Delta Apparel, Inc.
Q3 2020 Earnings Call Transcript

Published: 2 Aug 2020

[Operator:]

Good afternoon to everyone participating in Delta Apparel’s Fiscal 2020 Third Quarter Earnings Conference Call. Joining us from management are Bob Humphreys, Chairman and Chief Executive Officer and Deb Merrill, Chief Financial Officer and President of Delta Group. Before we begin, I would like to remind everyone that during the course of this conference call, projections or other forward-looking statements may be made by Delta Apparel’s executives. Such projections and statements suggest prediction and involve risk and uncertainty, and actual results may differ materially. Please refer to the periodic reports filed with the Securities and Exchange Commission, including the company’s most recent Form 10-K and Form 10-Q filed today. These documents identify important factors that could cause actual results to differ materially from those contained in the projections or forward-looking statements. Please note that any forward-looking statements are made only as of today. And except as required by law, the company does not commit to update or revise any forward-looking statements even if it becomes apparent that any projected result will not be realized. Today’s conference is being recorded.

[Bob Humphreys:]

Good afternoon and thank you for joining us on our fiscal 2020 third quarter earnings call. I’ll discuss our business results, highlighting the progress and momentum that we have experienced all of our business units, validating that Delta Apparel is not only prevailing through this difficult period but is on a clear path to returning to profitable growth and providing continued value for all of our stakeholders. I will then turn the call over to our CFO, Deb Merrill, for a more detailed discussion of our financial results, including the strong improvement in our liquidity as the quarter progressed, placing Delta Apparel in a solid and flexible financial position entering the final quarter of the year. I am sorry, I am having a minor technical problem here. Please bear with me. In light of the COVID-19, there was no playbook that we or our customers could use to predict how the third quarter would play out. With that said, the momentum we experienced across our businesses as the third quarter progressed has been extremely encouraging and has further validated Delta Apparel’s strategic advantages. Our diversification of sales channels, our broad geographic footprint and the strong emotional connection our Salt Life and Soffe brands have with consumers resulted in third quarter sales that exceeded our internal expectations. In fact, as we highlighted in our most recent press release, by the final month of the quarter, we were tracking at nearly 90% of our prior year sales. This strong momentum has continued through July with orders accelerating and derived from an even broader base of sales channels. We are truly seeing incredible digital print demand from our unique DTG2Go model with COVID-19-related disruptions and supply chains this quarter. And the inability for consumers to shop in traditional retail stores, the benefits of our DTG2Go model have become even more apparent in the marketplace. We were able to continue operations utilizing our network of facilities across the country, giving our existing customers and new customers a source of expanded revenue during times when needed most. We are the only digital print supplier in the world that can offer a seamless, vertically integrated solution utilizing our proprietary software and internal supply chain to offer a fully decorated on-demand product shipped directly to the consumer. This model will eliminate non-value-added cost and reduces the risks that come with third-party supply chains.

[Deb Merrill:]

Thank you, Bob. Our third quarter performance was in line with the preliminary results we issued a few weeks ago. Overall, the company incurred $23.1 million of nonrecurring expenses during the June quarter associated with the impacts from the COVID-19 pandemic. These include costs primarily related to the curtailment of our manufacturing operation, incremental costs to right-size production to new forecasted demand and increase accounts receivable and inventory reserves related to the heightened risk in the market as the U.S. continues its recovery. These costs, of which approximately $11 million are non-cash charges, primarily impacted the Delta Group segment. As a reminder, we also took $1.9 million of expenses related to the curtailment of manufacturing operations in our March quarter as the government-mandated closures began mid-March. While we believe the most significant costs associated with our manufacturing operations are behind us now, we do anticipate approximately $3 million of additional impact in our fourth quarter related to excess costs as manufacturing output is ramped back up after the curtailment. Our third quarter fiscal 2020 net sales were $71.8 million or about 60% of the prior year June quarter sales. Our monthly sales performance sequentially accelerated through the third quarter from April sales at 33% of the prior year levels to June sales at nearly 90% of prior year level.

[Bob Humphreys:]

