Delta Apparel, Inc.
Q2 2016 Earnings Call Transcript

Published: 12 May 2016

[Operator:]

Good day and welcome to the Delta Apparel, Inc. Fiscal 2016 Second Quarter Results Conference Call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Justin Grow, General Counsel. Please go ahead, sir.

[Justin Grow:]

Thank you and good morning to everyone participating on the 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 other forward-looking statements may be made by Delta Apparel's executives. Such statements suggest prediction 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 statements. 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. I'll now turn the call over to Delta's Chairman and Chief Executive Officer, Bob Humphreys.

[Bob Humphreys:]

Thanks, Justin and thank you all for joining us for our second quarter conference call. If you read the earnings release issued this morning, you already know that Delta Apparel had another good quarter. This marks the fourth consecutive quarter in which we reported margin expansion and improved profitability. In each of those quarters, Delta has shown increasing strength, despite a number of negative market forces that continue to plague our industry. The general economy remains sluggish and consumer spending on apparel is down driving some retailers into bankruptcy. Yet through all this, Delta Apparel has become stronger and improved our market position. The increasing strength of Delta Apparel is a testament to the effectiveness of the strategic initiatives we announced 18 months ago and the ability of our team to successfully implement them. We streamlined our administrative workforce and completed a comprehensive rationalization of all of our business units, product lines, and sales channels in order to refocus our capital and other resources one the areas we believe are most strategic to our business. We also made important improvements to our manufacturing platform, increasing our capacity, and expanding our flexibility in the products we can produce. The result has been higher demand for Delta Apparel products, lower manufacturing costs, significant margin expansion, and increased profitability. We continue to invest in areas of our business where we expect to yield higher returns. This quarter we began production on our new equipment in our Honduran textile facility, Ceiba Textiles. By expanding our production capabilities into open-width fabrics will reduce our reliance on purchase fabric which should allow us to better serve our customers and expand our product offerings. In addition, we will be further leveraging our fixed costs of internal production. Overall, we expect to achieve an annual savings of approximately $2 million from this investment which should be reflected in our fiscal 2017 results. We’ve also continued to make investments in our full package offerings, expanding our screen print and retail packaging operations to support growth in our catalog full package and private-label programs. During the past two years, we’ve taken steps to consolidate fabric production for basic tees into our lower called Ceiba Textile facility and reduced our overall domestic textile production. We also continue to focus on process improvement and cost reductions in order to remain competitive in the apparel marketplace. After a careful evaluation of our entire manufacturing platform, we've decided to embark upon a further manufacturing realignment and we expect will result in an $8 million annual reduction in manufacturing costs. This realignment will include additional expansion in our Honduran textile facility that will give us the ability to leverage the latest dyeing and finishing technology available and will also result in the closure of our domestic textile facility. The decision to stop production at the main plant and eliminate the jobs of about 160 employees who have contributed significantly to our growth and success over the years was obviously difficult. However, we can no longer justify the additional cost and longer lead times associated with domestic fabric production in the highly competitive T-shirt business. As a part of this realignment, we are expanding our sew facilities in Honduras and at El Salvador, and further modernizing and increasing capacity in our El Salvador screen print operations. We will be supporting our Mexico sew and screen-print production with in-country sourced fabric. We will also be sourcing domestic fabric from our existing U.S supplier base, which we believe should create additional job opportunities within those organizations. This domestic fabric will be sewn into garments in our Rowland, North Carolina apparel facility to support our Made in the USA programs. This realignment will require a capital investment of about $7 million which should all be incurred during fiscal 2016. Approximately $3 million of expenses or about $0.30 per diluted share is expected to be incurred in fiscal 2016 third quarter in connection with this realignment including severance, shutdown, and startup inefficiency and other expenses. Much of the work to complete this manufacturing initiative is already well underway. Sew production has been expanded in Honduras and El Salvador and the screen-print equipment for El Salvador has been received. Additional dye equipment and dryers are all order and will be installed in the next several months. The realignment should be completed by the end of fiscal year 2016 and we expect to begin realizing the associated cost-benefits in the first half of fiscal 2017 with the savings in the back half of fiscal 2017 expected to annualize at approximately $8 million or about $0.70 per diluted share. Although there's a lot of work to be done in the back half of fiscal 2016 to complete these initiatives, we’re excited about what they could mean to the future of Delta Apparel. We are pleased with the progress we have achieved in the first two quarters of fiscal 2016 and believe Delta Apparel is financially and operationally strong and poised for further growth in the last half of the year. At this point, I will turn the call over Deb Merrill to provide details of our second quarter results.

