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Edited Transcript of LAKE earnings conference call or presentation 10-Sep-18 8:30pm GMT

Q2 2018 Lakeland Industries Inc Earnings Call

RONKONKOMA Sep 27, 2018 (Thomson StreetEvents) -- Edited Transcript of Lakeland Industries Inc earnings conference call or presentation Monday, September 10, 2018 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher J. Ryan

Lakeland Industries, Inc. - CEO, President, Secretary & Director

* Teri W. Hunt

Lakeland Industries, Inc. - CFO

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Conference Call Participants

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* Alex Joseph Fuhrman

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* David Michael King

Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst

* Peter Muckerman

Raymond James - Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to Lakeland's Second Quarter Fiscal Year 2019 Earnings Release. (Operator Instructions) As a reminder, this conference is being recorded.

Forward-looking statements involve risks, uncertainties and assumptions as described from time-to-time in press releases and Forms 8-K, registration statements, quarterly and annual reports and other reports and filings filed with the Securities and Exchange Commission or made by management. All statements, other than statements of historical facts, which address Lakeland's expectations of sources or uses for capital or which express the company's expectation for the future with respect to financial performance or operating strategies can be identified as forward-looking statements. As a result, there can be no assurance that Lakeland's future results will not be materially different from those described herein as believed, projected, planned, intended, anticipated, estimated or expected or other words, which reflect the current view of the company with respect to future events.

We caution readers that these forward-looking statements speak only as of the date hereof. The company hereby expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any such statements to reflect any change in the company's expectations or any change in events, conditions or circumstances on which such statement is based.

I would now like to turn the conference over to your host, Christopher Ryan, CEO. Please go ahead.

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Christopher J. Ryan, Lakeland Industries, Inc. - CEO, President, Secretary & Director [2]

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Good afternoon to you all. Thank you for joining our fiscal 2019 second quarter financial results conference call. We are going to provide opening statements on the status of operations and on our financial results. The call will then be opened up so that we may respond to your questions.

Now on to my formal remarks. Our top line performance for the second quarter of fiscal 2019 shows strong improvement amid a continuation of global industrial growth trends that has favorably impacted Lakeland for the past 3 quarters. But the more important story is the progress achieved in our efforts to drive sustainable improvements in longer-term top line results, as well as bottom line performance. The global industrial economic landscape remains fertile. The oil and gas sector has rebounded from lows of the year or more ago, and the automotive sector has been cooperating.

In addition to these long-standing target markets for our products, we've been successfully introducing new products and penetrating multiple geographic markets to help drive our sales and brand on a global stage.

We achieved the second consecutive year of revenue growth for the second quarter since the level of sales in the second quarter of fiscal 2016 had been significantly heightened due to demand resulting from a devastating bird flu viral outbreak. Second quarter fiscal 2019 sales were 7.1% higher than the year-earlier period, which is higher rate of growth than the year-over-year improvement of 6.0% for the first quarter. Our second quarter '19 results would have been more outstanding if we had not missed 3 days of revenue from our U.S. operations due to the implementation in this country, the first phase of our global ERP system rollout.

The ERP implementation on the Sage X3 platform is a critical component of a more evolutionary development for Lakeland. I'm speaking about our digital transformation, which is expected to improve our long-term financial performance and competitiveness on a global scale. This transformation includes initiatives to generate higher sales from multiple product categories and customer segments, improve gross margins, drive operating leverage and cash management, further strengthening our balance sheet and yield sustainably higher long-term financial performance and management effectiveness.

In the immediate term of the second quarter and the third quarter of fiscal 2019, the investments and cut-over adjustments for the new system implemented in the U.S. will impact our financial results. On a rolling basis, we also will be deploying the ERP system in our other major operations globally, but the most significant costs and disruptions were incurred in the second quarter, as the implementation took hold in the U.S., which represents about half our global revenues.

