Delta Apparel, Inc.
Q2 2017 Earnings Call Transcript

Published: 10 May 2017

[Operator:]

Thank you, and good afternoon to everyone participating in Delta Apparel's Fiscal 2017 Second Quarter Conference Call. Joining us from management are Bob Humphreys, Chairman and Chief Executive Officer; and Deb Merrill, Chief Financial Officer and President, Delta Basics. Before we begin, I'd like to remind everyone that during the course of this conference call, projections or forward-looking statements may be made by Delta Apparel's executives. Such statements suggest predictions and involve risks 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. This document contains and identifies important factors that could cause actual results to differ materially from those contained in the projections or forward-looking statement. Please note that any forward-looking statements are made only as of today, and the company does not commit to update or revise these statements, even if it becomes apparent that any projected results will not be realized. Also, today's call is being recorded. And now your host for today's conference, Delta's Chairman and Chief Executive Officer, Bob Humphreys. Mr. Humphreys, please go ahead, sir.

[Bob Humphreys:]

Thank you, and thank you all for joining us for our Second Quarter Conference Call. We've been busy over the last few months and are pleased to report strong results for our second quarter. As you are aware, at the end of the second quarter, we sold the Junkfood business, a niche participant in the license graphic space. Over the years, this has been a good business for us, and we enjoyed nurturing it and see it more than double its revenues while we owned it. That being said, the retail environment and marketplace for license graphic tees has been changing, and being a niche player in this space has become increasingly challenging. The sale puts the Junkfood brand in the hands of others more focused on this space to continue to grow and develop the brand. For us, the sale of the business worked out well, yielding us a gain of $0.11 per diluted share and enabling us to further narrow our focus on the areas of our business that we believe will have the most significant impact on our growth and profitability. The $28 million of proceeds, of which $25 million were received at closing, are being used to fund increased share repurchases and deleverage our balance sheet, giving us more flexibility to fund both organic and strategic growth opportunities. I'm going to let Deb tell you more about our financial results, and then I'll return and take you through our outlook for the business.

[Deb Merrill:]

Thanks, Bob. This was, indeed, a good quarter for Delta Apparel. Our net income increased to $4.5 million or $0.58 per diluted share, a 35% increase from $3.4 million or $0.43 per diluted share for last year's second quarter. More significantly, even after excluding the gain on the sale of Junkfood, our earnings were nearly 10% higher than those in the prior year. As Bob mentioned, the Junkfood business has recently been very challenging, culminating in a 40% sales decline in the March quarter and a $1.2 million decrease in operating profit. Adjusting the quarter to remove the Junkfood operating results as well as the gain on the sale of the business, we would've achieved 8% operating profit, 160 basis points or 25% improvement over the prior year quarter. This is a significant improvement in profitability, especially given the relatively flat sales versus the prior year's quarter. As reported, our operating profit was $7.5 million or 7.2% of sales. Net sales for the 2017 second quarter were $104.1 million compared with $109.2 million in the prior year's period. Decline resulted from considerably lower sales at Junkfood and lost revenue at Soffe from The Sports Authority bankruptcy. Gross margins increased year-over-year in all of the businesses with the exception of Junkfood in the March quarter and, on a sequential basis, expanded 270 basis points. Overall gross margins were 30 basis points lower year over year at 23.3%, but excluding the impact from Junkfood, which have shown a 50 basis point improvement over the prior year. Basics segment net sales grew 1.4% to $70.8 million in the fiscal 2017 second quarter from $69.8 million in the prior year's quarter. Art Gun shipped record second quarter units of 18%, guiding sales growth of 11% with margins expanding 480 basis points. Activewear sales grew 1% during the second quarter, driven from a 7% increase in private label sales and a 40% growth in fashion basics. This was partially offset by continued softness in the retail licensing sales channel, although this channel did start to stabilize a bit as the quarter progressed. We have a good inventory position that should allow us to service the overall catalog market during this spring's selling season. Net sales for the branded segment were $33.3 million compared with $39.3 million in the 2016 second quarter. The decrease was primarily related to the significant sales decline at Junkfood and a lingering impact of the bankruptcy of The Sports Authority. The loss of The Sports Authority notwithstanding, Soffe enjoyed 150 basis point margin expansion as it continued to build solid relationships with strategic and independent sporting goods retailers and E-retailers. Soffe had strong ecommerce growth with its B2C sales increasing 38% for the quarter and 34% year to date. Salt Life also had expanded margins on a 10% revenue increase, a second quarter record. Operating profits were further enhanced by leveraged administrative expenses and lower distribution costs, helping drive Salt Life's to an all time record EBIT. Growth continues to be driven by Salt Life's expanded product lines and broadened distribution. Salt Life's ecommerce business also did exceptionally well, growing 42% for the quarter and 46% year to date. Capital spending for the quarter was $2.2 million, bringing the total so far this year to $3.9 million. This was principally related to ecommerce upgrade, retail store build out and manufacturing expansion. We anticipate capital spending for the full 2017 fiscal year to be somewhat lower than that of 2016 and should be around $10 million. Depreciation and amortization, including noncash compensation, was $2.9 million in the second quarter and $5.8 million year to date. During the second quarter, we repurchased 49,400 shares of Delta Apparel stock at an average price of $16.24 per share for a total cost of about $800,000. So far this year, we've invested $1.6 million to repurchase 96,043 shares at an average price of $16.90 per share. At the end of the second quarter, we had $7.5 million remaining of our board authorization for share repurchases. We continue to believe that the current share price range does not accurately reflect the true intrinsic value of the company and plan to pursue our share repurchasing program more aggressively in the second half of the year. With few exceptions, our March quarter met our expectation, and we look forward to a strong second half of the year. Bob will now take you through more about our strategies for growth and our outlook for the business.