[Deb Merrill:]

Thanks, Scott and Bob and good morning. As you see in the press release, margin expansion and earnings growth are the highlight of our fiscal 2016 second quarter, with Delta Apparel enjoying strong margin improvement in both the basics and branded business segment. Net sales in our fiscal 2016 second quarter were impacted to some degree by the bankruptcy of a large retail customer, but still came in at a $109.2 million. That is just 0.4% below the 109.6 million of sales in last year second quarter after adjusting for the $5.4 million of payout in the since-divested The Game business and sales of products under the Kentucky Derby license that we did not seek to renew for 2016. Our overall gross margins expanded 510 basis points over last year’s second quarter and 270 basis points sequentially. This led to an operating profit of $5.9 million or 5.4% of sales and net income of $3.4 million or $0.43 per diluted share. This compares to earnings of $0.03 per diluted share in the prior year second quarter after adjusting to exclude the $0.43 gain on the sale of The Game business realized during that quarter. Gross margins in the basic segment expanded 810 basis points over the prior year period continuing the sequential margin improvements that have occurred over the past several quarters. This yielded in operating profit of $6.9 million or 9.9% of basics segment sales. Net sales in the basics segment were $69.8 million, off 2.2% from the $71.4 million in the prior year second quarter. The decline primarily was due from a 7% decline in unit sales of basic tees. This was offset somewhat by excellent growth in fashion basics product, which exceeded 250% year-over-year growth, and catalog full-package growth of 15%. It reduced catalog sales of 1.5% for the quarter. While such a decline is never welcomed, it primarily affected our lower margin products and ultimately resulted in a more profitable overall product mix in our Delta catalog business. Private label sales improved 4%, with growth coming from regional, trendy brands as well as new customers acquired mid 2015. Art Gun, which showed good year-over-year growth in March experienced a sales decline of about $500,000 for the second -- for the full second quarter as it made necessary adjustments to correct inefficiencies that surfaced during the extremely high-volume 2015 holiday season. Turning to the branded segment, adjusted for The Game and Kentucky Derby sales, branded segment sales -- net sales grew 2.8% in the sector, while enjoying margin expansion of 110 basis points year-over-year and 470 basis points sequentially. Net sales for the fiscal 2016 second quarter were $39.3 million versus $38.2 million in the June -- or in the 2015 second quarter, after adjusting for The Game and Kentucky Derby sales. The branded segment experienced a negative impact of the Sports Authority bankruptcy mainly in our Soffe business unit, which otherwise would have achieved sales growth of near 5%. Soffe has improved service levels to the independent sporting goods channel and recently launched a new business-to-business Web site that should further enhance Soffe’s recent double-digit sales growth in that channel. While the junkfood.com e-commerce Web site saw growth of 26% for the second quarter, overall Junkfood sales were down $1.9 million from the prior year period. The decline is attributed to unsettled conditions in the retail apparel market and management team changes among some of our Junkfood specialty apparel customers. Such changes normally lead to more deliberative buy decisions and slower order placements during the transitions, which was the case in the second quarter. Salt Life continued its high growth trend with sales in the second quarter of 23% over the prior year quarter. The relocated Salt Life distribution center is functioning well and capable of handling their record shipment volumes we’re seeing in that business. The robust demand for the Salt Life brand continues and we’re seeing strong sell-through of the Spring ’16 product line. Sales on the Salt Life’s ecommerce Web site grew 48% during the second quarter bringing its year-to-date growth to nearly 70%. We continue to make progress with our direct-to-consumer initiative on the West Coast with California driving the highest viewer ship on our Salt Life YouTube channel. We are making progress on the new Salt Life’s store in San Clemente, California and look forward to its opening in mid-Summer this year. In this year’s first six months we increased our net sales to $199.3 million from a $197.6 million in the prior year period after adjusting for the sales attributed to The Game and Kentucky Derby license. Net income was $4.1 million, or $0.52 per diluted share, in the 2016 six months period compared to a net loss in the prior year period of $565,000 or $0.07 per diluted share. Capital spending was $3.3 million for the second quarter, bringing the year-to-date total to $6.7 million. Final payments related to our open-width project and the purchase of equipment for a new textile expansion constituted the majority of the capital spending. Depreciation and amortization including non-cash compensation was $3 million in the quarter and $5.9 million for the six months period. During the quarter, we repurchased 45,460 shares of Delta Apparel stock at an average price of $15.42 per share for a total cost of $700,000. Our remaining authorization for stock repurchases is approximately 10.8 million. This week we executed and amended and restated U.S credit facility. The agreement which extend our current $145 million facility for a five additional years also lowers our interest expense by some 50 basis points. We believe this underscores a solid financial and operational strength of Delta Apparel in the recognition of that strength by those in the financial community. I will now turn the discussion back to Bob, for a final comment.

