UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark one)
For the quarterly period ended July 31, 2014
OR
For the transition period from _______________ to _______________
Commission File Number: 0-15535
LAKELAND INDUSTRIES, INC.
(Exact name of Registrant as specified in its charter)
(631) 981-9700
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes xNo ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yesx No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a nonaccelerated filer or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12-b-2 of the Exchange Act. Check one.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12-b-2 of the Exchange Act). Yes ¨No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
AND SUBSIDIARIES
The following information of the Registrant and its subsidiaries is submitted herewith:
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Introduction
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
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.
LAKELAND INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three and Six Months Ended July 31, 2014 and 2013
The accompanying notes are an integral part of these condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
CONDENSED CONSOLIDATED BALANCE SHEETS
July 31, 2014 and January 31, 2014
Preferred stock, $.01 par; authorized 1,500,000 shares
(none issued)
Common stock, $.01 par; authorized 10,000,000 shares,
issued 5,717,122 and 5,713,180; outstanding 5,360,681 and 5,356,739 at July 31, 2014 and January 31, 2014, respectively
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Six Months Ended July 31, 2014
Additional
Paid-in
Retained
Earnings
(Accumulated
Accumulated
Other
Comprehensive
Total
Stockholders’
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended July 31, 2014 and 2013
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Lakeland Industries, Inc. and Subsidiaries (the "Company"), a Delaware corporation organized in April 1982, manufactures and sells a comprehensive line of safety garments and accessories for the industrial protective clothing and homeland security markets. The principal market for our products is the United States. No customer accounted for more than 10% of net sales during the six-month periods ended July 31, 2014 and 2013.
The condensed consolidated financial statements included herein have been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission, and reflect all adjustments (consisting of only normal and recurring adjustments) which are, in the opinion of management, necessary to present fairly the condensed consolidated financial information required therein. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) have been condensed or omitted pursuant to such rules and regulations. While we believe that the disclosures are adequate to make the information presented not misleading, it is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K and Forms 10-K/A filed with the Securities and Exchange Commission for the fiscal year ended January 31, 2014.
Our consolidated financial statements have been prepared using the accrual method of accounting in accordance with US GAAP.
The results of operations for the three and six-month periods ended July 31, 2014 are not necessarily indicative of the results to be expected for the full year.
In this Form 10-Q, (a) “FY” means fiscal year; thus, for example, FY15 refers to the fiscal year ending January 31, 2015 and (b) “Q” refers to quarter; thus, for example, Q2 FY15 refers to the second quarter of the fiscal year ending January 31, 2015 (c) “Balance Sheet” refers to the condensed consolidated balance sheet.
The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Inventories consist of the following:
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 market.
Basic earnings per share is calculated by dividing net (loss) income available to common stockholders by the weighted average number of common shares outstanding without consideration of common stock equivalents, but including contingently issuable shares. Diluted earnings per share are based on the weighted average number of common and common stock equivalents, that are not deemed anti-dilutive. The diluted earnings per share calculation takes into account the shares that may be issued upon exercise of stock options, or warrants reduced by the shares that may be repurchased with the funds received from their exercise, based on the average price during the period.
The following table sets forth the computation of basic and diluted earnings (loss) per share at July 31, 2014 and 2013.
Not included in the above are the potential shares issuable for interest on the subordinated debt. As of July 31, 2014, there was accrued $485,982 of payment in kind (“PIK”) interest. At the closing stock price per share on July 31, 2014 of $6.15 this would represent approximately 79,021 shares. Such shares would be antidilutive and as such are not included.
On June 28, 2013, Lakeland Industries, Inc. and its wholly-owned subsidiary, Lakeland Protective Wear Inc. (collectively with the Company, the “Borrowers”), entered into a Loan and Security Agreement (the “Senior Loan Agreement”) with AloStar Business Credit, a division of AloStar Bank of Commerce (the “Senior Lender”). The Senior Loan Agreement provides the Borrowers with a three-year $15 million revolving line of credit, at a variable interest rate based on LIBOR, with a first priority lien on substantially all of the United States and Canada assets of the Company, except for the Canadian warehouse and the Mexican facility.
On June 28, 2013, the Borrowers also entered into a Loan and Security Agreement (the “Subordinated Loan Agreement”) with LKL Investments, LLC, an affiliate of Arenal Capital, a private equity fund (the “Junior Lender”). The Subordinated Loan Agreement provides for a $3.5 million term loan to be made to the Borrowers with a second priority lien on substantially all of the assets of the Company in the United States and Canada, except for the Canadian warehouse and except for a first lien on the Company’s Mexican facility. Pursuant to the Subordinated Loan Agreement, among other things, Borrowers issued to the Junior Lender a five-year term loan promissory note (the “Note”). At the election of the Junior Lender, interest under the Note may be paid in cash, by PIK in additional notes or payable in shares of common stock (“Common Stock”), of the Company (the “Interest Shares”). If shares of Common Stock are used to make interest payments on the Note, the number of Interest Shares will be based upon 100% of an average of the then current market value of the Common Stock, subject to the limitations set forth in the Subordinated Loan Agreement. The Junior Lender also, in connection with this transaction, received a common stock purchase warrant (the “Warrant”) to purchase up to 566,015 shares of Common Stock (subject to adjustment), representing beneficial ownership of approximately 9.58% of the outstanding Common Stock of the Company, as of the closing of the transactions contemplated by the Subordinated Loan Agreement. The Company’s receipt of gross proceeds of $3.5 million (before original issue discount of $2.2 million related to the associated warrant) in subordinated debt financing was a condition precedent set by the Senior Lender, of which this transaction satisfied.