Another component of our digital transformation is an e-commerce strategy, with sales and distribution on Amazon.com. This is an important extension to our plans for long-term revenue growth and customer diversification, while potentially providing contributions to margin enhancements and inventory management benefits. Our e-commerce strategy utilizes Amazon.com as the cornerstone of our cloud-based platform for online distribution, and serves as an ideal complement to our long-standing practices of sales and marketing on a business-to-business basis and through third-party distributors.

We are in effect leveraging alternative distribution channels, principally with Amazon, for retail and small business customer sales. We began distributing a limited set of products earlier this year on Amazon.com. In the U.S., distribution on Amazon platform will be rolled out in multiple subsidiaries throughout our fiscal year. We commenced Amazon sales in Canada with a limited number of products during the fiscal second quarter. Mexico is being rolled out in the third quarter, with our next launches on Amazon to take place in Australia and Europe. Lakeland has hired an e-commerce specialist to help drive its online growth strategy. The company's global e-commerce activities will be managed from our primary U.S. operation center in Decatur, Alabama.

The current process involves building and growing Lakeland's online sales through the use of established global and regional platforms, such as Amazon. Additional regional e-commerce platforms in various parts of the world may be added as needed to accelerate Lakeland's online presence in the particular global market.

For these online efforts, we are developed -- we are also developing new marketing campaigns and product-specific images, infographics and videos, among other media for use with Amazon product listings. "Innovation meets protection" is the branding that has been created for use online, and is modeled after the company's global reputation for high-quality manufacturing, multisource materials and safeguarding advantages of its garments. Content will be available for use on other e-commerce platforms, and for use with the company's traditional distribution partners for their online needs.

As part of this rollout process, Lakeland has been building out its IT operations and marketing infrastructure to integrate with Amazon and other online outlets in multiple countries. Essentially, Lakeland intends to make online marketing the core competency that complements its traditional direct and indirect sales channels.

Greater emphasis is being placed on digital marketing strategies, including inbound marketing campaigns. To this end, Lakeland has been making great strides to be an even more recognizable and branded player, with new online training and webinars. For each of these markets where we market products via Amazon, our process leveraged the investments made by the company last year for development of fulfillment capabilities for the same-day, next-day delivery. The company has made additional information technology investments to accommodate its e-commerce strategy as part of the complete global ERP, management information and inventory system installation.

Across the board, we are making solid progress, as revenues increased in our domestic and international operations despite the U.S. dollar surging against most of the foreign currencies we do business in. All major country operations were profitable in the second quarter, so we continue to maintain focus on our profitability metrics, while investing in the future growth strategies. One such investment during the second quarter has been the ramping up and commencement of operations of our new manufacturing facility in Vietnam. Since the first quarter, we have nearly doubled the workforce at this facility, which had a staff of 350 at July 31, 2018. Longer term, we expect to increase our manufacturing team in Vietnam to 600. Manufacturing there should provide a lower cost basis, as compared to China, and presents more favorable trade conditions for our sales into Asia Pacific, Europe, Russia, South America and North America.

Approximately 60% of our $0.9 million in capital expenditures in the second quarter was from machinery in Vietnam. We also have begun investing in India, which is expected to become a very large manufacturing hub for the company. This additional production capacity positions the company to increase sales globally, and reduce our cost of production, while expanding our sourcing of raw materials.

An unintended beneficial consequence has also been realized by the diversification of our manufacturing. While at this juncture, we have not experienced any changes in demand or pricing resulting from recent U.S.-China trade discussions, we will be prepared with Vietnam and other manufacturing locational turns, should the need arise. With all these investments and the topping off of our inventory, our cash flow has enabled our cash to remain at a very healthy level at nearly $15 million at the end of the quarter or about $1.84 per basic share outstanding, while we continue to have very little long-term debt, and we're able to reduce total debt by over 12% since the beginning of the fiscal year to $1.5 million at July 31. This cash and open lines of bank credit should make small, strategic acquisitions doable. But we will only look at acquisitions that are easy fit-ins, and are anti-dilutive to the parent's earnings.