[Bob Humphreys:]

Thanks, Deb. Looking ahead to the second half of this fiscal year; we expect continued sluggishness in the retail marketplace. Given this environment, we still believe we can achieve further organic growth perhaps in the low single digits and continued gross margin expansion. This should be driven by market share gains based on the demand for our products, a trend towards our more profitable mix of products sold, and the expansion of the margin channels of distribution. We also expect the strength of our e-commerce business to continue to follow the high-growth trends that we saw in our B2B and B2C sites in the second quarter. These things combined with our other significant fixed cost reduction efforts points us to a strong second half of the year and provide a foundation for further improvement in fiscal 2017. Operator, you can now open-up the call to any questions our participants might have.

[Operator:]

Thank you, sir. [Operator Instructions] And we will take our first question from Dave King from Roth Capital Partners.

[Dave King:]

Thanks. Good morning, everyone.

[Deb Merrill:]

Good morning.

[Bob Humphreys:]

Good morning, Dave.

[Dave King:]

I guess, first off in terms of the gross margin it shows up nicely yet again. I guess, can you talk about the drivers of that improvement, how much of it is attributable to mix? I think that [indiscernible] in your comments, but versus manufacturing efficiency versus pricing benefits, etcetera. And then, I guess, as a follow to that as we think about the outlook exclusive of obviously the initiatives you’ve announced the [indiscernible] of course the new one. How should we be thinking about gross margins going forward? Thank you.

[Deb Merrill:]

Dave, good question on that and I think you did hit on the different pieces of what that gross margin expansion was, we did see that in both of our business segments and across our different business units. So I’d say that the larger contributor to that during this quarter was in the basics segment. And I’d say its probably during the quarter pretty evenly went across on the couple of the things you mentioned, certainly the product mix to a much higher fashion basics private-label and catalog full package and that having strong growth in the decline in those sales coming from the core basic tees that product mix changed certainly contributed to it. We’ve our ongoing manufacturing initiative or process improvement that consistently quarter-after-quarter does add gross margin and that lowers the product costs. And then, we did have some lower raw material prices that benefited us this year compared to the prior year. So, none of the initiatives needed open-width or obviously the newly announced impacted those gross margins in this quarter. And then in the branded segment as well, we had gross margin expansion in that certainly with the strength of the gross margins in the Salt Life business and a nice sales growth that we had in that certainly contributed to that as well. But our other businesses are also carrying some lower product costs benefiting those gross margins. As we go forward for the rest of the year, we still believe that in the back half of the year will be continued gross margin strength both year-over-year and sequentially in the quarters and -- so we expect that trend to continue and then as we mentioned in 2017 we get the added benefits of our open-width project and now the new recently announced structuring alignment that will continue to add strength to those gross margins.

[Dave King:]

Yes, that’s great color. Thanks, Deb. Then [indiscernible] gears a bit in terms of revenue, I guess, first-off what sort of drove the pressures in the basic tees, maybe just a little bit of color there would be helpful. And then, Bob, in terms of your low single-digit outlook or I think hope [indiscernible] single-digit outlook, what are sort of the drivers there obviously TSA I would think as weighing general retail pressures, I would think way weigh some of the benefits in the catalog business etcetera, offsetting, I guess, I will let you answer what you’re sort of thinking as the drivers to get sort of that outlook? Thank you.

[Bob Humphreys:]

Yes. So, I guess, to start with your -- the question about the basics business in the quarter, I think there is maybe a couple of things that are important. One is you may recall the second quarter of last year was a huge growth quarter for us in that business, somewhat moving past the first quarter with the industry which was a tough quarter as raw material prices and selling prices were misaligned and some action was taken by various competitors. So, anyway that delayed some first quarter business, first calendar quarter.

[Deb Merrill:]

First fiscal quarter.