Thanks, Deb. For our nation and our industry, the environment has been a challenging one to navigate. We have controlled what we can in the business by currently managing costs while capitalizing on the strength of our fully integrated and diversified business model as well as our emotionally connected Salt Life and Soffe brands to gain market share and expand our reach. Throughout the third quarter, we strengthened our financial position while smartly investing to support our high-growth businesses. We are now putting the final touches on our business plan for fiscal 2021 and are looking forward to starting a new year in just a few weeks. There remains considerable uncertainty on the effects of COVID-19 on the U.S. economy in general and our business specifically over the next several quarters. We believe the accelerated demand for DTG2Go is here to stay, with partners across many channels of distribution quickly adopting the technology we have to offer. We have additional equipment on order and are looking forward to the growth of our new facility in Phoenix, which further expands the advantage we enjoy in the marketplace. We anticipate adding further capacity as we progress through the year. Likewise, we are encouraged with the dramatic acceleration in demand on the Salt Life and Soffe consumer websites. This is one of our most profitable channels of distribution, and we’ll continue to focus on the growth of these businesses through stronger engagement with our consumers. We are very encouraged for the demand we are seeing for our undecorated basic activewear business, evidenced by the sales growth we achieved in the June period. This growth has continued through July, and we believe our expanded product offerings and new distribution channels will continue to drive our business. While our FunTees private label business was significantly impacted by the extended shutdown we experienced in our facilities in El Salvador, we are now operating our plants and our customers are anxious for us to rebuild our production for their programs. Additionally, FunTees has been able to win additional programs to be processed in our Mexican and domestic facilities. We expect the overall competitive landscape to change as well as new customer requirements could negatively impact future suppliers. We believe our higher service level combined with our vertical distributor model will served us well in this disruptive environment. We are looking forward to our new fiscal year with great anticipation and believe the future negative impacts to the U.S. economy and offshore manufacturing facilities are minimal, we will soon return to the improving sales and earnings growth we were enjoying just a few quarters ago. I want to again thank our Board of Directors and employees who have truly been amazing for their patience, hard work and support throughout this difficult period. Operator, we would now be happy to open up the call for questions.

[Operator:]

And we will take our first question from Dana Telsey with Telsey Advisory Group.

[Dana Telsey:]

Good afternoon, everyone and nice to see the progress and how business has improved even going into July. As you think under the hood in terms of looking at the components of gross margin and SG&A, what do you see as the main drivers of improvement going forward? And how much of the SG&A cost reductions stay permanent? And what do you see is the ability in terms of pricing to drive gross margin? Thank you.

[Bob Humphreys:]

Dana, that’s going to vary a lot obviously across our different business units. I think a good bit of our gross margin improvement that we see coming sequentially over the next several quarters, obviously, reloading our plants and absorbing the cost is a big help. The demand for our digital printing is at or beyond our capacity right now, so obviously we get some synergies with that; that being a higher gross margin business for us helps. And really, our highest gross margin business, at least direct-to-consumer products that are sold through our eCommerce site. So when you can start having the outsized growth that we have had there, it does help our overall gross margins. As all companies and different industries, when you go through something like this, you learn new things and what’s really necessary and what’s not necessary. We have obviously had a lot less travel, a lot less travel expense. And so I think we will obviously see that continue that way for quarters or perhaps years to come as we all get used to our new work environment. So that, combined with higher production going through our facilities over time, whether they are distribution facilities or manufacturing facilities, allows us to further leverage our fixed cost. And we are seeing that as we speak and we would expect that to continue if there is not further shocks to the system. Deb, you got anything to add on the cost side or any of those points?

[Deb Merrill:]

No. I think you covered that well, Bob. Thanks.

[Dana Telsey:]

And then just next up, on the new customers, what are you seeing in new customer growth? What are you seeing from existing customers, seems like the opportunities and new customer growth are extensive?

[Bob Humphreys:]

Yes. I will let Deb talk about that on the DTG2Go side and then maybe I will talk about the other parts of the business, since she’s intimately familiar with that.

[Deb Merrill:]

Sure. Good question on that, Dana. And we have been saying for a long time that the digital business is growing and the adoption rates are increasing. I would say that through the COVID situation and the disruptions in the marketplace and the new ways that more and more consumers are shopping and, obviously, the brick-and-mortar retailers have to find ways to service that business, but it has just really increased the acceleration rate of people looking at a digital model. And we experienced that, as we mentioned, with all of the new customers that we actually on-boarded during the June quarter that provided a lot of that sales growth as well as then the pipeline of expecting to bring on new customers here in the September quarter and the quarters to come. So I think that there is definitely new customers that will be coming on to the digital print model and in these channels on the distribution that we have been talking about, whether that is the traditional retailers that just like to go through an on-demand model, whether that is more in the promotional product areas or just even with our existing customers as more and more shopping is happening online. So we are quite excited about the growth opportunities in the business. And as Bob had talked about earlier, then all of our new ways that provides a capacity to service the growth in this business, which we are doing and are right in the middle of and excited about all of those opportunities.

[Bob Humphreys:]

And just to add to that in some other aspects of our business. Our eCommerce business has been growing strongly, retailers see that. So we are also seeing more interest from retailers for different product across a larger geographic region. That would certainly be true with Salt Life. And then we were able to keep most of our distributions running throughout the pandemic, or the first phase of it. And where we maybe would not have our primary one running, we were able to service customers through others. So I think we provided a really high level of service to our customers throughout this period of time, and we are seeing that gain new business for us, quite frankly. We believe with our customer base, they are all looking for higher levels of service, quicker reaction time, quicker shipment, being able to react to their needs. And we do that by picking to the piece, by shipping the same day and by providing other services such as EDI. Obviously we have screen printing both domestically and offshore. And our domestic screen printing really helped us out in periods of time when offshore screen printing was down when these countries were closed. So I think all-in-all, we did a nice job of servicing customers over the last quarter, and we are seeing them come back to the table with larger and more frequent orders even already.

[Dana Telsey:]

Thank you.

