Overview
We manufacture and sell a comprehensive line of safety garments and accessories for the industrial protective clothing market. Our products are sold by our in-house customer service group our regional sales managers and independent sales representatives to a network of over 800 safety and mill supply distributors. These distributors in turn supply end user industrial customers such as chemical/petrochemical, automobile, steel, glass, construction, smelting, munition plants, janitorial, pharmaceutical and high technology electronics manufacturers, as well as hospitals and laboratories. In addition, we supply federal, state and local governmental agencies and departments such as fire and police departments, airport crash rescue units, the Department of Defense, Central Intelligence Agency, Federal Bureau of Investigation, and the Centers for Disease Control. In fiscal 2006, we had net sales of $98.7 million and earnings per share of $1.26, which represent a growth rate of 3.6% and 11.6%, respectively, over our previous fiscal year. Our net sales attributable to customers outside the United States were $8.0 million, $9.0 million and $10.5 million, in fiscal 2004, fiscal 2005 and fiscal 2006, respectively.
Our major product categories and their applications are described below:
Limited Use/Disposable Protective Clothing. We manufacture a complete line of limited use/disposable protective garments offered in coveralls, lab coats, shirts, pants, hoods, aprons, sleeves and smocks. These garments are made from several non-woven fabrics, primarily Tyvek(R) and Tychem (both DuPont manufactured fabrics) and also our proprietary fabrics Micromax and Micromax NS manufactured pursuant to customer order. These garments provide protection from low-risk contaminants or irritants, such as chemicals, pesticides, fertilizers, paint, grease and dust, and from limited exposure to hazardous waste and toxic chemicals, including acids, asbestos, lead and hydro-carbons (or PCBs) that pose health risks after exposure for long periods of time. Additional applications include protection from viruses and bacteria, such as AIDS, streptococcus, SARS and hepatitis, at hospitals, clinics and emergency rescue sites and use in clean room environments to prevent human contamination in the manufacturing processes. This is our largest product line.
High-End Chemical Protective Suits. We manufacture heavy duty chemical suits made from TyChem(R) SL, TK and BR, and F, which are DuPont manufactured fabrics and Pyrolon CRFR. These suits are worn by individuals on
hazardous material teams to provide protection from powerful, highly concentrated and hazardous or potentially lethal chemical and biological toxins, such as toxic wastes at Super Fund sites, toxic chemical spills or biological discharges, chemical or biological warfare weapons (such as saran gas, anthrax or ricin), and chemicals and petro-chemicals present during the cleaning of refineries and nuclear facilities. These suits can be used in conjunction with a fire protective shell that we manufacture to protect the user from both chemical and flash fire hazards. Homeland Security measures and government funding of personal protective equipment for first responders to terrorist threats or attack have recently resulted in increased demand for our high-end chemical suits and we believe demand for these suits will continue to increase in the future as state and local Bioterrorism grants begin to be spent.
Fire Fighting and Heat Protective Apparel. We manufacture an extensive line of fire fighting and heat protective apparel for use by fire fighters and other individuals that work in extreme heat environments. Our branded fire fighting apparel Fyrepel(TM) is sold to local municipalities and industrial fire fighting teams. Our heat protective aluminized fire suits are manufactured from Nomex(R), a fire and heat resistant material, and Kevlar(R), a cut and heat resistant, high-strength, lightweight, flexible and durable material both produced by DuPont. This apparel is also used for maintenance of extreme high temperature equipment, such as coke ovens, kilns, glass furnaces, refinery installations and smelting plants, as well as for military and airport crash and rescue teams.
Gloves and Arm Guards. We manufacture gloves and arm guards from Kevlar(R) and Spectra(R), cut resistant fibers made by DuPont and Honeywell respectively as well as engineered composite yarns with Microgard antimicrobial for food service markets. Our gloves are used primarily in the automotive, glass, metal fabrication and food service industries to protect the wearer's hand and arms from lacerations and heat without sacrificing manual dexterity or comfort.
Reusable Woven Garments. We manufacture a line of reusable and washable woven garments that complement our fire fighting and heat protective apparel offerings and provide alternatives to our limited use/disposable protective clothing lines. Product lines include electrostatic dissipative apparel used in the automotive industry for control of static electricity in the manufacturing process, clean room apparel to prevent human contamination in the manufacturing processes, and flame resistant Nomex(R) coveralls and FR cotton coveralls used in chemical and petroleum plants and for wildland fire fighting and extrication suits.
We believe we are one of the largest independent customers of DuPont's Tyvek(R) and TyChem(R) apparel grade material. We purchase Tyvek(R) and TyChem(R) under North American licensing agreements and other DuPont materials, such as Kevlar(R), under international licensing agreements. While we have operated under these trademark agreements since 1995, we have been a significant customer of these DuPont materials since 1982. The trademark agreements require certain quality standards and the identification of the DuPont trademark on the finished product manufactured by us. We believe this brand identification with DuPont and Tyvek(R) significantly benefits the marketing of our largest product line, as over the past 30 years Tyvek(R) has become known as the standard for limited use/disposable protective clothing. We believe our relationship with DuPont to be excellent.
We maintain manufacturing facilities in Decatur, Alabama; Celaya, Mexico; AnQui City, China; Jiaozhou, China; New Delhi, India, Shillington, PA, and St. Joseph, Missouri, where our products are designed, manufactured and sold. We also have a relationship with a sewing subcontractor in Mexico, which we can utilize for unexpected production surges. Our China, Mexico, and India facilities allow us to take advantage of favorable labor and component costs, thereby increasing our profit margins on products manufactured in these facilities. Our China and Mexico facilities are designed for the manufacture of limited use/disposable protective clothing as well as our high-end chemical protective suits. We have significantly improved our profit margins in these product lines by shifting production to our international facilities and we are currently expanding our international manufacturing capabilities to include our gloves and reusable woven protective apparel product lines.
Industry Overview
According to Global Industry Analysts, Inc., the global market for industrial work clothing was projected to be approximately $6.3 billion in 2005, and is projected to grow at a compound annual growth rate of approximately 6.5%. Our primary market, North America, is the largest market, expected to make up over one-third, or approximately $2.0 billion, of the global market. The industrial work clothing market includes our limited use/disposable protective or safety clothing, our high-end chemical protective suits, our fire fighting and heat protective apparel and our reusable woven garments.
The industrial protective safety clothing market has evolved over the past 35 years as a result of governmental regulations and requirements and commercial product development. In 1970, Congress enacted the Occupational
Safety and Health Act, or OSHA, which requires employers to supply protective clothing in certain work environments. Almost two million workers are subject to OSHA standards today. Certain states have also enacted worker safety laws that supplement OSHA standards and requirements.
The advent of OSHA coincided with DuPont's development of Tyvek(R) which, for the first time, allowed for the economical production of lightweight, disposable protective clothing. The attraction of disposable garments grew in the late 1970s as a result of increases in labor and material costs of producing cloth garments and the promulgation of federal, state and local safety regulations.