The proceeds from such financings have been used to fully repay the Company’s former financing facility with TD Bank, N.A. in the amount of approximately US $13.7 million. Also repaid upon closing of the financings was the warehouse loan in Canada with a balance of CDN $1,362,000 Canadian dollars (approximately US $1,320,000), payable to Business Development Bank of Canada (“BDC”).
The following is a summary of the material terms of the financings:
$15 million Senior Credit Facility
On July 31, 2014, there was $1.6 million available under the senior credit facility
$3.5 million Subordinated Debt Financing
The Company recorded the debt and warrants using the relative fair value method, in which there was a debt discount recorded at the date the transaction of approximately $2.2 million recorded as a component of additional paid-in capital. This has been treated as Original Issue Discount (OID) and is being amortized as additional interest over the five-year term of the related subordinated debt. Including the 12% coupon and the amortization of the OID gives an effective per annum rate on just the debt of approximately 47%, assuming the warrant is broken out separately. However, management views this to be one blended loan or transaction along with the Senior Debt of up to $15 million at 6.25%, since the subordinated debt was a required condition of closing made by the Senior Lender.
Amounts outstanding as of July 31, 2014, under the Senior Lender Facility were $13.4 million and under the Junior Lender Facility, $1.7 million net of unamortized original issue discount of $1.8 million plus PIK interest of $0.5 million and net of $0.5 million prepayment, for a net value of $1.7 million included in the subordinated debt on the balance sheet.
Borrowings in UK
On December 19, 2013 the Company and its UK subsidiary entered into a one-year extension of its existing financing facility with HSBC Invoice Finance (UK) Ltd., pursuant to the same terms as disclosed in the Company's Form 8-K filed with the SEC on February 25, 2013, except for: the facility limit was increased from £1,000,000 (approximately US $1.6 million) to £1,250,000 (approximately US $2.1 million at current exchange rates), and the prepayment percentage (advance rate) was increased from 80% to 85% of eligible receivables; more fully described in the Company’s Form 8-K which was filed on December 23, 2013. The balance outstanding under this facility at July 31, 2014 was the equivalent of US $1.5 million and is included in short-term borrowings on the balance sheet. The per annum interest rate repayment rate is 3.44% and the term is for a minimum period of one year renewable on December 19, 2014. Interest charged to expense from this loan was approximately $19,000 for the six-months ended July 31, 2014.
Canada Loan
In September 2013 the Company refinanced its loan with the Development Bank of Canada (BDC) for a principal amount of approximately US $1.1 million. Such loan is for a term of 240 months at a per annum interest rate of 6.45% with fixed monthly payments of approximately US $7,620 (C$8,169) including principal and interest. It is collateralized by a mortgage on the Company's warehouse in Brantford, Ontario. The amount outstanding at July 31, 2014 is US $1.0 million which is included in long-term portion of Canada and Brazil loan on the balance sheet, net of current maturities of $50,000.
China Loan
On August 12, 2013, the Company’s China subsidiary borrowed approximately US $0.8 million at an interest rate of 5.395% for a term of one year as more fully described in the Company’s Form 8-K which was filed on August 16, 2013. The balance under this loan outstanding at July 31, 2014 was $0.8 million and is included in short-term borrowings on the consolidated balance sheet. Such amounts matured August 2014 and were repaid August 4, 2014.
On March 27, 2014, the Company’s China subsidiary, Weifang Lakeland Safety Products Co., Ltd (“WF”), and Weifang Rural Credit Cooperative Bank (“WRCCB”) completed an agreement to obtain a line of credit for financing in the amount RMB 8,000,000 (approximately USD $1.3 million), with interest at 120% of the benchmark rate supplied by WRCCB (which is currently 5.6%). The effective per annum interest rate is currently 6.72%. The loan is collateralized by inventory owned by WF. WRCCB had hired a professional firm to supervise WF’s inventory flow, which WF paid RMB 40,000 (approximately US $6,450). The balance under this loan outstanding at July 31, 2014 was RMB 8,000,000 (approximately USD $1.3 million) and is included in short-term borrowings on the consolidated balance sheet. There are no covenant requirements in this loan. The loans are comprised of several loans with dues dates ranging from June 18, 2014 to January 11, 2016.
Brazil Loans
Six-Months Ended
July 31, 2014
No supplier accounted for more than 10% of cost of sales during the six-month period ended July 31, 2014.
The Company has three main share-based payment plans: The Nonemployee Directors Option Plan (the “Directors Plan”) (expired in 2012) and two Restricted Stock Plans (the “2009 Equity Plan” and the “2012 Equity Plan”). Both the 2009 Equity Plan and the 2012 Equity Plan have identical structures. The below table summarizes the main provisions of each of these plans:
The following table represents our stock options granted, exercised and forfeited during the six-months ended July 31, 2014.
Number
of Shares
Weighted
Average
Exercise
Price per
Share
Remaining
Contractual
Term
Aggregate
Intrinsic
Value
There were no exercises or forfeitures during the six-months ended July 31, 2014.
Restricted Stock Plan and Performance Equity Plan
On June 17, 2009, the stockholders of the Company approved the 2009 Equity Plan. A total of 253,000 shares of restricted stock were authorized under this plan. On June 20, 2012, the stockholders of the Company authorized 310,000 shares under the 2012 Equity Plan. Under these restricted stock plans, eligible employees and directors are awarded performance-based restricted shares of the Company common stock. The amount recorded as expense for the performance-based grants of restricted stock are based upon an estimate made at the end of each reporting period as to the most probable outcome of this plan at the end of the three-year performance period (e.g., baseline, maximum or zero). In addition to the grants with vesting based solely on performance, certain awards pursuant to the plan have a time-based vesting requirement, under which awards vest from two to three years after grant issuance, subject to continuous employment and certain other conditions. Restricted stock has voting rights, and the underlying shares are not considered to be issued and outstanding until vested.