Amidst the many developments and initiatives taking place in the second quarter, it was important that we had the leadership to best address our opportunities and challenges. To this end, we were pleased to have strength in our leadership team in the promotion of Charles Roberson to the position of Chief Operating Officer in July. This marks another executive appointment through promotion from within the company, and demonstrates the depth of our management team. Charlie had been serving Lakeland as our Senior Vice President of International Sales since March 2009 and Head of Research and Development since 2008. He joined Lakeland in 2004 as Technical Marketing Manager and later served as International Sales Manager.

Prior to joining Lakeland, Charlie was employed by Precision Fabrics Group, Inc., and as a Marketing Manager and a Nonwovens Manufacturing Manager after beginning his career as a Manufacturing Manager for Burlington Industries. Charlie replaced our Former COO, who had retired from the company last year. This also led to a vacancy at our board level, although at that time we appointed Jeffrey Schlarbaum to our Board of Directors. I'm pleased to report that at the Annual General Meeting held in July, our shareholders elected Jeffrey to our board for a 3-year term. Jeffrey is President and Chief Executive Officer of an NYSE-listed IEC Electronics based in Upstate New York.

In conclusion, we have built a lot of momentum through the first half of fiscal 2019, and remain very encouraged by our strong financial condition and our continued ability to further improve the company's top and bottom line performance. As we look toward the balance of fiscal 2019 and beyond, we are very encouraged by our solid financial position and the growth prospects that are within reach, given our diversified business lines, our optimized supply chain and indications of continued global economic strength.

That concludes my remarks. I will now pass the call over to our CFO, Teri Hunt, to provide a more thorough review of the company's second quarter financial results.

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Teri W. Hunt, Lakeland Industries, Inc. - CFO [3]

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Thank you, Chris. The following addresses our review of the fiscal '19 second quarter, ended July 31, 2018.

Net sales from continuing operations grew to $25.6 million from $23.9 million in the year-earlier period and up from $24.3 million in the first quarter of this year. As compared to the earlier period, overall sales volume was higher, which resulted from global economic growth of a somewhat rebounded oil and gas sector and continued traction domestically and internationally. For the third consecutive quarter, demand for our products sold into the oil and gas sector has been strong and consistent with our expectation, as oil prices trade in a similar range as to where they are today.

Other growing product categories are FR, or flame retardant, and heat resistant garment. Both are generally higher margin, and include our new line of protective apparel developed for sale into the utility sectors.

Total sales in the U.S. increased 8.2%, primarily resulting from demand for disposables and wovens product lines, as well as FR-related garments. Among the company's larger international operations, sales in China into the Asia Pacific Rim increased 6.1%, mostly as a result of increased intercompany demand that's eliminated in consolidation. Canada sales decreased $0.2 million or 6.9%, as compared to the prior year period, in which the wildfire response created unusually high demand. U.K. sales increased $0.5 million or 22.9%, as new distributors in Europe continue to place initial stocking orders. Russia and Kazakhstan sales, combined increased $0.5 million as the company continues to gain customers in this region, and Latin America sales increased $0.5 million.

Domestic sales were 52.2% of total revenues, and international sales were 47.8% of total revenues in the second quarter. This compares with domestic sales of 52.8%, international sales of 47.2% of the total in the same period of fiscal 2018. Gross profit increased $0.5 million or 5.3% to $9.2 million for 2Q '19 over $8.7 million for the prior year period. Gross profit, as a percentage of net sales, decreased to 35.7% for 2Q '19 from 36.3% last year. The gross margin decline reflects sales mix for certain product groups within disposables and chemical suits and some warehouse reorganization expenses in our U.S. facility, which was partially offset by price increases in select markets around the world in effort to market higher-margin woven and FR products globally, particularly into the pipeline industry and to electric utilities domestically.

Operating expense increased 15.3% to $7.5 million for 2Q '19 from $6.5 million last year second quarter and from $7.1 million in the first quarter this year. The main factors for the increase in operating expenses as compared to the prior year period are a $0.1 million increase in equity compensation, and for sales salaries as the company continues to ramp up sales efforts and expands its international sales force; a $0.1 million increase for commissions in freight as a result of increased sales volumes; $0.2 million increase in currency expense relating to fluctuations primarily in Latin America, U.K., Canada; and a $0.1 million increase in IT infrastructure expenditures.