[Operator:]

We will now take a question from Jamie Wilen with Wilen Management.

[Jamie Wilen:]

Hi, guys. Just a few on DTG2Go, to start, did you say beyond Phoenix, you are also going to be adding capacity at several of your other centers this year?

[Deb Merrill:]

That is correct. And we do have opportunities in our other facilities to put more equipment and increase those outputs. We actually started to do that in the quarter already to service the business that we had, and we will continue to do that. So it really will be the Phoenix addition and expansion at the other existing 7 locations.

[Jamie Wilen:]

Would you care to hazard a guess of what type of revenues we can do in the next fiscal year in this business?

[Deb Merrill:]

Well, Jamie, what I would say is, prior to the pandemic, we were talking about this business being a 20% growth business. And what we are seeing is acceleration from that and foresee that continuing. So I would say it’s going to be a, from our outlook, it’s going to be a nice strong business as more and more people in the U.S. and worldwide adopt to this model of an on-demand-type product base.

[Jamie Wilen:]

So throw the numbers at me, what we did last year, this fiscal year and – or what you expect this fiscal year, then I will do the math from there.

[Deb Merrill:]

Well, again, as we had prior reported, we were down in the first two quarters. But this quarter we were up 30%, up 40% in the month of June and continuing at that pace as we had through the fourth question. And so you can take those numbers and put something north of a 20% growth rate on that, and that would be what we would expect to see in this business in the future year and years to come.

[Jamie Wilen:]

Okay. And EBITDA margins in the business, given that we are spreading the SG&A over more facilities?

[Deb Merrill:]

Correct. So our gross margins with the additional production, further are improving in the business. That coupled along with the higher usage of the Delta products, our operating profit remains in the double-digit range and/or with that profitability are north of that 20% mark that we have seen, and expanding from there.

[Jamie Wilen:]

Fantastic. Let me ask a question about how much of the decline in SG&A is going to be permanent. You took a couple million dollars off and obviously you can see how you can run your business a little differently, as necessity is the mother of invention. But how much of that decline will be permanent?

[Deb Merrill:]

So I would say, I mean, do keep in mind that some of that decline is just a variable selling cost associated with the lower sales level. So that will pick back up in dollars as the top line continues to expand. We did take action. And as Bob mentioned, during these times you figure out how you can do things differently in your business. So there will be some amounts that I think will continue, as he mentioned, in travel. I think advertising and things like that will continue to be done different than they might have been done in the past. So we would think that there’s some opportunity to continue to keep the cost out of there. At the same time, we do run the business in a very lean manner just as part of our culture. And so there is not a lot of added areas where we just continually have the costs out as the business returns back to a pre-COVID level.

[Jamie Wilen:]

Okay. And obviously, the pandemic created a bunch of difficulties for everybody and it does create some opportunities to gain new customers. Have any of your competitors had any difficulty and been forced to lose accounts or go fully out of business?

[Bob Humphreys:]

I think yet to be seen on the overall effect of that. Certainly there’s suppliers in the private label arena that are not as well capitalized as the public companies in the space that have had probably more difficulty, they don’t have the diversity of customers and distribution channels as we do. We think even in the pond of the big players, our diversity of customer base is a real asset that we have. And then there’s changing currents out there about service level and go-to-market strategies and all those things. So we will just have to see how all that ultimately plays out over the next several quarters. But given a solid economy to work from, we are confident of our position and our customer base and how that has evolved over time and having some new high-tech businesses really driving our growth in these consumer sites and DTG2Go.

[Jamie Wilen:]

Got it. And lastly, Hanes had a big number for what they did in protective clothing in the quarter, which is really surprising. I know you were doing some of that business. But is that going to be a focus or just a minor league item for you?

[Bob Humphreys:]

Yes. So we won’t have a big focus on that going forward. So like you said, they did a really nice job for that. I don’t think we are positioned to do that. There’s some really good large scale players in that industry that I am sure will gear up. A lot of it’s branded. So I think we will stay focused on what we think we know how to do better and stay with that.

[Jamie Wilen:]

Okay. And then one last thing industry pricing with no one able to produce for most of the quarter and now production plants coming back on stream, what does industry pricing look like now?

[Bob Humphreys:]

So I would say solid right now. There is people out there with different promotions going on for undecorated tees, but what we have seeing is demand is strong and supply is relatively tight and that’s normally a combination where you have solid prices.

[Jamie Wilen:]

Okay. Thanks. Nice job.

[Bob Humphreys:]

Thank you.

[Deb Merrill:]

Thank you.

[Operator:]

And it appears there are no further telephone questions. I would like to turn the conference back over to our presenters for any additional or closing remarks.

[Bob Humphreys:]

Okay. Well, thank you all very much for joining us today. And we will continue to be probably more proactive to keep the market informed of our results as the quarter goes on. Since we are operating in unusual circumstances, we feel like we need to keep people informed, so we will do that and look forward to having another conference call in just over 3 months. Thank you very much.

[Operator:]

And once again, that does conclude today’s conference. We thank you all for your participation. You may now disconnect.