Under the 2009 Equity Incentive Plan, the Company has issued 180,859 fully vested shares as of July 31, 2014. The Company has granted up to a maximum of 2,000 restricted stock awards remaining unvested as of July 31, 2014 with each award having a weighted average grant date fair value of $7.85. The Company recognizes expense related to performance-based awards over the requisite service period using the straight-line attribution method based on the outcome that is probable.
Under the 2012 Equity Plan, the Company has issued 2,172 fully vested shares as of July 31, 2014. The Company has granted 273,759 restricted stock awards as of July 31, 2014, assuming all maximum awards are achieved. All of these restricted stock awards are nonvested at July 31, 2014 (216,259 shares at “baseline”), and have a weighted average grant date fair value of $6.00. The Company recognizes expense related to performance-based awards over the requisite service period using the straight-line attribution method based on the outcome that is probable.
As of July 31, 2014, unrecognized stock-based compensation expense related to restricted stock awards totaled $502 pursuant to the 2009 Equity Incentive Plan and $1,322,683 pursuant to the 2012 Equity Incentive Plan, before income taxes, based on the maximum performance award level, less what has been charged to expense, which was set to zero on a cumulative basis through July 31, 2014. Such unrecognized stock-based compensation expense related to restricted stock awards totaled $502 for the 2009 Equity Incentive Plan and $952,383 for the 2012 Equity Incentive Plan at the baseline performance level. The cost of these nonvested awards is expected to be recognized over a weighted-average period of three years. The Board has estimated its current performance level to be at zero, and accordingly no expense has been recorded. The performance-based awards are not considered stock equivalents for earnings per share (“EPS”) calculation purposes.
Stock-Based Compensation
The Company recognized total stock-based compensation costs of $49,708 and $158,788 for the six-months ended July 31, 2014 and 2013, respectively, of which $20,204 and $10,790 result from the 2009 Equity Plan and $29,503 and $147,998 result from the 2012 Equity Plan for the periods ended July 31, 2014 and 2013, respectively, and $0 and $0, respectively, from the Director Option Plan. These amounts are reflected in selling, general and administrative expenses. The total income tax benefit recognized for stock-based compensation arrangements was $17,895 and $57,164 for the years ended July 31, 2014 and 2013, respectively.
9. Segment Data
We manage our operations by evaluating each of our geographic locations. Our North American operations include our facilities in Alabama (primarily the distribution to customers of the bulk of our products and manufacturing of our chemical suit and fire protective products), and Mexico (primarily disposable, glove, chemical suit, woven, and high visibility production). We also maintain two manufacturing companies in China (primarily disposable, chemical and woven suit production), a wovens manufacturing facility in Brazil and a small manufacturing facility in Argentina. We evaluate the performance of these entities based on operating profit, which is defined as income before income taxes, interest expense and other income and expenses. We have sales forces in Canada, Europe, Latin America, India, Russia, Kazakhstan and China, which sell and distribute products shipped from the United States, Mexico, Brazil or China. The table below represents information about reported segments for the periods noted therein:
Three Months Ended
July 31,
(in millions of dollars)
Six Months Ended
January 31, 2014
Income Tax Audits
The Company is subject to US federal income tax, as well as income tax in multiple US state and local jurisdictions and a number of foreign jurisdictions. The Company’s federal income tax returns for the fiscal years ended January 31, 2003, 2004, 2005 and 2007 have been audited by the Internal Revenue Service (“IRS”). The Company has received a final “No Change Letter” from the IRS for FY07 dated August 20, 2009. The Company has received notice from the IRS on March 21, 2011, that it will shortly commence an audit for the FY09 tax return. There have been no further communications from the IRS since.
Our three major foreign tax jurisdictions are China, Canada and Brazil. Chinese tax authorities have performed limited reviews on all Chinese subsidiaries as of tax years 2008, 2009, 2010, 2011, 2012, and 2013 with no significant issues noted. We believe our tax positions are reasonably stated as of July 31, 2014. On May 9, 2013, Weifang Lakeland Safety Products Co., Ltd., one of our Chinese operations, was notified by the local tax authority that it would conduct an audit on transfer pricing. After communication with the tax authority, we paid RMB50,000 additional income tax to the tax bureau, and the audit was closed.
Lakeland Protective Wear, Inc., our Canadian subsidiary, follows Canada tax regulatory framework recording its tax expense and tax deferred assets or liabilities. As of this statement filing date, we believe the Lakeland Protective Wear, Inc.’s tax situation is reasonably stated in accordance with accounting principles generally accepted in the United States of America, and we do not anticipate future tax liability.
The Company’s Brazilian subsidiary is currently under a tax audit, which raised some issues regarding the tax impact related to the merger in 2008 and the goodwill resulting from the structure which was set up at the Company's Brazilian counsel's suggestion. This structure is relatively common in acquisitions of Brazilian operations made by non-Brazilian companies. In general, acquisitions with this structure have survived challenge by the taxing authorities in Brazil. The cumulative amount of tax benefits recognized on the Company’s books through July 31, 2014, resulting from the tax deduction of the goodwill amortization, is now zero, net of the deferred tax valuation reserve. This results from the goodwill on the Brazilian books which, for Brazilian tax purposes, is eligible for tax write-off over a five-year period dating from November 2008. The Company’s Brazilian subsidiary has received notice from the Brazilian tax authorities of a claim totaling approximately US $1.0 million (R$ 2,265,728) consisting of tax of approximately US $127,000 (R$ 280,416) and the remainder in interest and penalty. Management believes it is probable it will ultimately prevail in this claim and as such no provision has been recorded.