In addition, we experienced elevated expenses in connection with the ERP installation in the U.S. that could to a lesser degree continue into Q3 and Q4. As we've previously disclosed, 5 salespeople were added in calendar 2017, and we added at least 3 more sales and marketing people to the first half of calendar '18. It typically takes 6 to 12 months for salespeople to meet their quotas while we begin to break even on them. So again, we have expectations that our sales will grow to provide greater coverage on our present expense level.

We are now carrying more personnel from the ramping up of manufacturing operations in Vietnam, and to a much lesser extent, India. India will see a more pronounced increase in operating expenses next year. Our manufacturing productivity in Vietnam and India require additional training before approaching efficiency levels of our other production facilities.

For our international expansion, we're building out our presence in various foreign markets, and adding sales and marketing staff, warehousing and other support personnel. These comps are elevated today, relative to contributions from their respective operations. But as we gain operating leverage, as our brand and sales development efforts take hold, and when our manufacturing teams get up to speed, we expect them to normalize.

Consolidated operating expense, as a percentage of net sales, was 2.93% -- 29.3%, up from 27.2% for the prior year period. As a result of the aforementioned, operating income decreased to $1.6 million for 2Q '19 from $2.2 million for the same period in the prior year. Operating margins were 6.5% for 2Q '19 compared with 9.1% in the prior year. All primary geographic regions where we have revenues produced positive operating income for the quarter.

Net income for the 3 months ended July 31, 2018, was $1.0 million or $0.12 per diluted share compared with $1.8 million or $0.25 per diluted share for the 3 months ended July 31, '17. The results for the 3 months ended July 31, '18, are primarily due to increased operating expenses, including spending on global growth initiatives, such as additional salespeople, investment in lower-cost manufacturing in Vietnam and IT investments, and a reduced gross margin, which was partially offset by an increase in sales volume.

Income tax expense for the quarter was $0.6 million compared with $0.3 million in the same quarter last year. The company continues to be required to pay local taxes on certain country operations when those operations are profitable on a local basis and prior to consolidation for U.S. GAAP. Cash paid for foreign subsidiary taxes in the second quarter of fiscal '19 was $0.5 million compared with $0.4 million for the second quarter of fiscal '18.

Adjusted earnings before interest, tax, depreciation and amortization, a non-GAAP measure which includes stock-based compensation, was $2.1 million as compared to just under $2.5 million in 2Q '18.

Free cash flow, also a non-GAAP measure, was over $0.6 million in 2Q '19, down from $1.8 million in the prior year period. On the balance sheet, cash and cash equivalents decreased to $15 million from $15.8 million at the beginning of the fiscal year.

To accommodate continued global growth in the ERP system switchover in the U.S., inventories increased to $46.4 million, up from $44.4 million at the end of 1Q '19 and $42.9 million at the beginning of the fiscal year. Working capital increased to $68.3 million from $66 million at the end of the first quarter and $66.1 million at January 31, '18. At July 31, '18, the balance of borrowings under our $20 million revolving credit facility stood at 0, which was the same as at the end of the last quarter and last year end.

Total debt outstanding at July 31, '18 was $1.5 million, down from $1.6 million at April 30, 2018, and $1.7 million at the start of the fiscal year. The company incurred CapEx of approximately $0.9 million during the second quarter, as compared with $0.3 million for the first quarter of fiscal 2019. Capital expenditures principally relate to the addition of equipment in Vietnam and India, and for the phased global ERP rollout. We expect CapEx for all fiscal '19 to be approximately $2.0 million to $2.5 million, which includes the cost for our increased manufacturing capacity and additional IT investments.

That concludes my remarks. I will turn the call back to the operator to begin the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Dave King from Roth Capital.

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David Michael King, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [2]

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What sort of impacts did the ERP implementation have on gross profit and OpEx during the quarter even on a dollar or margin basis? And then to what extent do you expect those costs to subside in the coming quarters? It sounds like you'll be expecting them to come down a bit, just trying to get a sense of the magnitude there. And then on the shipment delays, have those continued into Q3? And how long did those continue? Is it still impacting the business?