[Bob Humphreys:]

Thanks. As Deb just review with you, we had a strong second quarter with earnings of $0.58 per share, a 35% increase over the prior year, and excluding the gain on the Junkfood sale, earnings were up nearly 10%. As a result of our expanded sales and marketing strategies, new product introductions and our manufacturing realignment completed last year, we achieved significant improvement in the Activewear business during the second quarter. Introduction of Activewear's 2017 fashion basics product is going well, particularly the Delta Platinum line, which features softer fabrics, a refreshingly different color palette and great price points. Continued growth in programs with some of our international brand partners bolstered our private label business as there are solid demand for our specialized vertical manufacturing capabilities, combined with our sensitivity to social and environmental compliance that are still important to major brands and retailers. In that regard, I'm pleased to report that we met our production and cost goals that we set for our manufacturing realignment. We saw the initial positive results in the March period and expect all of them to become increasingly apparent in the second half of the fiscal year. Art Gun achieved outstanding results for the first half of the year, positioning itself for a strong 2017 performance. Art Gun's e-commerce fulfillment and digital print model provides a unique service model to the new retail landscape, where products are virtual until sold. We already have additional equipment on order to expand Art Gun's capacity, keep pace with demand, particularly during the upcoming holiday season. Over the next several quarters, we'll also be expanding our geographic footprint with Art Gun, utilizing our existing distribution facilities to better service customers with reduced shipping time and getting products to the end consumer faster while also allowing us to leverage existing inventory. Soffe, which is rebuilding volume through several emerging channels of distribution, is gradually overcoming the difficulties posed by some of its traditional retail customers. We're building our direct-to-consumer business at Soffe, achieving double-digit growth on our Soffe website. We opened a new Soffe retail store earlier in the year and plan to open two more during the remainder of this year. Retail stores are expected to be profitable and used to reinforce the Soffe brand identity and connect directly with our consumers. We're seeing profits at Soffe, although still well below our long-term goals. We'll continue to build on the strength of the Soffe brand and leverage our strengths in Made in America and military product. With this focus, combined with continued improvement on the operational front, we believe Soffe can improve its profitability to meet our goals for the business. During the quarter, Salt Life experienced strong shipments for the initial spring store set, and early indications point to good spring sell through. Our product expansions in ladies and youth products are driving growth in these channels, and our performance products continued to be a strong product category. Salt Life has attracted a large Internet following through its YouTube and other social media outlet, achieving over 1 million followers across social media. Our new YouTube shows, including our recently launched Yoga series, are tracking new subscribers. We've now have nearly 50,000 subscribers on the YouTube channel and with nearly 18 million minutes of youth content. California remains one of the top three states that views on the channel, and interestingly, the State of Illinois was in the top five in March. The traffic on the Salt Life website was up 24%, and through higher conversions and larger purchases, sales on the website grew by over 40%. We also have just introduced a new Salt Life rewards program that provides a bonus incentive to consumers who shop on the Salt Life website. Overall, we anticipate continued double-digit growth through Salt Life's omni-channel model and its branded e-commerce site. This was a good quarter by a lot of measures, and it demonstrate the value of the strategic initiatives that we embarked upon and completed several quarters ago. More importantly, it sets the stage for what we believe we can achieve in the second half of the year. We expect Salt Life and Art Gun to continue their double-digit growth and should see continued improvements in Activewear and Soffe. Our e-commerce businesses should continue to expand, and we expect our new branded retail stores to build incremental revenue. All the while, our product costs should improve as we receive the full benefit from our manufacturing realignment over the next several quarters. While the retail environment continues to be a challenge, we believe that the strategic initiatives that we completed over the last several years, combined with our broad channels of distribution, will result in the future of solid performance for Delta Apparel. Operator, you can now open up the lines for questions, please.