Except in Canada and partially in China, it is our practice and intention to reinvest the earnings of our non-US subsidiaries in their operations. As of July 31, 2014, the Company had not made a provision for US or additional foreign withholding taxes on approximately $17.0 million of the excess of the amount for financial reporting over the tax basis of investments in foreign subsidiaries that are essentially permanent in duration. Generally, such amounts become subject to US taxation upon remittance of dividends and under certain other circumstances. If theses earnings were repatriated to the US, the deferred tax liability associated with these temporary differences would be approximately $3.0 million at July 31, 2014.
In China, a dividend of $1.3 million was declared and paid in July from Weifang Lakeland Safety Products Co., Ltd. (“Weifang”) and in August a dividend of $450,000 was declared from Weifang Meiyang Protective Products Co., Ltd. (“Meiyang”). The Lakeland Board of Directors has instituted a plan to pay annual dividends of $1.0 million from Weifang’s future profits and 33% of Meiyang’s future profits starting in the next fiscal year. All other retained earnings will be reinvested indefinitely.
Change in Accounting Estimate/Valuation Allowance
We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. In making such determination, we considered all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations. The valuation allowance was zero at July 31, 2014 and January 31, 2014.
Income Tax Expense
Income tax expenses consist of federal, state and foreign income taxes. Income tax expenses were $0.7 million for the three months ended July 31, 2014, as compared to an income tax benefit of $3.6 million for the three months ended July 31, 2013. Income taxes included a non-cash charge of $325,000 for the dividend paid by Weifang to the US in July 2014 and further reflect $200,000 of non-cash charges in fiscal 2015 for additional US taxes on UK and Canada income. The income tax benefit for the fiscal 2013 period resulted from the reversal of a $4.5 million valuation allowance relating to a going concern deferred tax entry recorded in FY13 which was resolved when US financing was secured on June 28, 2013.
The Company is exposed to foreign currency risk. In the third quarter of FY14, the Company established a foreign exchange facility with Wells Fargo Bank, N.A. Such contracts are largely timed to expire with the last day of the fiscal quarter, with a new contract purchased on the first day of the following quarter, to match the operating cycle of the Company. The Company has continued its currency hedging in China. We designated the forward contracts as derivatives but not as hedging instruments, with loss and gain recognized in current earnings. In the six-months ended July 31, 2014, the Company sustained a loss on foreign exchange in China of $16,929 included in operating expenses on the accompanying statement of operations.
The Company accounts for its foreign exchange derivative instruments by recognizing all derivatives as either assets or liabilities at fair value, which may result in additional volatility in both current period earnings and other comprehensive income as a result of recording recognized and unrecognized gains and losses from changes in the fair value of derivative instruments.
We have two types of derivatives to manage the risk of foreign currency fluctuations. We enter into forward contracts with financial institutions to manage our currency exposure related to net assets and liabilities denominated in foreign currencies. Those forward contract derivatives, not designated as hedging instruments, are generally settled quarterly. Gain and loss on those forward contracts are included in current earnings. There were no outstanding forward contracts at July 31, 2014 or 2013.
We enter into cash flow hedge contracts with financial institutions to manage our currency exposure on future cash payments denominated in foreign currencies. The effective portion of gain or loss on cash flow hedges is reported as a component of accumulated other comprehensive income. The notional amount of these contracts was $3.6 million and $0.0 million at July 31, 2014 and 2013, respectively. The corresponding asset and income which is recorded in other comprehensive income is immaterial to the consolidated financial statements at July 31, 2014 and 2013.
Please see footnote 10 of the Company’s Annual Report on Form 10-K for the year ended January 31, 2014 for a more detailed discussion.
The Bahia state tax auditors filed several claims for VAT taxes. The claims assert that the state VAT taxes are owed to the state of domicile of the ultimate importer/user and disregarded the fact that the VAT taxes had already been paid to the neighboring state.
Once the arrangement with the Bahia State Tax Department is completed, the formal judicial process could take from 5 to 10 years. The Company believes there is a strong likelihood that another amnesty would be offered by the state prior to such completion.
The Company has accepted amnesty for a smaller claim which will result in 8 monthly payments of about US $19,000 (R$ 42,000 ) which reflects abatement of 80% of penalty and interest. An accrual of US $153,000 has been charged to expense in Q4FY14 and US $82,000 (R$ 189,000) is included in Other Accrued Expenses on the consolidated balance sheet as of July 31, 2014.
In December 2013, the Company learned of a different VAT tax claimed by the State of Sao Paulo for a tax in the amount of approximately US $45,000 and the total claim including interest and penalty totaling approximately US $200,000. In July 2014 management settled this claim for an amount of US $75,000 (R$ 172,000) net present value which will be paid in 120 monthly installments of R$ 4,500 fixed with no interest or monetary depreciation. An amount of US $75,000 (R$ 172,000) has been charged to expense in Q2FY14.
A table summarizing all four different VAT claims remaining open and their status is listed below:
Approximate
for Totals
The R$ 6,209,836 for the larger VAT claim is intended to be paid into the next amnesty and as such is included on the condensed consolidated balance sheet as a long-term liability of US $3,328,478 as of July 31, 2014.
Lakeland Industries, Inc. and its wholly-owned subsidiary, Lakeland Brasil S.A. (“Lakeland Brasil” and together with Lakeland Industries, Inc., “Lakeland”) were parties to an arbitration proceeding in Brazil involving Lakeland and two former officers (the “former officers”) of Lakeland Brasil. On May 8, 2012, Lakeland received notice of an arbitral award in favor of the former officers.