In 1990, additional standards proposed and developed by the National Fire Protection Association and the American Society for Testing and Materials were adopted by OSHA. These standards identify four levels of protection, A through D, and specify the equipment and clothing required to adequately protect the wearer at each level:
o Level A requires total encapsulation in a vapor proof chemical suit with self contained breathing apparatus, or SCBA, and appropriate accessories.
o Level B calls for SCBA or a positive pressure supplied respirator with escape SCBA, plus hooded chemical resistant clothing (coveralls), one or two piece chemical splash suit, or disposable chemical resistant coveralls.
o Level C requires hooded chemical resistant clothing, such as coveralls, two piece chemical splash suit, or disposable chemical resistant coveralls.
o Level D involves work and/or training situations that require minimal coverall protection.
In response to the terrorist attacks that took place on September 11, 2001, the federal government has provided for additional protective equipment funding through programs that are part of the Homeland Security initiative. The Fire Act of 2002 created the federal Assistance to Firefighters Grant Program, or AFGP, to provide funds directly to local fire districts to help improve their readiness and capability to respond to terrorist attacks. Funds are allocated under AFGP to the following areas: fire operations/firefighter safety; fire prevention; emergency medical services; and firefighting vehicle acquisition. AFGP will provide more than $2.15 billion in funding through 2005, with approximately $750 million appropriated for 2003, $750 million in 2004, $650 million more in 2005 and $648 million in 2006. The Bio Terrorism Preparedness and Response Act of 2002, which we refer to as the Bio Terrorism Act, appropriated $3.643 billion for Bioterrorism Preparedness and $1.641 billion for Bioterrorism Hospital Preparedness between 2002 and 2005. Hospital Preparedness is where we expect to see most of our garment sales. The 2006 appropriations bill provides $550 million for Hospital Preparedness. The $514.6 million of bioterrorism hospital preparedness monies appropriated in 2005 are expected to be disbursed in 2006 and 2007, and the funding for 2006 should be disbursed in 2007 and 2008.
Recently, federal and state purchasing of industrial protective clothing and federal grants to fire departments have increased demand for industrial protective clothing to protect first responders against actual or threatened terrorist incidents. Specific events such as the 2002 U.S. Winter Olympics, the SARS epidemic in 2003 the anthrax letters incidents in 2001 and the ricin letter incidents in 2004 have also resulted in increased demand for our products.
Industry Consolidation
The industrial protective clothing industry is highly fragmented and consists of a large number of small, closely-held family businesses. DuPont, Lakeland and Kimberly Clark are the dominant disposable industrial protective apparel manufacturers. Since 1997, the markets for manufacturing and distribution have consolidated. A number of large distributors with access to capital have acquired smaller distributors. The acquisitions include Vallen Corporation's acquisitions of Safety Centers, Inc., All Supplies, Inc., Shepco Manufacturing Co., and Century Safety (Canada) and Hagemeyer's acquisition of Vallen Corporation; W.W. Grainger's acquisitions of Allied Safety, Inc., Lab Safety Supply, Inc., Acklands Limited, Gempler's safety supply division and Ben Meadows, Inc.; Air Gas' acquisitions of Rutland Tool & Supply Co., Inc., IPCO Safety Supply, Inc., Lyon Safety, Inc., Safety Supply, Inc., Safety West, Inc. and Delta Safety Supply, Inc.; and Fischer Scientific's acquisitions of Safety Services of America, Cole-Parner, Retsch and Emergo.
As these safety distributors consolidate and grow, we believe they are looking to reduce the number of safety manufacturing vendors they deal with and support, while at the same time shifting the burden of end user selling to
the manufacturer. This creates a significant capital availability issue for small safety manufacturers as end user selling is more expensive, per sales dollar, than selling to safety distributors. As a result, the manufacturing sector in this industry is seeing follow-on consolidation. DuPont has acquired Marmac Manufacturing, Inc., Kappler, Inc., Cellucup, Melco, Mfg., and Regal Manufacturing since 1998, while in the related safety product industries Norcross Safety Products L.L.C. has acquired Morning Pride, Ranger-Servus, Salisbury, North and Pro Warrington and Christian Dalloz has acquired Bacou, USA which itself acquired Uvex Safety, Inc., Survivair, Howard Leight, Perfect Fit, Biosystems, Fenzy, Titmus, Optrel, OxBridge and Delta Protection.
We believe a larger industrial protective clothing manufacturer has competitive advantages over a smaller competitor including:
o economies of scale when selling to end users, either through the use of a direct sales force or independent representation groups;
o broader product offerings that facilitate cross-selling opportunities;
o the ability to employ dedicated protective apparel training and selling teams;
o the ability to offer volume and growth incentives to safety distributors; and
o access to international sales.
We believe we have a substantial opportunity to pursue acquisitions in the industrial protective clothing industry, particularly because many smaller manufacturers share customers with us.
Business Strategy
Key elements of our strategy include:
o Dealing with Price Increases in Raw Materials. One major supplier, DuPont, increased the price of Tyvek fabrics by 3.7% in January, 2005, by 4 to 6% in June 2005 and by 4.9% in November 2005. However, in June of 2005 DuPont also published new garment price increases of 4% to 6%, depending on style, and again increased garment prices in November 2005 by 6%. These increases were mostly predicated upon increases in oil and natural gas which are prime components in the manufacturing of Tyvek. We react to such increases by increasing our inventories of Tyvek roll goods prior to such announced increases. Additionally, we have negotiated discounts on such roll goods based upon volume purchases. Nonetheless, Tyvek garment pricing to prime volume accounts was competitive in the fourth quarter of fiscal 2006. In order to offset any negative effect of these prices increases we are continuing the operating cost reduction program already in effect and have initiated new measures.
For example:
1. We continue to press our raw material and component suppliers for price reductions and better payment terms.
2. We are sourcing more raw materials and components from our China based operations as opposed to sourcing in Europe and North America.
3. We are re-engineering many products so as to reduce the amount of raw materials used and reduce the direct labor in such products.
o Increase Sales to the First Responder Market. Our high-end chemical protective suits meet all of the regulatory standards and requirements and are particularly well qualified to provide protection to first responders to chemical or biological attacks. For example, our products have been used for response to recent threats such as the 2001 anthrax letters and the 2004 ricin letters. A portion of appropriations for the Fire Act of 2002 and the
Bio Terrorism Act of 2002 are available for purchase of products for first responders that we manufacture, and we are aggressively targeting this Homeland Security market.
o Improve Marketing in Existing Markets. We believe significant growth opportunities are available to us through the better positioning, marketing and enhanced cross-selling of our reusable woven protective clothing, glove and arm guards and high-end chemical suit product lines, along with our limited use/disposable lines as a bundled offering. This allows our customers one stop shopping using combined freight shipments.
o Decrease Manufacturing Expenses by Moving Production to International Facilities. We have additional opportunities to take advantage of our low cost production capabilities in Mexico and China. Beginning in 1995, we successfully moved the labor intensive sewing operation for our limited use/disposable protective clothing lines to these facilities. Beginning January 1, 2005, pursuant to the United States World Trade Organization Treaty with China, the reduction in quota requirements and tariffs imposed by the U.S. and Canada on textiles goods such as our reusable woven garments have made it more cost effective to move production for these product lines to our assembly facilities in China. We are half way through this process and expect to complete this process by the fourth quarter of fiscal 2007. As a result, we expect to see profit margin improvements for these product lines, which will allow us to compete more effectively as quota restrictions are removed and tariffs lowered. There are currently no items we produce in China subject to quotas. There are only a few minor items in our Mifflin Valley line which would presently fall into quota restraints. At this time, no such items are produced in China.