[Operator:]

[Operator Instructions] And for our first question, we'll go to Dave King with Roth Capital.

[Dave King:]

Maybe first, on the margins. Are we able to quantify how much of a -- I think it was a 60 basis points of year-on-year improvement on the basics side was due to the manufacturing realignment, and then, Bob, based on your remarks, it sounds like you hit your targets. Is it fair for us to still be assuming kind of $8 million in annual savings from that? Or is there a potential that to maybe even be higher?

[Bob Humphreys:]

Yes. So I think some of that margin was from the manufacturing realignment, but remember, we really just started seeing that in the March quarter -- I mean, the March period. And based on where we are seeing today, we would expect to be about $8 million of cost savings from that project.

[Dave King:]

Okay. So it sounds like you haven't seen much of it yet and a lot of that is still -- so a lot of that start to flow through and still [indiscernible] okay.

[Bob Humphreys:]

Exactly. So basically, they're on the balance sheet in lower cost inventory that we started shipping in March and we'll continue to ship.

[Dave King:]

Okay, that helps. And then what are sort of your updated thoughts on the move in cotton prices? Any potential for pricing actions on that front? And then how should we be thinking about the impact on margins from that, if at all?

[Bob Humphreys:]

Yes. So from where we sit today and where cotton is today, I think it's in a manageable area. There's been some price increases through the basic undecorated tee market. There'll be price increases going through the private label market. And we think in other places of our business, we've got some opportunities to raise prices as well. So yes, more to come based on consumer demand and a lot of other stimuli. But I would say, cotton prices today should be neutral on margins over the next 12 to 18 months.

[Dave King:]

Okay, that helps. In terms of the $25 million in cash generated on Junkfood, it sounds like share repurchase and deleveraging, and then, Deb, I think maybe from your comments, it sounds like, I think you said aggressive on the share repurchase front, which I think would be welcomed. I guess how should we be thinking about just the prioritization of those, of the uses of that cash and then maybe even versus kind of reinvestment of the business?

[Bob Humphreys:]

Yes. Well, somewhat opportunistically, we're definitely bullish on buying back our shares. And we're, we do that through the safe harbor process and so we'll continue to do this. But this will give us more, very liquid money to apply to that. So we will be more aggressive. And then obviously, the easy thing to do short term is payback debt, but we're always willing to invest in a current business or a complementary business, if we think the opportunities for the right returns are there, so.

[David King:]

Okay. That actually was, so that was my last question. So maybe along those lines, with Junkfood now sold, I guess what are your updated thoughts on potential to sell any other brands at this point? And then you've sort of alluded to it a bit, what are your thoughts on acquisitions out there? How are the bid-ask spreads? And how does the pipeline look for doing that? And what's the appetite?

[Bob Humphreys:]

Yes. Okay, that's a long list of, our thing with our businesses is when we don't have what we consider a good vision for success, then we should move them on to someone who has a different vision or more focused on that part of the marketplace. And really, that was where we were with, first, The Game, from the collegiate license business. And then ultimately, Junkfood, we think is under great hands, and I think they'll do well with it, but are very focused on that space and we were not. So Junkfood made good money for us over the years, and so we were able to harvest that, those retained earnings and turned them into cash, which we think was the right thing to do. Right now, we think we have a pretty good vision of success for our current inventory of businesses. So our focus is on working on those and making them better and becoming better users of working capital and that sort of thing. So from a pipeline, yes, there's lots of stuff out there. To me, it's generally expensive compared to what we have historically paid for businesses, and I can't think of any that, at the end of the day, we thought we underpay. So, and I've seen a lot of deals go down that we were glad we weren't a part of. So we'll remain confined by our expectation of evaluations on these things over time, and we want things, I think, to make sure that our core got better versus getting our efforts diluted on some small outlier.

[Operator:]

[Operator Instructions] And for our next question, we'll go to Jamie Wilen with Wilen Management.

[James Wilen:]

A couple of questions. First, starting with the buyback. I was surprised at how late it was in the quarter, given what you see within your business. And obviously, the closing of Junkfood didn't happen till the end of the quarter, but you probably had a decent understanding that it could come to pass. So I was just surprised that you would've been more aggressive in the current quarter.

[Bob Humphreys:]

Well, again, we go by a safe harbor process to repurchase our shares. So we follow the same blackout periods that any other insider would. And so we, that and capital available versus other things we're doing is what ultimately manages what we can go after during the quarter.

[James Wilen:]

But how can you be more aggressive then?

[Bob Humphreys:]

Well, then we can reset what we're doing under -- getting out of a blackout period.