On September 11, 2012, Lakeland and the former officers entered into a settlement agreement (“Settlement Agreement”) which fully and finally resolved all alleged outstanding claims against Lakeland which are settled through the arbitration proceeding. Pursuant to the Settlement Agreement, the Company agreed to a payment schedule to the former officers with a balance remaining as of July 31, 2014 of $4.5 million in US dollars consisting of 18 consecutive quarterly installments of US $250,000 ending on December 31, 2018. Lakeland is current with all obligations pursuant to the Settlement Agreement. There is no interest payable. This amount is shown on the accompanying consolidated balance sheet as $1,000,000 current maturity of arbitration settlement and $3,336,487 long-term portion ($163,513 of imputed interest).
In addition, pursuant to the Settlement Agreement, as additional security for payment of the Settlement Amount, Lakeland Brasil agreed to grant the former officers a second mortgage interest on certain of its property in Brazil, which mortgage is expressly behind the lien securing the payment of tax debts to a state within Brazil related to certain notices of tax assessment on such property. Lakeland also agreed to become a co-obligor, in lieu of a guarantor, for payment of the Settlement Amount.
There was no change in the carrying amount of goodwill during Q2 fiscal year 2015.
The Company considers the applicability and impact of all accounting standards updates (ASUs). No recent accounting pronouncement is expected to have a material impact on the consolidated financial statements.
From time to time, we are a party to litigation arising in the ordinary course of our business. Other than the proceedings related to the VAT tax issue described in Note 12 to the condensed consolidated financial statements, we are not currently a party to any litigation or other legal proceedings that we believe could reasonably be expected to have a material adverse effect on our results of operations, financial condition or cash flows.
On June 26, 2014, Lakeland Brazil S.A. (“Lakeland Brazil”), a wholly-owned subsidiary of Lakeland Industries Inc. (the “Company”), received notice of a court judgment entered against it in a labor proceeding in Brazil in the amount of approximately US $1,086,000. Based on the advice of Brazilian counsel handling the action, the Company had not anticipated a judgment to be entered against Lakeland Brazil in this proceeding, if at all, in excess of US $45,000 (R$ 100,000), which amount was deemed not material and therefore not previously disclosed.
Lakeland Brazil is working with, and relying upon the advice of, new legal counsel and accountants in Brazil and intends to appeal the judgment on the basis that, among other things, the judgment is mathematically incorrect.
Based on review of the case with our new legal counsel and based upon their assessments of our likelihood to prevail on appeal, the Company has taken a charge to earnings in Q2 fiscal 2015 of US $380,000, which is our estimate of what the outcome will ultimately be on this case.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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.
Overview
We manufacture and sell a comprehensive line of safety garments and accessories for the global industrial protective clothing markets. Our products are sold by our in-house sales force and independent sales representatives to a network of over 1,200 North American safety and mill supply distributors, end-users, and distributors internationally. These distributors in turn supply end user industrial customers, such as integrated oil, utilities, chemical/petrochemical, automobile, steel, glass, construction, smelting, janitorial, pharmaceutical and high technology electronics manufacturers. In addition, we supply federal, state and local governmental agencies and departments domestically and internationally, such as municipal fire and police departments, airport crash rescue units, the military, the Department of Homeland Security and the Centers for Disease Control and state and privately owned utilities and integrated oil companies.
We have operated facilities in Mexico since 1995, in China since 1996 and in Brazil since May 2008. 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 of America and permit us to purchase certain raw materials at a lower cost than they are available domestically. As we have increasingly moved production of our products to our facilities in Mexico and China, we have seen improvements in the profit margins for these products. Our net sales attributable to customers outside the United States of America were $12.6 million and $12.3 million for the three months ended July 31, 2014 and July 31, 2013, respectively.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of our 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 estimates on our 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 condensed consolidated financial statements.
Revenue Recognition. The Company derives its sales primarily from its limited use/disposable protective clothing and secondarily from its sales of high-end chemical protective suits, firefighting and heat protective apparel, gloves and arm guards and reusable woven garments. Sales are recognized when goods are shipped, at which time title and the risk of loss pass to the customer. Some sales in Brazil may be sold on terms with F.O.B. destination, which are recognized when received by the customer. Sales are reduced for sales returns and allowances. Payment terms are generally net 30 days for United States sales and net 90 days for international sales.
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 market. Inventory is written down for slow-moving, obsolete or unusable inventory.
In the year ended January 31, 2014, the Company implemented a standardized policy for calculating slow-moving inventory outside the US. Previously, the Company wrote-down the inventory value on an individual product analysis basis.
Allowance for Doubtful Accounts. 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. Management considers the following factors when determining the collectability of specific customer accounts:
Customer creditworthiness, past transaction history with the customer, 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 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.
Income Taxes and Valuation Allowances. We are required to estimate our income taxes in each of the jurisdictions in which we operate as part of preparing our 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 carry forwards and tax credits, are recorded as deferred tax assets or liabilities on our balance sheet. A judgment must then be made of the likelihood that any deferred tax assets will be realized 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 we determine that we may not be able to realize all or part of our 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 net income in the period of such determination.
Uncertain Tax Positions. In the event the Company determines that it may not be able to realize all or part of our deferred tax assets 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.
Valuation of Goodwill and Other Intangible Assets. Goodwill and indefinite lived, intangible assets are tested for impairment at least annually; however, these tests may be performed more frequently when events or changes in circumstances indicate the carrying amount may not be recoverable. Goodwill impairment is evaluated utilizing a two-step process as required by US GAAP. Factors that the Company considers important that could identify a potential impairment include: significant underperformance relative to expected historical or projected future operating results; significant changes in the overall business strategy; and significant negative industry or economic trends. The Company measures any potential impairment on a projected discounted cash flow method. Estimating future cash flows requires the Company’s management to make projections that can differ materially from actual results.
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 carrying value of a long-lived asset is considered impaired when the total projected undiscounted cash flows from the asset are separately identifiable and are 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.