[Bob Humphreys:]

Of course, yes, fiscal -- the December quarter business for us that we had a very robust second quarter. And secondly, you may recall from prior calls that we came into this quarter really lean on inventorial basics. So we were hurt by not having as robust of an inventory position on basic products, so we chose to sell what we could, where we could and quite frankly didn't got paid better for it, then just chased some volume of stuff that we were in short supply of anyone. So as we move forward, obviously there is a difficult retail environment out there for apparel, particularly through traditional retail channels. Now one of the strength of Delta Apparel over the last, really decade has been that we sell our product through a lot of different distribution channels. So we’re not relying on just department stores or dismays or just sporting goods. And so that always gives us some comfort as we get through times of hesitation like this in the marketplace. We expect continued strong growth with Salt Life. We expect continued strong growth in all of our e-commerce sites. And then you’ve the other e-retailers out there that we’ve a growing business with as well. We’re growing nicely in the independent sporting good channel and that will help on the Soffe side and offset some of the TSA business. So not easy slitting [ph] for sure, but when you add it all up, we think we have an opportunity for some slight organic growth and traditionally we’ve had good organic growth and more difficult apparel retail markets.

[Dave King:]

That’s great color. And then, lastly from me in terms of buyback. Obviously, stock had a pretty good run and there is no longer that opportunity to kind of get the book value accretion from -- book value per share improvement right just doing the buyback at a discount and I guess what are sort of the thoughts around future repurchase activity, how do you weigh that versus debt pay down etcetera?

[Bob Humphreys:]

Well, I’d say the intellectual formula in our mind has not changed. So you sit here, you think about what the intrinsic value of our Company is based on cash flow and earnings ability and future growth and then how that relates to where our stock is trading, and our other opportunities to invest money. This is going to create superior return for our shareholders. So, we are obviously encouraged that the marketplace is raw that we work, trading at what we -- almost a big discount to intrinsic value and even into our book value. As we pointed out in the past, we do have significant tangible assets and intangible assets that have great value, but they're not valued on our balance sheet. So we still look at that combined and I think you can see that we’ve significant earnings not only momentum right now, but a platform that’s going to continue to drop out for the next 12 to 15 months. So, we will just have to see how the marketplace responds to that and our debt is low cost and as Deb pointed out, got near than lower cost. Our lenders have been incredibly supportive of us during our whole tenure as a public company and we appreciate that. It gives us a lot of flexibility to keep trying to work to get investments out there that we can leverage our cost of money and make money for our shareholders. So we will take all that into account and we do still have a large availability under our authorized program to repurchase shares.

[Bob Humphreys:]

Okay. Thanks, Bob. Nice quarter and good luck for the rest of the year.

[Bob Humphreys:]

Thank you.

[Deb Merrill:]

Thank you.

[Operator:]

We will now take a question from Lynn Parry from Wilen Management.

[Lynn Parry:]

Good morning, Bob, and Deb. How are you?

[Bob Humphreys:]

Good.

[Deb Merrill:]

Good morning, Lynn. Very Good. Thank you.

[Bob Humphreys:]

Good morning.

[Lynn Parry:]

Nice quarter. I’ve two questions on Salt Life. On the Salt Life’s stickers [indiscernible] for the brand, do you have a number of how many sales accrued [indiscernible] brand again?

[Bob Humphreys:]

We do not, but we could probably come up with some reasonable estimates. So, we will work on that maybe have a little color on that for our next call. The good call out.

[Lynn Parry:]

Okay. Okay. And you had mentioned that you’re [indiscernible] with the West Coast retailer. Could you give any more of an update [indiscernible] of beginning mid summer?

[Deb Merrill:]

Yes. Lynn, you’re asking about how we were talking about having a retailer on the West Coast …

[Lynn Parry:]

Yes.

[Deb Merrill:]

… that would be primarily in California and how that -- that was unfortunately hurt that half with the bankruptcy of the Sports Authority. They still now want our products and time will just tell how -- well how that bankruptcy plays out. We are working with some other national retailers that have some interest and have endorsed in California, so we will see if we can get that placed with some other retailers in light of recent activity there.

[Lynn Parry:]

Okay. Thank you. Is the sales growth uniform throughout the country or is it coming mostly from geographical expansion?

[Deb Merrill:]

You’re asking about the Salt Life growth, if that’s centered …?