[Deb Merrill:]

Yes. So Jamie, it's just a matter of resetting when we're in a window that we can reset what those parameters are. So by all accounts, so those would be reset which then would allow us to open up and be able to get back more shares.

[James Wilen:]

Got you. Have you reset those already?

[Bob Humphreys:]

Well, we will when -- in three days.

[Deb Merrill:]

In 48 hours.

[Bob Humphreys:]

3 days past our earnings announcement.

[James Wilen:]

Okay. On the Soffe side, was Soffe indeed more profitable in this quarter?

[Bob Humphreys:]

Yes.

[James Wilen:]

And you would expect Soffe to be nicely -- or profitable for the year and its subsequent quarters. It's now moving in the right direction, certainly, cost-wise.

[Bob Humphreys:]

Yes. I mean, we still got a lot of work to do at Soffe, and we got inventories starting to move in the right direction and, I think, some good initiatives. And it's encouraging to see how the product is selling when it gets in front of consumers. So our ecommerce business is very strong. Some of our most successful sporting goods retailers, our business is growing nicely with. The military business is improving for a number of reasons. So we got some good initiatives with Soffe, and we're encouraged with the value of the brand and our military business, some other unique offerings we have. But we got work to do to get better volumes and lever our overhead.

[James Wilen:]

Did you say you were opening up some retail stores in Soffe as well?

[Bob Humphreys:]

Yes. Soffe has had retail stores since our acquisition of it, and we just opened up an additional one, which brings it to three. It's a new small site near Fort Bragg and that military drives a lot of our Soffe business. And we have another one scheduled to open near another military base on Jacksonville, North Carolina, and we're going to do one more in a large college town in North Carolina, where East Carolina University is.

[James Wilen:]

Got you. And these are just strictly Soffe. You don't intersperse any of your other brands in there?

[Bob Humphreys:]

That's correct, and that would be our intent for the foreseeable future.

[James Wilen:]

Okay. And Salt Life, you opened up another store, but there's another -- there are several additional retail stores that you will open later this year?

[Bob Humphreys:]

That's correct. So we opened Huntington Beach in California. So we have two stores in California. We are opening a store near our Columbus headquarters in the downtown riverfront section of Columbus, Georgia. And then we're going to do an outlet store on I-95 just north of Daytona Beach in a new Tanger outlet. So those will be open, certainly, by calendar yearend, and, hopefully, by fiscal yearend.

[James Wilen:]

Okay. When you first started opening stores, they were kind of merchandising stores to show the retailers how to do it. It sounds like these stores are for profit enterprises?

[Bob Humphreys:]

Yes. And that first store in Jacksonville Beach is profitable and is having -- so this is our seventh year, I guess, and they're still having good organic growth in that store. So that's encouraging. But yes, we're opening for profit stores. Certainly, the California stores also have a strong -- we want to build a brand in California the right way, show the product via merchandise, but long term, we expect them to be profitable as well.

[James Wilen:]

And the growth in Salt Life, is it through the number of doors? Or are you getting -- or it's more sell through existing doors or both?

[Bob Humphreys:]

Yes. So I think it's actually a somewhat complex mix, to be honest with you. We are selling more product, and the retailers who are expanding their product offerings are seeing great result. Retailers who are building out Salt Life selling space are seeing outstanding results. Our e-commerce business is growing very nicely. Now remember, we're also up against the headwinds that so many people are facing in retail with, last year, The Sports Authority going away, who was a growing Salt Life customer and then Gander Mountain just going away, who had some big stores that were really good Salt Life stores. So it is that complexity of the major retailers going away, but us being able to trump that with growth in other areas.

[James Wilen:]

Okay. And on the manufacturing cost realignment, you expect, on an annual basis, to achieve $8 million.

[Bob Humphreys:]

Yes.

[Deb Merrill:]

That's correct.

[James Wilen:]

And it's starting to really come into play. In the June quarter, we'll start to see basically 2 million a quarter moving forward, and we have seen very little so far.

[Bob Humphreys:]

Yes. So you would seasonally adjust that just with our stronger quarters. It'll be basically as units go out the door. But yes, we'll see a significant amount of that in the June quarter.

[James Wilen:]

Okay, excellent results. And I hope you rejigger the buyback program too as much as you possibly can do. Nice job.

[Operator:]

[Operator Instructions] And with that, ladies and gentlemen, we have no further questions on our roster. Therefore, Mr. Humphreys, I will turn the conference back over to you for any closing remarks.

[Bob Humphreys:]

Okay. Well, thank you all for joining our call today, and we look forward to updating you on our third quarter earnings in just a few months and give you a further update on how our business is progressing. Thank you.

[Operator:]

And again, ladies and gentlemen, this will conclude today's conference. Thank you for your participation. You may now disconnect.