Foreign Currency Risks. The functional currency for the Brazil operation is the Brazil Real; the United Kingdom, the Euro; the trading company in China, the RenminBi; the Canada Real Estate, the Canadian dollar; and the Russia operation, the Russian Ruble and Kazakhstan Tenge. All other operations have the US dollar as its functional currency.
Self-Insured Liabilities. We have a self-insurance program for certain employee health benefits. The cost of such benefits is recognized as expense based on claims filed in each reporting period and an estimate of claims incurred but not reported during such period. Our estimate of claims incurred but not reported is based upon historical trends. If more claims are made than were estimated or if the costs of actual claims increase beyond what was anticipated, reserves recorded may not be sufficient, and additional accruals may be required. We maintain separate insurance to cover the excess liability over set single claim amounts and aggregate annual claim amounts.
Loss Contingencies. Certain conditions may exist as of the date the consolidated financial statements are issued, which may result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur. The Company’s management and its legal counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company’s legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims, as well as the perceived merits of the amount of relief sought or expected to be sought therein.
If the assessment of a contingency indicates that it is probable that a material loss has been or is probable of being incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in the Company’s condensed consolidated financial statements. If the assessment indicates that a potentially material loss contingency is not probable, but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material, would be disclosed.
Loss contingencies considered remote are generally not disclosed unless they involve guarantees, in which case the nature of the guarantee would be disclosed.
Significant Balance Sheet Fluctuation July 31, 2014, As Compared to January 31, 2014
Cash increased by $1.6 million and borrowings under the revolving credit facility increased by $1.0 million while inventory net of reserves had a modest decrease of $0.3 million. Accounts receivable increased $2.2 million primarily due to sales volume in the UK and increased volume in disposable sales in the US. Prepaid income tax increased $0.9 million for tax refunds receivable in Latin America and the UK. Accrued compensation and benefits increased $0.8 million primarily as a result of payroll accruals in Brazil for a labor dispute and standardization of payroll accruals for all international subsidiaries. Other accrued expenses increased $0.8 million due to taxes payable in the UK and Brazil. Short term borrowing increased $1.9 million mainly as the UK increased inventory levels to shorten lead times to customers and China continued to source raw materials in that country where extended payment terms with suppliers are negotiable.
Three Months ended July 31, 2014, As Compared to the Three Months Ended July 31, 2013
Net Sales. Net sales remained level at $24.6 million for the three months ended July 31, 2014 and for the three months ended July 31, 2013. Sales in China and to the Asia Pacific Rim remained level at $3.9 million excluding those previous year sales from our Qingdao facility which was sold in June 2013. In the prior year, Qingdao had some external OEM sales at a loss taken to keep the plant busy. UK sales increased by $0.5 million, or 15.6%. Russia and Kazakhstan sales combined increased by $0.3 million, or 102%. Latin America sales decreased $0.4 million, or 28.1%, primarily due to continuing issues with clearing raw materials purchases through Argentine customs as a result of local government inefficiencies. US domestic sales of disposables increased by $0.4 million, mainly due to peak season sales, chemical sales increased $0.1 million though there were large government sales included in previous year sales, fire protection sales increased $0.1 million as a result of the introduction of new products into the market place, wovens sales decreased $0.5 million and reflective sales decreased by $0.5 million as a result of the initial conversion volume for one large utility last year which is not replacement orders, for an overall external sales decrease in the US of $0.4 million, or 2.9%. Sales in Brazil have stabilized under new management and were equal to prior year. Numbers may not add due to rounding.
Gross Profit.Gross profit increased $0.6 million, or 8.0%, to $8.1 million for the three months ended July 31, 2014, from $7.5 million for the three months ended July 31, 2013. Gross profit as a percentage of net sales increased to 32.8% for the three months ended July 31, 2014, from 30.3% for the three months ended July 31, 2013. Major factors driving the changes in gross margins were:
Operating Expenses.Operating expenses increased $0.4 million, or 7.0%, to $6.6 million for the three months ended July 31, 2014 from $6.2 million for the three months ended July 31, 2013. Operating expenses as a percentage of net sales was 26.8% for the three months ended July 31, 2014 up from 25.1% for the three months ended July 31, 2013. Major factors comprising this increase were:
Operating Profit. Operating profit increased to a profit of $1.5 million for the three months ended July 31, 2014, from $1.3 million for the three months ended July 31, 2013, mainly as a result of cost reductions in the China and USA operations. Operating margins were 6.0% for the three months ended July 31, 2014, compared to 5.3% for the three months ended July 31, 2013.
Interest Expenses. Interest expenses increased $0.2 million to $0.7 million for the three months ended July 31, 2014, from $0.5 million for the three months ended July 31, 2013, due to higher rates prevailing in Brazil, US, and UK and the completion of US financing in June of last year. Also included in interest expense in fiscal 2015 is a non-cash charge of approximately $0.1 million of amortization of original issue discount (“OID”) on the Subordinated Loan.
Income Tax Expense. Income tax expenses consist of federal, state and foreign income taxes. Income tax expenses were $0.7 million for the three months ended July 31, 2014, as compared to an income tax benefit of $3.6 million for the three months ended July 31, 2013. Income taxes included a non-cash charge of $325,000 for the dividend paid by Weifang to the US in July 2014 and further reflect $200,000 of non-cash charges in fiscal 2015 for additional US taxes on UK and Canada income. The income tax benefit for the fiscal 2013 period resulted from the reversal of a $4.5 million valuation allowance relating to a going concern deferred tax entry recorded in FY13 which was resolved when US financing was secured on June 28, 2013.
