once they get established in the marketplace, people trust them more. We're at the beginning of the start-up in Chile. Although we were pleased -- I mean, Chile is really only been open for six months and I think they did $235,000 in sales last quarter as a total start-up and I think they came close to break even. What generally occurs is you see these small sales of $200,000 or $300,000 as a start-up. But then they can generate and go to $1 million, one year, $2 million the next, $3 million, $4 million, $5 million,, almost on a yearly basis. And so we're looking out three to five years, you know, we can see a $5 million sales subsidiary in South America, UK, China, and other areas of the world, like India. And they are coming in at above-average gross margins than the U.S.

You know, our perception of the U.S. market is that it's flattened in terms of sales, and there's not going to be a lot of growth left here in North America. So we have to reach out to the, you know, the economies, they are expanding at 9% or 10% and that are for the first time initiating their own OSHA-type laws. This is where the real growth is and this is where the margins are. In terms of say three years, what I can see is on international sales being $9 million to $15 million higher than they are today. And they're probably -- they're currently coming in at about 25% gross margins in the UK, higher in South America, and higher in China. So, you know, we're looking for margin and sales improvement. But it's really over the next three years. I mean our Canadian subsidiary is a good example. Canada's not truly a big market, with only 18 million people, but it's running at about $8 million in sales today. And when you look at Asia and Europe, those markets are ten times that size.

And when you think the capital requirements associated with that over the next three years?

Capital requirements -- it's not really capital intensive in the sense that there's no heavy equipment required. When we start out, we can just rent a facility. In Canada we're now finally building our own facility, a warehouse and distribution center for $2 million. But that's -- Canada's been open how long, Chris?

Seven years.

And as Chris said it's now doing $8 million U.S. a year in sales. The investment really is in receivables and inventory and working capital. and some operating losses during the start-up periods. It's really not -- what we experienced with India is a different animal. That's not a sales office, as Chris is discussing here. That's a glove factory or manufacturer, which has very different characteristics.

Yes, this is a company with fairly expensive glove-making equipment that we essentially are buying in bankruptcy. To replace this equipment new would probably cost $12 million to $15 million and we're buying it at about $3.4 million. We don't have much of an existing sales here. We need to invest $200,000 to $300,000 in equipment to get it up to speed in terms of quality. But it is a bi -- t is is the big capital investment, but it also will serve as a platform for a new sales office next year for the Indian domestic economy with all of our products. But this is the last big capital investment we see, other than an acquisition in the future.

Okay. And that would drive -- that would drive additional debt. Indian operation should drive additional growth beyond that $9 million to $15 million you talked about over the three years?

Yes, this is a very big market worldwide. Just the products this factory makes presently it's a $1 billion market. In the United States it's a $300 million market. It's much bigger than the markets -- for instance, our Tyvek® markets are much smaller than this particular glove market. So we don't think it should be a big problem to get to break even on this Indian glove division because it really only requires about $2 million in sales to get to break even. And being a manufacturing operation that's fairly automated, it's like knocking out widgets. Once you get past break even, the profits go up substantially and rather quickly.

Okay. Great. Thank you very much.

Thank you. [OPERATOR INSTRUCTIONS] Our next question comes from [Alan Capman], private investor. Please go ahead.

Yes. Hi. Can you say anything more about the drop in sales of gloves in the quarter?

It's really, I think, economy oriented. General motors, Ford, and Chrysler are having their problems. And some of our sales in to those customers ar -- essentially to those customers have dropped off. They are laying off people. They are not buying. When they want to buy, they want prices below cost. It's going to take some time for the market to even out there.

Do you have sales to like Toyota and their suppliers and so on?

We have sales into Honda, and I guess our losses are coming from Ford.

Okay. And as far as Michelin, what what was going on there? I mean, some of their sales are fire related, but any thing else you can say about the drop in sales there, in Michelin balance?