o Increase International Sales Opportunities. We also intend to increase our penetration of the International markets for our product lines. We have recently opened new sales offices in Beijing, China; Tokyo, Japan; and Santiago, Chile: Our sales in our existing Canadian and United Kingdom operations grew by 21.5% and 35.9% respectively in fiscal 2006.
o Emphasize Customer Service. We continue to offer a high level of customer service to distinguish our products and to create customer loyalty. We offer well-trained and experienced sales and support personnel, on-time delivery and accommodation of custom and rush orders. We also seek to advertise our brand names.
o Acquisitions. We believe that the protective clothing market is fragmented and presents the opportunity to acquire businesses that offer comparable products or specialty products that we do not offer. We intend to consider acquisitions that afford us economies of scale, enhanced opportunity for cross-selling, expanded product offerings and an increased market presence. We currently have an option to purchase for $2.75 million the plant and machinery of the Indian glove operation, that we are presently leasing and at which we are producing gloves. We also acquired Mifflin Valley, Inc., a manufacturer of high visibility protective clothing in August 2005.
o Introduction of New Products. We continue our history of product development and innovation by introducing new proprietary products across all our product lines. Our innovations have included Micromax(R) disposable protective clothing line, our Despro(TM) patented glove design, Microgard antimicrobial products for food service and our engineered composite glove products for high cut and abrasion, our Thermbar glove and sleeve products for heat protection, Grapolator(TM) sleeve lines for hand and arm cut protection and our Thermbar(TM) Mock Twist glove for hand and arm heat protection. We own 14 patents on fabrics and production machinery and have 9 additional patents in application. We will continue to dedicate resources to research and development.
o Increase Penetration of the North American Tyvek(R) Market. We intend to increase our sales of Tyvek(R)-based garments by introducing Tyvek(R) in industries which have generally used woven reusable garments, such as food processing and food service industries including kitchens, grocery stores and chicken and fishery slaughter operations. We believe that limited use/disposable garments are more effective at preventing contamination than reusable garments that are exposed to possible contamination while in transit or while being laundered. We also plan to expand our sales of Tyvek(R)-based products and marketing efforts in Mexico and Canada. Industrial safety gear utilized in U.S. manufacturing often gains acceptance as standard equipment for new facilities and factories operated by U.S. companies in other countries.
Our Competitive Strengths
Our competitive strengths include:
o Industry Reputation. We devote significant resources to creating customer loyalty by accommodating custom and rush orders and focusing on on-time delivery. Additionally, our ISO 9001 certified facilities manufacture high-quality products. As a result of these factors, we believe that we have an excellent reputation in the industry.
o Long-standing Relationship with DuPont. We believe we are the largest independent customer for DuPont's Tyvek(R) and TyChem(R) material for use in the industrial protective clothing market. Our trademark agreements with DuPont for Tyvek(R), TyChem(R) and Kevlar(R) require certain quality standards and the identification of the DuPont brand on the finished product. We believe this brand identification with DuPont significantly benefits the marketing of our product lines, as over the past 30 years Tyvek(R) has become known as the standard for limited use/disposable protective clothing. We believe our relationship with DuPont to be excellent.
o International Manufacturing Capabilities. We have operated our own manufacturing facilities in Mexico since 1995 and in China since 1996. Our three facilities in China total over 160,000 sq. ft. of manufacturing, warehousing and administrative space while our facility in Mexico totals over 25,000 sq. ft. of manufacturing, warehousing and administrative space. Our facilities and capabilities in China and Mexico allow access to a less expensive labor pool than is available in the United States and permits us to purchase certain raw materials at a lower cost than they are available domestically.
o India. We are currently leasing a 30,155 square foot facility in New Delhi, India where we are producing nitrile, latex and neoprene gloves which are being sold in Europe and South America presently. We intend to enter the North American market in autumn 2006 with a newly designed line of gloves. We have an option to purchase this facility after November 2006, if we are satisfied with its production and quality.
o Sales Offices. We have sales offices around the world to service various major markets, Toronto, Canada for Canada, Newport, United Kingdom for the European Common Market, Beijing, China for China and Southeast Asia, Tokyo, Japan for Japan and Santiago, Chile for the South American market.
o Comprehensive Inventory. We have a large product offering with numerous specifications, such as size, styles and pockets, and maintain a large inventory of each in order to satisfy customer orders in a timely manner. Many of our customers traditionally make purchases of industrial protective gear with expectations of immediate delivery. We believe our ability to provide timely service for these customers enhances our reputation in the industry and positions us strongly for repeat business, particularly in our limited use/disposable protective clothing lines.
o Manufacturing Flexibility. By locating labor-intensive manufacturing processes such as sewing in Mexico and China, and by utilizing sewing sub-contractors, we have the ability to increase production without substantial additional capital expenditures. Our manufacturing systems allow us flexibility for unexpected production surges and alternative capacity in the event any of our independent contractors become unavailable.
o Experienced Management Team. We have an experienced management team. Our executive officers other than the CFO average greater than 21 years of experience in the industrial protective clothing market. The knowledge, relationships and reputation of our management team helps us maintain and build our customer base.
Products
The following table summarizes our principal product lines, the raw materials used to manufacture them, their applications and end markets:
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(1) Industrial grade Nitrile, Latex, Neoprene, Buytl and other combinations thereof will be added to our product line if we exercise our option to acquire the Indian glove facility we are working with now. These industrial gloves are used to protect workers from hazardous chemicals and will complement our line of cut resistant Kevlar and Spectra string knit gloves.
Limited Use/Disposable Protective Clothing
We manufacture a complete line of limited use/disposable protective garments, including coveralls, laboratory coats, shirts, pants, hoods, aprons, sleeves, arm guards, caps, and smocks. Limited use garments can also be coated or laminated to increase splash protection against many inorganic acids, bases and other liquid chemicals. Limited use garments are made from several non-woven fabrics, including Tyvek(R) and TyChem QC (both DuPont fabrics) and our own trademarked fabrics such as Pyrolon(R) Plus 2, XT, CRFR, Micromax(R), Micromax NS, Safegard "76" (R), Zonegard(R), Body Gard(R), RyTex(R) and TomTex(R), which are made of spunlaced polyester, polypropylene and polyethylene materials, laminates, films and derivatives. We incorporate many seaming and taping techniques depending on the level of protection needed in the end use application.
Typical users of these garments include chemical plants, petrochemical refineries and related installations, automotive manufacturers, pharmaceutical companies, construction companies, coal and oil power generation utilities and telephone utility companies. Numerous smaller industries use these garments for specific safety applications unique to their businesses. Additional applications include protection from viruses and bacteria, such as AIDS, streptococcus, SARS and hepatitis, at hospitals, clinics and emergency rescue sites and use in clean room environments to prevent human contamination in the manufacturing processes.
Our limited use/disposable protective clothing products range in unit price from $.04 for shoe covers to approximately $14.00 for a TyChem(R) QC laminated hood and booted coverall. Our largest selling item, a standard white Tyvek(R) coverall, sells for approximately $2.50 to $3.75 per garment. By comparison, similar reusable cloth coveralls range in price from $30.00 to $60.00, exclusive of laundering, maintenance and shrinkage expenses.