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Teri W. Hunt, Lakeland Industries, Inc. - CFO [3]

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Well, on the shipment delays, it was about 2 weeks somewhat. It was a slowdown process, not a stoppage altogether. For 3 days, we were down doing inventory and putting opening balances into the new system. So we don't anticipate the ERP implementation to negatively impact Q3 sales due to delayed shipping. As far as the impact on margin, on gross margin, there was some additional labor and management process and warehouse reorganization that took place in the quarter that we don't expect to be significant in Q3 and Q4. There were some expenses also associated with the ERP in terms of just general cleanup and getting the information into the system, data entry, that type of thing, that was an impact on both gross margins and operating margin. To a lesser degree, we will see some continuing operating expenses associated with ERP into Q3 and Q4, but, again, it will make a lesser impact as those process -- all of our processes smooth out, and we have -- don't have the required -- have the need for additional temporary labor to do some of the lower level data entry type work, and the relabeling, things of that nature in the warehouse that we're on top of at this point.

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David Michael King, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [4]

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Okay. So just to kind of get a sense to size this up, in Q2, you've kind of had a several hundred thousand dollars of incremental cost of goods sold in OpEx? Or is it tens of thousands of dollars?

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Teri W. Hunt, Lakeland Industries, Inc. - CFO [5]

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Yes -- no, no. It's a couple hundred thousand dollars that we had to incur to get all this done. Some of it is expenses that -- the vast majority of expenses associated with the ERP we could capitalize, but there were some things that are really more associated with reorganization and cleanup of data and that type of thing that could not be capital on.

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David Michael King, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [6]

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Okay, okay. That helps. Then switching gears, in terms of Vietnam, how much production is out of Vietnam now? And then, Chris, where do you see that going by year end and then into fiscal '20? I get you can probably get up to 600 workers fairly quickly, but just given the efficiency probably not being as good as it is in China, just what's your best kind of guess from where we sit today in terms of where you can be?

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Christopher J. Ryan, Lakeland Industries, Inc. - CEO, President, Secretary & Director [7]

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Okay, well, we should be up to 600 workers by next March or April of '19. It all depends on sales. We've built a healthy inventory margin for the changeover, so that we could meet delivery. We wouldn't fall into the problem of not being able to deliver, as so many companies I know have when they've changed over, particularly to SAP. So we have plenty of inventory. We've got to clear that inventory. Once that is cleared out in the next 3 to 4 months, that's when Vietnam will go full online, and that's when it will probably start really making money as compared to China cost.

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David Michael King, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [8]

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Okay, that helps. That's good color. And then, like, lastly for me, I'll step back. Pharmaceutical suits, I didn't hear what they've been saying with that, if I missed it. But when do you expect to launch some of those products and begin shipping some of those products?

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Christopher J. Ryan, Lakeland Industries, Inc. - CEO, President, Secretary & Director [9]

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We are basically selling a lot of the non-sterile, and we are still delayed on the sterile for another couple of months.

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Operator [10]

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(Operator Instructions) Our next question comes from the line of Alex Fuhrman from Craig-Hallum Capital Group.

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Alex Joseph Fuhrman, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [11]

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Congratulations on another really strong revenue quarter despite the stronger dollar. Wanted to ask about some of the changes that you're making to your distribution. Specifically, it seems like the rollout of Amazon and e-commerce opens up a lot of new avenues for the company. Curious how the rollout in Canada went and what learnings you have, in particular, what types of customers that's been attracting, and how that might impact your rollouts into other markets on Amazon.

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Christopher J. Ryan, Lakeland Industries, Inc. - CEO, President, Secretary & Director [12]

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Okay. Well, we're rolling out in Canada and Australia, United States to the consumer, the typical Amazon consumer buying, which we all know and do ourselves, okay. Canada is relatively new. We haven't gotten too much in the way of results on that. Next quarter, we'll be able to tell you in a lot more detail about Canada and Australia and how much the U.S. has grown, say, from here to the next time we report in the quarter.