Net Loss. Net loss increased $(4.6) million to ($0.4) million for the three months ended July 31, 2014, from $4.2 million income for the three months ended July 31, 2013, mainly due to the reversal of a $4.5 million valuation allowance relating to a going concern deferred tax entry recorded in FY13 which was resolved when US financing was secured June 28, 2013.
Six Months ended July 31, 2014, As Compared to the Six Months Ended July 31, 2013
Net Sales. Net sales increased $1.7 million, or 3.8%, to $48.1million for the six months ended July 31, 2014, from $46.4 million for the six months ended July 31, 2013. Sales in China and to the Asia Pacific Rim increased by $0.3 million or 4.9% excluding those previous year sales from our Qingdao facility which was sold in June 2013. In the prior year, Qingdao had some external OEM sales at a loss taken to keep the plant busy. China sales increased primarily due to growth in the Asia Pacific and China markets. UK sales increased by $0.6 million, or 9.9%. Russia and Kazakhstan sales combined remained level at $1.1million. Latin America sales increased $0.4 million, or 14%, primarily due to a large sale of fire gear in Ecuador. US domestic sales of disposables increased by $1.0 million, mainly due to peak season sales, chemical sales decreased $0.6 million due to a large government sales included in previous year sales, fire protection sales increased $1.0 million as a result of the introduction of new products into the market place, wovens sales decreased $0.6 million and reflective sales decreased by $0.4 million primarily due to the initial conversion volume for one large utility last year which is now replacement sales, for an overall sales gain in the US of $0.5 million, or 2.0%. Sales in Brazil have stabilized under new management and were equal to prior year. Sales for Lakeland worldwide increased $1.7million, or 3.8%, over the second quarter of last year. Numbers may not add due to rounding.
Gross Profit.Gross profit increased $1.6 million, or 12.0%, to $15.2 million for the six months ended July 31, 2014, from $13.5 million for the six months ended July 31, 2013. Gross profit as a percentage of net sales increased to 31.5% for the six months ended July 31, 2014, from 29.2% for the six months ended July 31, 2013. Major factors driving the changes in gross margins were:
Operating Expenses.Operating expenses increased $0.6 million, or 5.1%, to $13.1 million for the six months ended July 31, 2014 from $12.5 million for the six months ended July 31, 2013. Operating expenses as a percentage of net sales was 27.3% for the six months ended July 31, 2014 up from 27.0% for the six months ended July 31, 2013. Major factors comprising this increase were:
Operating Profit. Operating profit increased to a profit of $2.0 million for the six months ended July 31, 2014, from $1.1 million for the six months ended July 31, 2013, mainly as a result of improvement of the Brazilian operations resulting from new management and overall improvement in worldwide operations. Operating margins were 4.3% for the six months ended July 31, 2014, compared to 2.3% for the six months ended July 31, 2013.
Interest Expenses. Interest expenses increased $0.6 million to $1.3 million for the six months ended July 31, 2014, from $0.7 million for the six months ended July 31, 2013, due to higher rates prevailing in Brazil, US, and the UK, along with the new financing in the US. Also included in interest expense for fiscal 2015 is a non-cash charge of approximately $0.2 million of amortization of original issue discount (“OID”) on the Subordinated Loan.
Income Tax Expense. Income tax expenses consist of federal, state and foreign income taxes. Income tax expenses were $0.7 million for the six months ended July 31, 2014, as compared to an income tax benefit of $3.4 million for the six months ended July 31, 2013. Income taxes included a non-cash charge of $325,000 for the dividend paid by Weifang to the US in July 2014 and further reflect $200,000 of non-cash charges in fiscal 2015 for additional US taxes on UK and Canada income. The income tax benefit for the fiscal 2013 period resulted from the reversal of a $4.5 million valuation allowance relating to a going concern deferred tax entry recorded in FY13 which was resolved when US financing was secured on June 28, 2013.
Net Loss. Net loss increased $(2.9) million to $(0.4) million loss for the six months ended July 31, 2014, from $3.3 million income for the six months ended July 31, 2013, mainly due to the reversal of a $4.5 million valuation allowance relating to a going concern deferred tax entry recorded in FY13 which was resolved when US financing was secured June 28, 2013.
Liquidity and Capital Resources
Cash Flows. As of July 31, 2014, we had cash and cash equivalents of approximately $6.2 million and working capital of $38.5 million. Cash and cash equivalents increased $1.6 million and working capital decreased $0.1 million from January 31, 2014. International cash management is affected by local requirements and movements of cash across borders can be slowed down significantly.
Net cash used in operating activities of $(0.3) million for the six-months ended July 31, 2014 was primarily due to an increase to accrued expenses of $1.3 million, inventory increase of $0.8 million, $0.7 million of non-cash interest expense resulting from amortization of warrant OID and PIK interest and $0.7 million depreciation and amortization offset by an increase in accounts receivables of $2.2 million, a reduction in income and VAT prepaid taxes of $0.9 million and reductions of inventory reserves and bad debt provision in a combined total of $0.5 million. Net cash provided by financing activities was $2.1 million in the six-months ended July 31, 2014, due to net borrowings under the credit agreement, China new borrowings and Brazil new borrowings.
We currently have one Senior credit facility: A $15.0 million revolving credit facility which commenced June 28, 2013, of which we had $13.4 million of borrowings outstanding as of July 31, 2014, expiring on June 30, 2016 at a current per annum rate of 6.25%. Maximum availability in excess of amount outstanding at July 31, 2014 was $1.6 million. Our current credit facility requires, and any future credit facilities may also require, that we comply with specified financial covenants relating to earnings before interest, taxes, depreciation and amortization and others 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 lenders, including BDC (our Canadian lender), have a security interest in substantially all of our US and Canadian assets and pledges of 65% of the equity of the Company’s foreign subsidiaries, outside Canada. If our lenders declare amounts outstanding under any 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. Our current availability under our Credit Facility, coupled with our anticipated operating cash and cash management strategy, is expected to be sufficient to cover our liquidity needs for the next 12 months.