We cut, warehouse and sell our limited use/disposable garments primarily at our Decatur, Alabama and China facilities and warehouse in Las Vegas, NV and Shillington, PA. The fabric is cut into required patterns at our Decatur plant and shipped to our Mexico facility for assembly. Our assembly facilities in China or Mexico and independent contractors sew and package the finished garments and return them primarily to our Decatur, Alabama plant, normally within one to eight weeks, for immediate shipment to the customer.
We presently utilize one independent domestic sewing contractor and one international contractor under agreements that are terminable at will by either party. In fiscal 2006, no independent sewing contractor accounted for more than 5% of our production of limited use/disposable garments. We believe that we can obtain adequate alternative production capacity should any of our independent contractors become unavailable.
The capacity of our facilities, complemented by the availability of existing and other available independent sewing contractors, allow us to reduce by 5%, or alternately increase by 10%, our production capacity without incurring large on going costs typical of many manufacturing operations. This allows us to react quickly to changing unit demand for our products.
High-End Chemical Protective Suits
We manufacture heavy-duty chemical suits made from DuPont TyChem(R) QC, SL, TK, TyChem F and TyChem(R) BR fabrics. These suits are worn by individuals on hazardous material teams to provide protection from powerful, highly concentrated and hazardous or potentially lethal chemical and biological toxins, such as toxic wastes at Super Fund sites, toxic chemical spills or biological discharges, chemical or biological warfare weapons (such as anthrax, ricin, or saran gas), and chemicals and petro-chemicals present during the cleaning of refineries and nuclear facilities. Our line of chemical suits range in cost from $24 per coverall to $1192. The chemical suits can be used in conjunction with a fire protective shell that we manufacture to protect the user from both chemical and flash fire hazards. We have also introduced two garments approved by the National Fire Protection Agency (NFPA) for varying levels of protection that are manufactured from DuPont materials:
o TyChem(R) TK - a co-polymer film laminated to a durable spun bonded substrate. This garment offers the broadest temperature range for limited use garments of -94(degree)F to 194(degree)F. TyChem(R) TK meets all OSHA Level A requirements. It is available in National Fire Protection Agency 1991-2000 certified versions when worn with an aluminized over cover. o TyChem(R) BR - meets all OSHA Level B and all National Fire Protection Agency 1994 fabric requirements and offers splash protection against a wide array of chemicals.
We manufacture chemical protective clothing at our facilities in Decatur, Alabama, Mexico and China. Using fabrics such as TyChem(R) SL, TyChem(R) TK, TyChem F, and TyChem(R) BR, we design, cut, glue and/or sew the
materials to meet customer purchase orders.
The federal government, through the Fire Act of 2002, appropriated approximately $750 million in 2003 to fire departments in the United States and its territories to fund the purchase of, among other things, personal protective equipment, including our fire fighting and heat protective apparel and high-end chemical protective suits. An additional $750 million was appropriated for 2004, $650 million for 2005 and $648 million for 2006. The Bio Terrorism Preparedness and Response Act of 2002 included appropriations of $3.643 billion for Bioterrorism Preparedness and $1.641 billion for Bioterrorism Hospital Preparedness between 2002 and 2005. Hospital Preparedness is where we expect to see most of our garment sales. The 2006 appropriations bill provides $550 million for Hospital Preparedness.
Fire Fighting and Heat Protective Apparel
We manufacture an extensive line of products to protect individuals who work in high heat environments. Our heat protective aluminized fire suit product lines include the following:
o Kiln entry suit - to protect kiln maintenance workers from extreme heat.
o Proximity suits - to give protection in high heat areas where exposure to hot liquids, steam or hot vapors is possible.
o Approach suits - to protect personnel engaged in maintenance, repair and operational tasks where temperatures do not exceed 200(degree)F ambient, with a radiant heat exposure up to 2,000(degree)F.
We manufacture fire fighter protective apparel for domestic and foreign fire departments. We developed the popular Sterling Heights(TM) style (short coat and bib pants) bunker gear. Crash rescue continues to be a major market for us, as we were one of the first manufacturers to supply military and civilian markets with airport fire fighting protection.
Our fire suits range in price from $480 for standard fire department turn out gear to $2,000 for a fire entry suit. Approximately 70% of our heat protective clothing is currently manufactured at our facility in St. Joseph, Missouri with the remainder being made in our China facilities. Our Fyrepel(TM) brand of fire fighting apparel continues to benefit from ongoing research and development investment, as we seek to address the ergonomic needs of stressful occupations. Additionally, we have introduced a new line of turnout gear manufactured in China in order to compliment our US line.
Gloves and Arm Guards
We manufacture and sell specially designed gloves and arm guards made from Kevlar(R), a cut and heat resistant material produced by DuPont, Spectra(R), a cut resistant fiber made by Honeywell, and our proprietary patented yarns. We are one of only seven companies licensed in North America to sell 100% Kevlar(R) gloves, which are high strength, lightweight, flexible and durable. Kevlar(R) gloves offer a better overall level of protection and lower worker injury rates, and are more cost effective, than traditional leather, canvas or coated work gloves. Kevlar(R) gloves, which can withstand temperatures of up to 400(degree)F and are cut resistant enough to allow workers to safely handle sharp or jagged unfinished sheet metal, are used primarily in the automotive, glass and metal fabrication industries. Our higher end Kevlar(R) and Spectra(R) gloves range in price from $37 to $240 for a dozen pair.
We manufacture gloves primarily at our Alabama and Mexican facilities, and we are shifting lower cost yarn production to our China facilities. We completed our shift of glove production to Mexico this year and will continue shifting more to our Chinese facilities and our Indian glove facility (if we exercise our option to acquire) in this fiscal year and next fiscal year. Foreign production will allow lower fabric and labor costs.
We have received patents on manufacturing processes that provide hand protection to the areas of a glove where it wears out prematurely in various applications. For example, the areas of the thumb crotch, and index fingers are made heavier than the balance of the glove providing increased wear protection and longer glove life reducing overall glove costs. This proprietary manufacturing process allows us to produce our gloves more economically and provide a greater value to our end user.
Reusable Woven Garments
We manufacture and market a line of reusable and washable woven garments that complement our fire fighting
and heat protective apparel offerings and provide alternatives to our limited use/disposable protective clothing lines and give us access to the much larger woven industrial and health care-related markets. Cloth reusable garments are favored by customers for certain uses or applications because of familiarity with and acceptance of these fabrics and woven cloth's heavier weight, durability and longevity. These products allow us to supply and satisfy a wider range of safety and customer needs. Our product lines include the following:
o Electrostatic dissipative apparel - used primarily in the automotive industry.
o Clean room apparel - used in semiconductor manufacturing and pharmaceutical manufacturing to protect against human contamination.
o Flame resistant Nomex(R)/FR Cotton coveralls/pants/jackets - used in chemical and petroleum plants and for wild land firefighting.
o Cotton and Polycotton coveralls, lab coats, pants, and shirts.