We're also doing quite well on Alibaba in China, too. So that's something we didn't -- we don't discuss too much, but it's growing also. And once we get on Amazon lined up in Europe, India, Australia and Mexico to Canada, then we'll start lining up some of the other e-platform selling groups, whether it's Walmart or somebody or Alibaba or the Indian version of them. But right now, it's really too early to tell how fast we'll ramp up. Ask me next quarter, then I'll be able to give you some hard numbers.

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Alex Joseph Fuhrman, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [13]

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That's helpful. And then just thinking about kind of the opportunity with your customer base more broadly, can you give us a sense of how much you think -- what share of your customers are currently small business? It certainly seems as you move into more online marketing and ramp that up, that, that could be an area of growth for you. Is that an area that's currently a sizable portion of your customer base? Just trying to understand if you have a good sense of how many of your end-users are big corporations versus smaller businesses and consumers versus government agencies and things like that?

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Christopher J. Ryan, Lakeland Industries, Inc. - CEO, President, Secretary & Director [14]

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That's fairly tough to say. We do deal with 1,200 distributors, which are for the most part, smaller than the top 80 guys. But we do, do business with the top 3 of the top 80 guys that's substantial business. But I think what you're really trying to get at is the cannibalization, if we start selling small businesses, will that cannibalize our distributor business? And yes, to some extent, it will. But then on the other hand, we have other competitors, like Kimberly-Clark and DuPont. So it will bite into their business as well. So will we lose some business? Yes, we will, but I don't think we'll cannibalize much more than 10% or 15% of our existing small-distributor business.

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Operator [15]

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Our next question comes from the line of Pete Muckerman from Raymond James.

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Peter Muckerman, Raymond James - Analyst [16]

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The majority of my questions have been answered, so I thought I'd just jump in there and ask, in relation to some of these hotspots around the world, China's swine flu, India's got a breakout, you've got Ebola in the Congo, where are you all in that mix? I know you guys have stated in the past that it has really become a crisis before. It really impacts you, but I just thought I'd ask.

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Christopher J. Ryan, Lakeland Industries, Inc. - CEO, President, Secretary & Director [17]

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Okay. Yes, it does impact our sales, but not in a big way. These are small outbreaks. In Africa, today, it's only 43 people. In India, it's only 60. This is out of continental populations of 1.5 billion, so it's not a big deal in either in sales. It's when it really breaks away and starts affecting thousands of people. Then everybody panics, and that's when the demand goes through the ceiling. It's when prices go through the ceiling, and it has not happened yet. If it were to happen anywhere, and really sends a panic or really could take off or sends a panic, it would happen in India, because the population in India is so compact, things would spread very quickly, as they did in Kerala.

Whereas in the Congo, you're talking about African villages that are separated by miles, so -- and not a lot of transportation. I'm surprised it spread in Africa as much as it did in the last big outbreak.

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Peter Muckerman, Raymond James - Analyst [18]

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Yes, okay. Just one really quick last question. What is -- I don't know if you can comment on it, but what is -- you guys have not utilized any of the buyback yet. What is -- can you elaborate or touch on that? Do you feel comfortable doing that? Just...

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Christopher J. Ryan, Lakeland Industries, Inc. - CEO, President, Secretary & Director [19]

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Yes, we feel very good comfortable doing it, and every time I try to pull the trigger, the stock goes up $0.50.

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Teri W. Hunt, Lakeland Industries, Inc. - CFO [20]

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That's a beautiful problem to have.

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Operator [21]

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There are no further questions at this time. And I would like to turn the call back to Christopher Ryan for closing remarks.

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Christopher J. Ryan, Lakeland Industries, Inc. - CEO, President, Secretary & Director [22]

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Okay. We appreciate your participation on Lakeland's 2019 Second Quarter Financial Results Conference Call. Our expanded global team remains energized for the opportunities ahead. We are very well positioned for continued growth in sales, market share and profitability, which we believe will deliver value for our shareholders. Thank you, again, for joining us for today's conference call. Goodbye.