Subordinated Debt Financing (Junior Lender). As described more fully in Note 6, the June 28, 2013 financing included Subordinated Debt which contained warrants. The Company recorded the debt and warrants using the relative fair value method, in which there was a debt discount recorded at the date the transaction of approximately $2.2 million recorded as a component of additional paid-in capital. The value of the warrants was treated as Original Issue Discount (OID) and will be amortized over the term of the loan. In management’s view, this financing is at favorable terms considering Lakeland’s then deteriorating financial conditions at the time of the closing and the year prior as well as the alternatives available to the Company. Lakeland considered several “Unitranche” transactions with overall cost less favorable than the overall cost of the combined Senior and Junior financing closed June 28, 2013. A prepayment of $500,000 of this debt was made in July 2014.
Capital Expenditures.Our capital expenditures principally relate to purchases of building and equipment in Brazil and Mexico, manufacturing equipment, computer equipment and leasehold improvements. We anticipate FY15 capital expenditures not to exceed $1.0 million. Our facilities in China have not been encumbered by commercial bank mortgages and, thus, Chinese commercial mortgage loans or the sale of a facility may be available with respect to these real estate assets if we need additional liquidity.
Item 3. Quantitative and Qualitative Disclosures About Market Risk -
Not applicable.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
We conducted an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of July 31, 2014. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based on their evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of July 31, 2014 based on the material weaknesses described below.
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accepted accounting principles generally accepted in the United States of America.
Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.
Management has assessed the effectiveness of the Company’s internal control over financial reporting as of July 31, 2014. In making this assessment, management used the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based upon an evaluation performed, our management concluded that our internal control over financial reporting was not effective as of July 31, 2014. We have identified the material weaknesses below:
China
In FY13 the Company determined that there were inadequate controls and procedures in place in China. The Company further determined in Q3 of FY14, partially as a result of the change in management with the International Controller departure in Q2, that the Company’s intended remediation was not adequate. Management devoted considerable time in Q3 and Q4 of FY14 to resolving the accounting issues, and management is confident the financial reporting is correct at July 31, 2014. Management intends to further remediate the internal controls in place in China and to make changes as appropriate during FY15, including changes in financial accounting management personnel.
In May and June 2014, the Company hired a new controller for China and also an additional internal auditor. Management feels that once these two new hires get acclimated the remediation of this material weakness will be complete.
Brazil
Management determined in FY14 that we did not have adequate internal controls in place in Brazil which constituted a material weakness. The Company has operated without adequate cash resources in Brazil and our loan agreements in the USA precluded us from sending any more cash to Brazil. As a result, we were not able to invest funds in Brazil to improve internal controls until the operation could be returned to profitability. In FY14 we completely changed the senior management in Brazil and recruited and hired a new CEO specializing in turnaround situations who started in September 2013 and recruited a new CFO who started in February 2014. It was not possible to address the internal controls in Brazil until late in Q4 of FY14 at which time the Company engaged an outside CPA firm in Brazil to review the internal controls and procedures. Their report was rendered March 29, 2014. The conclusion of the report was that the design of the activity/process controls does not meet the minimum requirements needed for information security controls. In addition, the report indicated that the controls resulted in high exposure in the areas of purchase, accounting closing, sales, financial, production, payroll, and logistics. Since the material weakness was identified prior to January 31, 2014, action was taken by management such that it did not result in a misstatement for the fiscal year ended January 31, 2014 or for the quarters ended April 30, 2014 and July 31, 2014. However, the material weakness in internal controls was not fully remediated before FY14 year-end or by July 31, 2014 and could result in misstatements impacting all accounts and disclosures that would result in a material misstatement of the financial statements that would not be prevented or detected. Accordingly, management has determined that this control deficiency constitutes a material weakness.
Failure of Entity Level Controls
As a result of the multiple material weaknesses identified above regarding financial reporting in international locations, the Company concluded that it does not have sufficient internal controls in place to monitor the internal controls in remote locations. In addition, the Company had not performed a sufficient level of review of the financial information from the foreign subsidiaries to ensure that all general ledger accounts are reconciled and that estimates are properly stated. Since the material weakness was identified prior to January 31, 2014 and all accounts were properly reconciled and reviewed, it did not result in a misstatement for the fiscal year-end January 31, 2014. While the Company believes it has taken the appropriate steps to initiate the remediation of the weaknesses, several of these steps will take time to complete and thus it was unable to complete by July 31, 2014 the remediation of the material weakness from FY13 and others identified in FY14.
Since the Company qualifies as a smaller reporting company, an attestation report of management’s assessment of internal control by our independent auditors is not required.
Changes in Internal Control over Financial Reporting
Though Lakeland has made progress in the remediation of the material weaknesses disclosed above, there have been no changes in Lakeland Industries, Inc.'s internal control over financial reporting that occurred during Lakeland's second quarter of fiscal 2015 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting:
All internal control testing that cannot be conducted by existing personnel will be outsourced. The internal control program will be monitored/tested in a manner consistent with full Sarbanes-Oxley compliance.
PART II. OTHER INFORMATION
Items 1, 1A, 2, 3, 4 and 5 are not applicable
Item 6. Exhibits:
Exhibits:
_________________SIGNATURES_________________
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
(Registrant)
Date: September 10, 2014
/s/ Christopher J. Ryan Christopher J. Ryan,
Chief Executive Officer, President and Secretary
(Principal Executive Officer and Authorized Signatory)
/s/Gary PokrassaGary Pokrassa,
Chief Financial Officer
(Principal Accounting Officer and Authorized Signatory)