Our reusable woven garments range in price from $10 to $100 per garment. We manufacture and sell woven cloth garments at our facilities in China and St. Joseph, Missouri. We are continuing to relocate highly repetitive sewing processes for our high volume, standard product lines such as woven protective coveralls and high visibility vests and shirts to our facilities in China where lower fabric and labor costs allow increased profit margins. We expect the relocation process to be substantially complete by the fourth quarter of fiscal 2007.
High Visibility Clothing
In August 2005, we acquired the assets of Mifflin Valley, Inc. of Shillington, PA. Mifflin is a manufacturer of protective clothing specializing in safety and visibility, largely for the Emergency Services market, but also for the entire public safety and traffic control market. Mifflin's high visibility products include Flame Retardant garments for the Fire Industry, Nomex clothing for utilities, and high visibility Reflective Outerwear for Departments of Transportation. Mifflin products are our strategic fit for our Woven and Fire Line of garments and we expect higher than normal sales growth out of this subsidiary as our existing sales force starts promoting this new line.
Quality Control
Our Alabama, Missouri, Mexico and China manufacturing facilities are ISO 9001 certified. ISO standards are internationally recognized quality manufacturing standards established by the International Organization for Standardization based in Geneva, Switzerland. To obtain our ISO registration, our factories were independently audited to test our compliance with the applicable standards. In order to maintain registration, our factories receive regular announced inspections by an independent certification organization. We believe that the ISO 9001 certification makes us more competitive in the marketplace, as customers increasingly recognize the standard as an indication of product quality.
Marketing and Sales
We employ an in-house sales force of 17 people, 3 regional sales managers and utilize 42 independent sales representatives. These employees and representatives call on over 800 safety and mill supply distributors nationwide in order to promote and provide product information for and sell our products. Distributors buy our products for resale and typically maintain inventory at the local level in order to assure quick response times and the ability to service their customers properly. Our sales employees and independent representatives have consistent communication with end users and decision makers at the distribution level, thereby allowing us valuable feedback on market perception of our products, as well as information about new developments in our industry. During fiscal 2006, one single distributor accounted for 5% of our net sales. No other single distributor accounted for more than 5% of our net sales.
We seek to maximize the efficiency of our established distribution network through direct promotion of our products at the end user level. We advertise primarily through trade publications and our promotional activities include sales catalogs, mailings to end users, a nationwide publicity program and our Internet web site. We exhibit at both regional and national trade shows such as the National Safety Congress and the American Industrial Hygienists Convention.
Research and Development
We continue to evaluate and engineer new or innovative products. In the past three years we have introduced the Micromax(R) line of disposable protective clothing; a newly configured line of fire retardant work coveralls and fire turn-out gear; a SARS protective medical gown for Chinese hospital personnel; the Despro(TM), Grapolator(TM) and Microgard-anti microbial cut protective glove and sleeve lines for food service; and our patented Thermbar(TM) Mock Twist that provides heat protection for temperatures up to 600(degree)F. We own 14 patents on various fabrics, patterns and production machinery. We plan to continue investing in research and development to improve protective apparel fabrics and the manufacturing equipment used to make apparel. Specifically, we plan to continue to develop new specially knit and coated gloves, woven gowns for industrial and medical uses, fire retardant cotton fabrics and protective non-woven fabrics. During fiscal 2004, 2005 and 2006, we spent approximately $82,000, $89,000, and $90,000 respectively, on research and development.
Suppliers and Materials
Our largest supplier is DuPont, from whom we purchase Tyvek(R) under North American trademark licensing agreements and Kevlar(R) under international trademark licensing agreements. Commencing in 1995, anticipating the expiration of certain patents on its proprietary materials, DuPont offered certain customers of these materials the opportunity to enter into two year trademark licensing agreements. We entered into such agreements and have renewed them continually since. In fiscal 2006, we purchased approximately 74.1% of the dollar value of our materials from DuPont, and Tyvek(R) constituted approximately 64.4% of our cost of goods sold and 69.1% of the dollar value of our raw material purchases. We believe our relationship with DuPont to be excellent and our Tyvek/Tychem trade mark licenses with DuPont have been extended until January 31, 2008.
We do not have long-term, formal agreements with any other suppliers of non-woven fabric raw materials used by us in the production of our limited use/disposable protective clothing product lines. Materials such as polypropylene, polyethylene, polyvinyl chloride, spun laced polyester and their derivatives are available from thirty or more major mills. Flame retardant fabrics are also available from a number of both domestic and international mills. The accessories used in the production of our disposable garments, such as thread, boxes, snaps and elastics are obtained from unaffiliated suppliers. We have not experienced difficulty in obtaining our requirements for these commodity component items.
We have not experienced difficulty in obtaining materials, including cotton, polyester and nylon, used in the production of reusable non-wovens and commodity gloves. We obtain Spectra(R) yarn used in our super cut-resistant Dextra Guard gloves from Honeywell, and we believe Honeywell will be able to meet our needs for this material in the future. We obtain Kevlar(R), used in the production of our specialty safety gloves, from independent mills that purchase the fiber from DuPont. Our use of Kevlar(R) is subject to an international trademark licensing agreement with DuPont.
Materials used in our fire and heat protective suits include glass fabric, aluminized glass, Nomex(R), aluminized Nomex(R), Kevlar(R), aluminized Kevlar(R), polybenzimidazole and Gortex, as well as combinations utilizing neoprene coatings. Traditional chemical protective suits are made of Viton, butyl rubber and polyvinyl chloride, all of which are available from multiple sources. Advanced chemical protective suits are made from TyChem(R) SL, TK and BR fabrics, which we obtain from DuPont, and our patented fabrics. We have not experienced difficulty obtaining any of these materials.
Competition
Our business is highly competitive due to large competitors who have monopolistic positions in the fabrics that are standards in the industry. We believe that the barriers to entry in the reusable garments and glove markets are relatively low. We face competition in some of our other product markets from large established companies that have greater financial, research and development, sales and technical resources. Where larger competitors, such as DuPont and Kimberly Clark, offer products that are directly competitive with our products, particularly as part of an established line of products, there can be no assurance that we can successfully compete for sales and customers. Larger competitors also may be able to benefit from economies of scale and technological innovation and may introduce new products that compete with our products.
Seasonality
Our operations have historically been seasonal, with higher sales generally occurring in February, March, April and May when scheduled maintenance on nuclear, coal, oil and gas fired utilities, chemical, petrochemical and smelting facilities, and other heavy industrial manufacturing plants occurs, primarily due to moderate spring temperatures. Sales decline during the warmer summer and vacation months and generally increase from Labor Day
through February with slight declines during holidays. As a result of this seasonality in our sales, we have historically experienced a corresponding seasonality in our working capital, specifically inventories, with peak inventories occurring between September and March coinciding with lead times required to accommodate the spring maintenance schedules. We believe that by sustaining higher levels of inventory, we gain a competitive advantage in the marketplace. Certain of our large customers seek sole sourcing to avoid sourcing their requirements from multiple vendors whose prices, delivery times and quality standards differ.
In recent years, due to increased demand by first responders for our chemical suits and fire gear, our historical seasonal pattern has shifted. Governmental disbursements are dependent upon budgetary processes and grant administration processes that do not follow our traditional seasonal sales patterns. Due to the size and timing of these governmental orders, our net sales, results of operations, working capital requirements and cash flows can vary between different reporting periods. As a result, we expect to experience increased variability in net sales, net income, working capital requirements and cash flows on a quarterly basis.