I think it's probably more related to the fact that it's a time when we're digesting and when we're working on integrating them into our corporate products. We're just putting, I think [inaudible] just went out recently, we're getting the distribution channels organized. They had their own distribution. Much of them sold directly. So it's taking some time to integrate it, probably a little longer than we thought. And in the meantime -- and we -- the sales manager, rather than selling himself went around training some distributors. That took some time away. We think that's just the blip and that will rebound.

In other words you're substituting your distributors for theirs?

Well, we're integrating them --

Yes, we're integrating our sales force into their sales force. They historically had sold a lot of product to end users at very high margins. We want to have them keep that business, but on the other hand what we're just beginning to set up now is to bring in Chinese -- their products made in China, but sold in large volume to big distributors at lower margins, but incremental dollar profits should increase once we do that. But there's a movement from basically training salesmen and moving into a [distrin] type of distributor. So we're basically getting going with U.S. product at lower margins, which will then be replaced by Chinese product at a much lower cost and, therefore, get the margins back up.

Okay. Thank you.

Thank you. [OPERATOR INSTRUCTIONS] Your next question comes from Matthew Miller of [inaudible]. Please go ahead.

[Shanaclear Holdings]. No problem there. Good afternoon, gentlemen. I wonder if you might be able to talk about the competitive landscape in some of those new markets that you're in; India, Chile, Japan? What's the nature of those relationships? Are you facing incumbents there, multi-national? What does that landscape look like?

Well, in India we're making a line of gloves that we will primarily sell in the United States, but we do have South American and European customers. In essence, it'll be sold worldwide. The major players on this line are Ansel Edmont, which is an Australian public company. They're doing about $300 million in this product line. I suppose the next biggest player is [Mapa], which is a French company. They sell internationally, they're probably doing about $200 million in this product line. The next, I think is Best, which is a U.S. company, doing about $95 million in this product line. The list goes on and on. It's a -- worldwide it's about $1 billion market.

But those are who we are competing against. And therefore, I don't think it will be all that difficult to take $2 million of business to get to break even this year. Out of these large players. many of them very large players in the United States. The United States is the biggest market. Most of our current distributors who buy Tyvek® are buyers of these gloves. Indeed, one out of every three people who buy our Tyvek® garments buy these [nitrial] gloves, so it's almost a natural combined sale. And we hope to bundle them in shipments -- to bundle these gloves with the Tyvek® to our customers and in some cases, by a bundling operation they can get freight free because they can buy enough gloves and enough Tyvek® garments to take advantage of our freight-free policy, whereas if they were just buying Tyvek® they couldn't do it.

It's a minimum size dollar order for the freight free --

Is the Chilean market there more of a sales office there? Are you facing incumbents there, local incumbents or --?

The local incumbents are, again, the large multi-nationals --

Okay, all right.

In garments, it's Dupont. In gloves, it's Ansel and Mapa. Pretty much the -- some of the same competitors. However, you've got different markets there. You've got the Indian PAC, you're bot the [mercasore] markets. We see, quite frankly, a lot of the larger companies are not servicing their customers very well. Very slow deliveries. We feel that we can, you know, overcome that. We -- most of the product that Argentina -- I mean Chile is selling is coming out of China. Chile only has a 6% duty on almost all of our products coming in from China. That duty goes to 3% in '07 and 0% in '08, so we see a lot of opportunities in South America. Brazil's the biggest market, We recently hired a sales person in Brazil, so we're starting there but -- What were the sales? About $235,000 last quarter?

For the quarter, yes.

For the quarter, so they're almost running at $1 million right now, and this is after six months.

All right. Appreciate it. Thanks, guys.

[OPERATOR INSTRUCTIONS] Thank you, sir. At this time there appear to be no further questions.

Okay. Thank you, gentlemen. We'll finish the speech right here.

Good evening and good night.

Thank you. This concludes today's Lakeland Industries conference call. You may now disconnect and have a wonderful day.

Thank you.