[Lynn Parry:]

Yes, [multiple speakers] Salt Life, I’m sorry.

[Deb Merrill:]

Yes. No, problem. So, yes, I’d say that we’re getting growth in Salt Life across all of the different areas we’re in. We are still heavily working on California. We think that’s a big future growth opportunity for us. But as we’ve said, we’re doing that in the grassroots kind of disciplined away with those consumers in California. But we do continue to add different retailers. I’d say a lot of that growth is coming from product expansion, in gender expansion within the doors that we’re in where retailers may have started just in the men's category and now are picking up our women’s [indiscernible] line or our kid line as well as our different products that we are growing with our performance products and things like that. So, I’d say those are probably the bigger driver of the growth rather than necessarily new retailers although we are adding those, but we’re certainly working on that product expansion of growing that line.

[Lynn Parry:]

Okay. Thank you. And then, sell-through on Salt Life, is there a reorder cycle from retailers or they mostly one big stocking [ph] order?

[Bob Humphreys:]

No, we’ve kind of two different lines that go through there that act differently. So we go produce a forward line and we presale that line and we source our fashion products based on the pretty solid demand we’ve -- we will drop things that are not responded too like we were expecting by retailers. And then we may source some safety stock on that. For certain products we can kind of do one reorder in season which we’re really doing right now for spring. So that would be all the passionate performance, and then all of the basic products though -- although 100% cotton screen-print that we make in our vertical operations, we’re in constant re-supply of that.

[Lynn Parry:]

Okay. Thank you. And then, lastly on Salt Life, you have 23% sales growth in the first quarter. Is this a pretty good normal from what our sales will be in Salt Life and if you had to give a 5% range, it would be 20% to 25% growth?

[Bob Humphreys:]

I’d say 17% to 22%, how about that?

[Lynn Parry:]

Okay. Thank you. Okay. And then, I have a question on Soffe. It continues to be a soft brand or soft hedge. Can you talk about the changes in the strategic plan selling or how you dealt with -- to the market; I think you could [indiscernible]?

[Bob Humphreys:]

Yes. We are seeing, and particularly in the quarter we just finish and we think we will see more of it in the quarter that we just began. But a lot of the work over the last year or so is starting to bear fruit, it is Soffe. So, I’d say it started with a better and more updated product offering even in the basic products, some updated looks in packaging and labeling. And then with that we improved our customer service performance dramatically in that business and a part of that was having a larger in stock position on our basics products. And we are seeing that resonate with a number of our traditional channels of distribution. So for example the Soffe basics shorts is now in all big locations which is a significant increase from prior years. We are seeing a good sell-through there. We are seeing expanded business in our military operations and improved graphics out there in the marketplace. So, some good things really going along Soffe from a product standpoint and service standpoint and offset to some degree by the [indiscernible] at retail in the sporting goods channel.

[Lynn Parry:]

Okay. Thank you. And then on the -- on you have a growing retail from kind of with the two Salt Life stores and Junkfood. Are these just marketing endeavors for the brand or these actually contributing to the profitability?

[Bob Humphreys:]

Yes. So, the current Salt Life Store in Jacksonville is for while profitable and we expect the same thing in San Clemente. The Junkfood store -- the store at this point is not profitable and there is more of a branding exercise that is interesting. We just did a recent survey of our e-commerce customers from Junkfood and over 50% of them learned up the brand through that store. So, it’s obviously driving people to the brand. But our -- [indiscernible] for any retail store, but particularly the Salt Life expansion of doors is to be profitable in the same kind of operating margins that we’re enjoying on the brand as a whole.

[Lynn Parry:]

Okay. On the Salt Life store, you’re playing on targeting more of the stores in other areas around the country?

[Bob Humphreys:]

Well, I’d say short-term, we in the next couple of years we will be building out several doors in California and continuing to work on a proof-of-concept and make sure we know what we're doing, and we have the right size for we’re in the right look, in the right economic model that makes those stores profitable.

[Lynn Parry:]

Okay. Great. Thank you.

[Deb Merrill:]

Thanks, Lynn.

[Operator:]

And we currently have no additional questions at this time.

[Bob Humphreys:]

Okay. Well, thank you all very much for joining us on our call this morning and we look forward to updating you on our third quarter results at about three months. Thank you.

[Operator:]

And ladies and gentlemen, this does conclude today’s conference. We do thank you for your participation. You may now disconnect and have a wonderful rest of your day.