Patents and Trademarks
We own 14 patents and have 9 patents in the application and approval process with the U.S. Patent and Trademark Office. We own 11 Trademarks and have 9 Trademarks in the application and approval process. Additionally, a Patent Corporation Treaty application was filed for our Unilayer Glove Fabrics which involves technology using a robotic knitter that allows us to knit a glove using stronger or weaker yarns in different parts of the glove, as necessary, depending on the expected wear. Intellectual property rights that apply to our various products include patents, trade secrets, trademarks and to a lesser extent copyrights. We maintain an active program to protect our technology by ensuring respect for our intellectual property rights. We presently have no contracts with these unions
Employees
As of March 31, 2006, we had approximately 1,634 full time employees, 1,348, or 82.50%, of whom were employed in our international facilities and 286, or 17.50%, of whom were employed in our domestic facilities. An aggregate of 582 of our employees, representing a majority of our employees in our Mexico facility and in each of our China facilities, are members of unions. We are not currently a party to any collective bargaining agreements. We believe our employee relations to be excellent. We presently have no contracts with these unions.
Environmental Matters
We are subject to various foreign, federal, state and local environmental protection, chemical control, and health and safety laws and regulations, and we incur costs to comply with those laws. We own and lease real property, and certain environmental laws hold current or previous owners or operators of businesses and real property responsible for contamination on or originating from property, even if they did not know of or were not responsible for the contamination. The presence of hazardous substances on any of our properties or the failure to meet environmental regulatory requirements could affect our ability to use or to sell the property or to use the property as collateral for borrowing, and could result in substantial remediation or compliance costs. If hazardous substances are released from or located on any of our properties, we could incur substantial costs and damages.
Although we have not in the past had any material costs or damages associated with environmental claims or compliance and we do not currently anticipate any such costs or damages, we cannot assure you that we will not incur material costs or damages in the future, as a result of the discovery of new facts or conditions, acquisition of new properties, the release of hazardous substances, a change in interpretation of existing environmental laws or the adoption of new environmental laws.
Available Information
We make available free of charge through our Internet website, www.lakeland.com, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission.
ITEM 1A. RISK FACTORS ---------------------- RISK FACTORS
You should carefully consider the following risks before investing in our common stock. These are not the only risks that we may face. If any of the events referred to below actually occurs, our business, financial condition, liquidity and results of operations could suffer. In that case, the trading price of our common stock could decline
and you may lose all or part of your investment. You should also refer to the other information in this Form 10-K and Annual Report and in the documents we incorporate by reference into this Form 10-K and Annual Report, including our consolidated financial statements and the related notes.
Risk Related to Our Business
We rely on a limited number of suppliers and manufacturers for specific fabrics, including Tyvek(R) and Tychem(R), and we may not be able to obtain substitute suppliers and manufacturers on terms that are as favorable, or at all, if our supplies are interrupted.
Our business is dependent to a significant degree upon close relationships with vendors and our ability to purchase raw materials at competitive prices. The loss of key vendor support, particularly support by DuPont for its Tyvek(R) products, could have a material adverse effect on our business, financial condition, results of operations and cash flows. We do not have long-term supply contracts with DuPont or our other fabric suppliers. In addition, DuPont also uses Tyvek(R) and Tychem (R) in some of its own products which compete directly with our products. As a result, there can be no assurance that we will be able to acquire Tyvek(R), Tychem(R) and other raw materials and components at competitive prices or on competitive terms in the future. For example, certain materials that are high profile and in high demand may be allocated by vendors to their customers based upon the vendors' internal criteria, which are beyond our control.
In fiscal 2006, we purchased approximately 74.01% of the dollar value of our raw materials from DuPont, and Tyvek(R) constituted approximately 69.1% of our cost of goods sold. For periods in 1985 and 1989, DuPont placed all purchasers of Tyvek(R) on "allocation." "Allocation" is a circumstance in which demand outstrips supply and fabrics are sold based upon the amount a buyer purchased the prior year. This allocation limited our ability to meet demand for our products. There can be no assurance that an adequate supply of Tyvek(R) or Tychem(R) will be available in the future. Any shortage could adversely affect our ability to manufacture our products, and thus reduce our net sales.
Other than DuPont's Tyvek(R) and TyChem(R) fabrics, we generally use standard fabrics and components in our products. We rely on non-affiliated suppliers and manufacturers for the supply of these fabrics and components that are incorporated in our products. If such suppliers or manufacturers experience financial, operational, manufacturing capacity or quality assurance difficulties, or if there is a disruption in our relationships, we will be required to locate alternative sources of supply. We cannot assure you that we will be able to locate such alternative sources. In addition, we do not have any long-term contracts with any of our suppliers for any of these components. Our inability to obtain sufficient quantities of these components, if and as required in the future, may result in:
o Interruptions and delays in manufacturing and resulting cancellations of orders for our products; o Increases in fabrics or component prices that we may not be able to pass on to our customers; and o Our holding more inventory that normal because we cannot finish assembling our products until we have all of the components
We are subject to risk as a result of our international manufacturing operations.
Because most of our products are manufactured at our facilities located in China and Mexico, our operations are subject to risk inherent in doing business internationally. Such risks include the adverse effects on operations from war, international terrorism, civil disturbances, political instability, governmental activities and deprivation of contract and property rights. In particular, since 1978, the Chinese government has been reforming its economic and political systems, and we expect this to continue. Although we believe that these reforms have had a positive effect on the economic development of China and have improved our ability to successfully operate our facilities in China, we cannot assure you that these reforms will continue or that the Chinese government will not take actions that
impair our operations or assets in China. In addition, periods of international unrest may impede our ability to manufacture goods in other countries and could have a material adverse effect on our business and results of operations.
Our results of operations could be negatively affected by potential fluctuations in foreign currency exchange rates.
Most of our assembly arrangements with our foreign-based subsidiaries or third party suppliers require payment to be made in U.S. dollars. These payments aggregated $9.9 million in fiscal 2006. Any decrease in the value of the U.S. dollar in relation to foreign currencies could increase the cost of the services provided to us upon contract expirations or supply renegotiations. There can be no assurance that we will be able to increase product prices to offset any such cost increases and any failure to do so could have a material adverse effect on our business, financial condition and results of operations.
We are also exposed to foreign currency exchange rate risks as a result of our sales in foreign countries. Our net sales to customers in Canada and China were $8.1 million, in fiscal 2006. Our sales in Canada are denominated in Canadian dollars. If the value of the U.S. dollar increases relative to the Canadian dollar and we are unable to raise our prices proportionally, then our profit margins could decrease because of the exchange rate change. Although our fabric and compenent costs in China are denominated in the Chinese Yuan, this currency has historically been largely pegged to the U.S. dollar, which has minimized our foreign currency exchange rate risk in China. Recently, however the Chinese Yuan has been allowed to float against to the U.S. dollar, and therefore, we will be exposed to additional foreign currency exchange rate risk. This risk will also increase as we continue to increase our sales in other foreign countries. See "Management's Discussion and Analysis of Financial condition and Results of Operations - Quantitative and Qualitative Disclosures About Market Risk - Foreign Currency Risk."
Rapid technological change could negatively affect sales of our products and our performance.
The rapid development of fabric technology continually affects our apparel applications and may directly impact the performance of our products. For example, microporous film-based products have eroded the market share of Tyvek(R) in certain applications. We cannot assure you that we will successfully maintain or improve the effectiveness of our existing products, nor can we assure you that we will successfully identify new opportunities or continue to have the needed financial resources to develop new fabric or apparel manufacturing techniques in a timely or cost-effective manner. In addition, products manufactured by others may render our products obsolete or non-competitive. If any of these events occur, our business, prospects, financial condition and operating results will be materially and adversely affected.
Acquisitions or future expansion could be unsuccessful.
Mifflin Valley, Inc., a Pennsylvania company, acquired on August 1, 2005, and a portion of the assets of RFB Latex, an Indian company, which we have the option to acquire in autumn 2006 currently market high visibility clothing and chemically resistant gloves. These two new lines may accelerate our growth in the personal protective equipment market. This past and potential upcoming acquisition involve various risks, including: difficulties in integrating these companies' operations, technologies, and products, the risk of diverting management's attention from normal daily operations of the business; potential difficulties in completing projects associated with in-process research and development; risks of entering markets in which we have limited experience and where competitors in such markets have stronger market positions; initial dependence on unfamiliar supply chains; and insufficient revenues to offset increased expenses associated with these acquisitions.
In the future, we may seek to acquire additional selected safety products lines or safety-related businesses which
will complement our existing products. Our ability to acquire these businesses is dependent upon many factors, including our management's relationship with the owners of these businesses, many of which are small and closely held by individual stockholders. In addition, we will be competing for acquisition and expansion opportunities with other companies, many of which have greater name recognition, marketing support and financial resources than us, which may result in fewer acquisition opportunities for us as well as higher acquisition prices. There can be no assurance that we will be able to identify, pursue or acquire any targeted business and, if acquired, there can be no assurance that we will be able to profitably manage additional businesses or successfully integrate acquired business into our company without substantial costs, delays and other operational or financial problems.
If we proceed with any significant acquisition for cash, we may use a substantial portion of our available cash in order to consummate any such acquisition. We may also seek to finance any such acquisition through debt or equity financings, and there can be no assurance that such financings will be available on acceptable terms or at all. If consideration for an acquisition consists of equity securities, our stockholders could be diluted. If we borrow funds in order to finance an acquisition, we may not be able to obtain such funds on terms that are favorable to us. In addition, such indebtedness may limit our ability to operate our business as we currently intend because of restrictions placed on us under the terms of the indebtedness and because we may be required to dedicate a substantial portion of our cash flow to payments on the debt instead of to our operations, which may place us at a competitive disadvantage.
Acquisitions involve a number of special risks in addition to those mentioned above, including the diversion of management's attention to the assimilation of the operations and personnel of the acquired companies, the potential loss of key employees of acquired companies, potential exposure to unknown liabilities, adverse effects on our reported operating results, and the amortization or write down of acquired intangible assets. We cannot assure you that any acquisition by us will or will not occur, that if an acquisition does occur that it will not materially and adversely affect our results of operations or that any such acquisition will be successful in enhancing our business.
If we are unable to manage our growth, our business could be adversely affected.
Our operations and business have expanded substantially in recent years, with a large increase in employees and business areas in a short period of time. To manage our rapid growth properly, we have been and will be required to expend significant management and financial resources. There can be no assurance that our systems, procedures and controls will be adequate to support our operations as they expand. There can also be no assurance that our management will be able to manage our growth and operate a larger organization efficiently or profitably. To the extent that we are unable to mange growth efficiently and effectively or are unable to attract and retain additional qualified management personnel, our business, financial condition and results of operations could be materially and adversely affected.
We must recruit and retain skilled employees, including our senior management, to succeed in our business.
Our performance is substantially dependent on the continued services and performance of our senior management and certain other key personnel, including Christopher J. Ryan, our chief executive officer, president, general counsel and secretary, and Gary Pokrassa, our chief financial officer, who has 36 years of financial and accounting experience, and James McCormick our Controller and treasurer, Greg Willis, our Executive Vice President, and Harvey Pride, Jr., our vice president in charge of manufacturing, due to their long experience in our industry. Our executive officers, other than CFO, have an average tenure with us of 18 years and an average of 21 years of experience in our industry. The loss of services of any of our executive officers or other key employees could have a material adverse effect on our business, financial condition and results of operations. In addition, any future expansion of our business will depend on our ability to identify, attract, hire, train, retain and motivate other highly skilled managerial, marketing, customer service and manufacturing personnel and our inability to do so could have a material adverse effect on our business, financial condition and results of operations.
Because we do not have long-term commitments from many of our customers, we must estimate customer demand and errors in our estimates could negatively impact our inventory levels and net sales.
Our sales are generally made on the basis of individual purchase orders, which may later be modified or canceled by the customer, rather than long-term commitments. We have historically been required to place firm orders for fabrics and components with our suppliers, prior to receiving an order for our products, based on our forecasts of customer demands. Our sales process requires us to make multiple demand forecast assumptions, each of which may introduce error into our estimates, causing excess inventory to accrue or a lack of manufacturing capacity when needed. If we overestimate customer demand, we may allocate resources to manufacturing products that we may not be able to sell when we expect or at all. As a result, we would have excess inventory, which would negatively impact our financial results. Conversely, if we underestimate customer demand or if insufficient manufacturing capacity is available, we would lose sales opportunities, lose market share and damage our customer relationships. On occasion, we have been unable to adequately respond to delivery dates required by our customers because of the lead time needed for us to obtain required materials or to send fabrics to our assembly facilities in China and Mexico.
We face competition from other companies, two of which have substantially greater resources than we do.
Two of our competitors, DuPont and Kimberly Clark, have substantially greater financial, marketing and sales resources than we do. In addition, we believe that the barriers to entry in the reusable garments and gloves markets are relatively low. We cannot assure you that our present competitors or competitors that choose to enter the marketplace in the future will not exert significant competitive pressures. Such competition could have a material adverse effect on our net sales and results of operations. For further discussion of the competition we face in our business, see "Business - Competition."
Some of our sales are to foreign buyers, which exposes us to additional risks.
We derived approximately 9.8% of our net sales from customers located in foreign countries in fiscal 2006. We intend to increase the amount of foreign sales we make in the future. The additional risks of foreign sales include: o Potential adverse fluctuations in foreign currency exchange rates; o Higher credit risks; o Restrictive trade policies of foreign governments; o Currency nullification and weak banking institutions; o Changing economic conditions in local markets; o Political and economic instability in foreign markets; and o Changes in leadership of foreign governments.
Some or all of these risks may negatively impact our results of operations and financial condition.
Covenants in our credit facilities may restrict our financial and operating flexibility.
We currently have one credit facility;
o A five year $25 million revolving credit facility, of which we had $7.3 million of borrowings outstanding as
of January 31, 2006; and
Our current credit facility requires, and any future credit facilities may also require, that we comply with specified financial covenants relating to interest coverage, debt coverage, minimum consolidated net worth, and earnings before interest, taxes, depreciation and amortization. Our ability to satisfy these financial covenants can be affected by events beyond our control, and we cannot assure you 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 have a security interest in substantially all of our assets to secure the debt under our current credit facilities, and it is likely that our future lenders will have security interests in our assets. 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.
We may need additional funds, and if we are unable to obtain these funds, we may not be able to expand or operate our business as planned.
Our operations require significant amounts of cash, and we may be required to seek additional capital, whether from sales of equity or by borrowing money, to fund acquisitions, for the future growth and development of our business or to fund our operations and inventory, particularly in the event of a market downturn. Although we have the ability until July 31, 2010 to borrow additional sums under our $25 million revolving credit facility, this facility contains a borrowing base provision and financial covenants that may limit the amount we can borrow thereunder or from other sources. We may not be able to replace or renew this credit facility upon its expiration on terms that are as favorable to us or at all. In addition, a number of factors could affect our ability to access debt or equity financing, including; o Our financial condition, strength and credit rating; o The financial markets' confidence in our management team and financial reporting; o General economic conditions and the conditions in the homeland security sector; and o Capital markets conditions.
Even if available, additional financing could be costly or have adverse consequences. If additional funds are raised through the incurrence of debt, we will incur increased debt servicing costs and may become subject to additional restrictive financial and other covenants. We can give no assurance as to the terms or availability of additional capital. If we are not successful in obtaining sufficient capital, it could reduce our net sales and net income and adversely impact our financial position, and we may not be able to expand or operate our business as planned.
A reduction in government funding for preparations for terrorist incidents that could adversely affect our net sales.
As a general matter, a significant portion of our sales growth to our distributors is dependent upon resale by those distributors to customers that are funded in large part by federal, state and local government funding. Specifically, approximately 60% of our high-end chemical suit sales is dependent on government funding. Congress passed the 2001 Assistance to Firefighters Grant Program and the Bioterrorism Preparedness and Response Act of 2002. Both of these Acts provide for funding to fire and police departments and medical and emergency personnel to respond to terrorist incidents. Appropriations for these Acts by the federal government could be reduced or eliminated altogether. Any such reduction or elimination of federal funding, or any reductions in state or local funding, could cause sales of our products purchased by fire and police departments and medical and emergency personnel to decline.
We may be subject to product liability claims, and insurance coverage could be inadequate or unavailable to
cover these claims.
We manufacture products used for protection from hazardous or potentially lethal substances, such as chemical and biological toxins, fire, viruses and bacteria. The products that we manufacture are typically used in applications and situations that involve high levels of risk of personal injury. Failure to use our products for their intended purposes, failure to use our products properly or the malfunction of our products could result in serious bodily injury to or death of the user. In such cases, we may be subject to product liability claims arising from the design, manufacture or sale of our products. If these claims are decided against us and we are found to be liable, we may be required to pay substantial damages and our insurance costs may increase significantly as a result. We cannot assure you that our insurance coverage would be sufficient to cover the payment of any potential claim. In addition, we cannot assure you that this or any other insurance coverage will continue to be available or, if available, that we will be able to obtain it at a reasonable cost. Any material uninsured loss could have a material adverse effect on our financial condition, results of operations and cash flows.
Environmental laws and regulations may subject us to significant liabilities.
Our U.S. operations, including our manufacturing facilities, are subject to federal, state and local environmental laws and regulations relating to the discharge, storage, treatment, handling, disposal and remediation of certain materials, substances and wastes. Any violation of any of those laws and regulations could cause us to incur substantial liability to the Environmental Protection Agency, the state environmental agencies in any affected state or to any individuals affect by any such violation. Any such liability could have a material adverse effect on our financial condition and results of operations.
The market price of our common stock may fluctuate widely.
The market price of our common stock could be subject to significant fluctuations in response to quarter-to-quarter variation in our operating results, announcements of new products or services by us or our competitors, and other events or factors. For example, a shortfall in net sales or net income, or an increase in losses, from levels expected by securities analysts, could have an immediate and significant adverse effect on the market price and volume fluctuations that have particularly affected the market prices of many micro and small capitalization companies and that have often been unrelated or disproportionate to the operating performance of these companies. These fluctuations, as well as general economic and market conditions, may adversely affect the market price for our common stock.
Our results of operations may vary widely from quarter to quarter.
Our quarterly results of operations have varied and are expected to continue to vary in the future. These fluctuations may be caused by many factors, including:
o Competitive pricing pressures; o Seasonal buying patterns resulting from the cyclical nature of the business of some of our customers; o The size and timing of individual sales; o Changes in the mix of products and services sold; o The timing of introductions and enhancements of products by us or our competitors; o Market acceptance of new products; o Technological changes in fabrics or production equipment used to make our products; o Changes in the mix of domestic and international sales;
o Personnel changes; o Our expansion of international operations; and o General industry and economic conditions.
These variations could negatively impact our stock price.
Compliance with the Sarbanes-Oxley Act of 2002 and rules and regulations relating to corporate governance and public disclosure may result in additional expenses and negatively impact our results of operations.
The Sarbanes-Oxley Act of 2002 and rules and regulations promulgated by the Securities and Exchange Commission and the Nasdaq Stock Market have greatly increased the scope, complexity and cost of corporate governance, reporting and disclosure practices for public companies, including our company. Keeping abreast of, and in compliance with, these laws, rules and regulations have required an increased amount of resources and management attention. In the future, this may result in increased general and administrative expenses and a diversion of management time and attention from sales-generating and other operating activities to compliance activities, which would negatively impact our results of operations.
In addition, the corporate governance, reporting and disclosure laws, rules and regulations could also make it more difficult for us to attract and retain qualified executive officers and members of our board of directors. In particular, the Nasdaq Stock Market rules require a majority of our directors to be "independent" as determined by our board of directors in compliance with the Nasdaq rules. It therefore has become more difficult and significantly more expensive to attract such independent directors to our Board.
Our directors and executive officers have the ability to exert significant influence on our company and on matters subject to a vote of our stockholders.
As of April 12, 2006, our directors and executive officers beneficially owned approximately 19.2% of the outstanding shares of our common stock. As a result of their ownership of common stock and their positions in our company, our directors and executive officers are able to exert significant influence on our company and on matters submitted to a vote by our stockholders. In particular, as of April 12, 2006, Raymond J. Smith, our chairman of the board, and Christopher J. Ryan, our chief executive officer, president, general counsel and secretary and a director, beneficially owned approximately 9.56% and 6.52% of our common stock, respectively. The ownership interests of our directors and executive officers, including Messrs. Smith and Ryan, could have the effect of delaying or preventing a change of control of our company that may be favored by our stockholders generally.
Provisions in our restated certificate of incorporation and by-laws and Delaware law could make a merger, tender offer or proxy contest difficult.
Our restated certificate of incorporation contains "super majority" voting and classified board provisions, authorized preferred stock that could be utilized to implement various "poison pill" defenses and a stockholder authorized, but as yet unused, Employee stock Ownership Plan, all of which may have the effect of discouraging a takeover of Lakeland which is not approved by our board of directors. Further, we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which prohibit us from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in the prescribed manner. For a description of these provisions, see "Description of Capital Stock - Anti-Takeover Provisions."
ITEM 1B: UNRESOLVED STAFF COMMENTS ---------------------------------- None.
