Delta Apparel, Inc.
Q2 2015 Earnings Call Transcript

Published: 11 May 2015

[Operator:]

Thank you, and good afternoon to everyone participating in Delta Apparel's Fiscal 2015 Second Quarter Earnings Conference Call. Joining us from management are Bob Humphreys, Chairman and Chief Executive Officer; and Deb Merrill, Vice President and Chief Financial Officer. 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 or that any contemplated actions or initiatives will not be implemented. I'll now turn the call over to Delta's CFO, Deb Merrill, who will provide the details of the company's fiscal 2015 second quarter ended March 28, 2015.

[Deborah H. Merrill:]

Thank you and for everyone joining the call we appreciate your interest in Delta Apparel. I’m pleased to report that during our fiscal 2015 second quarter, Delta Apparel resumed net sales growth in profitability. Our fiscal 2015 second quarter net sales were $115 million, compared to $114.5 million in the prior year period. While the growth may appear modest, there are a couple of important factors to consider. Net sales during the quarter were affected by the sale of the Game college bookstore business and the associated removal of that revenue stream in the quarter. Our operations were interrupted as we separated the Game from our ERP system and pulled the Game’s screen print in apparel distribution operations out of our Seattle location and relocated our Salt Life’s headquarters to a new office. Cooler weather across the country in February and March also hampered results. In spite of these headwinds, we’re pleased to achieve sales growth in each of our business units, but the exception of one. Gross margins expanded 210 basis points from the December quarter to 18.5% in the March quarter. Gross margins were actually 60 basis points higher at 19.1% if you adjust for the indirect expenses associated with the sale of the Game, which were recorded in cost of sales. I’ll walk you through the recording of this sales transaction in more detail in a few minutes. While gross margins in the Delta activewear business continued to be hindered by market place premier mix including lower selling prices and higher input costs. All of our business units expanded gross margins from the prior year March quarter. We also had indirect expenses associated with the sale of the Game, which were required to be included in selling, general and administrative expenses. Adjusting for these expenses, we reduced selling, general and administrative expenses by $1 million to 17.6% of sales, compared to 18.6% in the prior period. The 100 basis point improved resulted primarily from lower fixed compensation and benefit cost of About $1.2 million, along with lower professional fees offset partially from higher advertising expenses associated with the Salt Life and Soffe brands. Net income for our 2015 second quarter, was $3.6 million or $0.46 per diluted share, with $0.03 per share attributable to ongoing operations and $0.43 per share to the sale of the game asset. This compares with our 2014 second quarter net loss of $763,000 or $0.10 per diluted share. As you know about six months ago, we set forth a number of strategic initiatives to improve the profitability of Delta Apparel. We are proud of the progress we’ve made in the results that can already be seen in our financials from the implementation of these initiatives. As mentioned earlier our SG&A expenses reflect the reduced compensation expense and other reductions we have implemented. We also engaged in a comprehensive rationalization analysis of our operating units, product lines and sales channel. From this, we decided to sell the Game brand into collegiate headwear and apparel business and completed that sale on March, 2. We believe this transaction further strengthened our balance sheet and now enables us to focus on areas of our business that are more strategic to our long term goal. While we sold the business consisting of the Game’s branded product sold nationally in college bookstores and through team dealers, we continue to own Salt Life and our corporate business Kudzu that operated within through the Game LLC and have changed the name of that entity to Salt Life LLC. The sale included all decorated finished goods inventory, certain undecorated finished goods inventory, fixed assets and some other assets net of certain liabilities. The transaction did not include accounts receivable and certain undecorated apparel inventory, from which we anticipate collecting approximately $6 million from these assets. We incurred about $400,000 in direct selling expenses associated with this transaction. In addition, we incurred certain indirect cost associated with the transaction including about $800,000 of devaluation on inventory that was not included in the sales and $1.4 million of indirect incentive based expenses. The pretax gain on the sale of the Game asset includes of both the direct and indirect expenses worth $5.6 million. This net gain was recorded across our financial statement as follows, $800,000 of expense in cost of sales, lowering our gross margin by 60 basis point; $1.4 million of expense in SG&A expense, increasing our SG&A expenses as a percentage of sale by over a 100 basis points; and the remaining $7.7 million gain on the sale of the business. For income tax purposes, this gain net of associated indirect expenses was treated as a discreet item at full applicable statutory rate and resulted in $2.2 of income tax expense, resulting in net earnings per share of $0.43 related to the sale transaction. Another outcome of the rationalization analysis is the deficient to not renew our license which were chilled down [ph]. Since acquiring to the Game in 2009, we’ve been the licensee for onsite licensed merchandise sales during the Kentucky ops [ph] in Derby events, which also allowed us to sell licensed merchandise to certain retailers. Although it provided a profitable revenue stream of approximately $3 million, this business required the time attention of key resources within our organization for a certain period of time and tier thereby taking their attention away from our core businesses. In addition it carried the inherent risk associated with then driven business, where it takes only one day of bad weather to negatively impact profitability. Overall, we enjoyed operating this business, but felt that we’re better served focusing our resources on more strategic area that was in our company, areas with strong growth and profit potential. Another of our strategic initiative was to continue working on our manufacturing platform to lower overall product cost. We have recently embarked to find an expansion of our Honduran textile operations involving new equipments that will allow us to internally produce open-width fabrics used in many of our business units. We expect to spend approximately $4 million on this expansion, which should allow us to internally produce approximately 80,000 pounds of fabric weekly that we are currently sourcing on the outside. The equipment is expected to arrive in the fourth calendar quarter of 2015 and we expect it to be fully operational by the end of the first calendar quarter of 2016. This should reduce our reliance on purchased fabric and further leverage our internal production. We expect to realize annualized savings of approximately $2 million that we should start seeing in our results beginning in the back half of our fiscal 2016. Including the additional capital spending associated with the textile expansion, we now expect capital spending in fiscal 2015 to be approximately $9 million. During the March quarter we spent about $0.5 million on capital spending, bringing our year-to-date capital spending to $2.5 million. Depreciation and amortization including non-cash compensation was $2.9 million for the quarter and $5.3 million in the first six months of fiscal 2015. Total debt increased $4.6 million from December to $135.1 million in March. While the sale of the Game generated approximately $14 million in cash, after payment of transaction cost, normal seasonality in the working capital in the business that resulted in the increase in debt during the quarter. As we progress to the back half of the year, we anticipate that inventory levels will continue to decline, both in units and with lower cost inventory. We believe this coupled with the profitability we expect in the business to generate strong positive cash flows in the coming quarters and drive debt to be in the $19 million range by September fiscal year end. During the March quarter, we did not repurchase any additional Delta Apparel stock. However, we’ll continue to evaluate share repurchases against other opportunities going forward. I’ll now turn the call over to our Chairman and CEO, Bob Humphreys and he’ll provide you with more details on our outlook for the business.

[Robert Humphreys:]

Thanks, Deb and thank you all for being on the call with us today. The results of our second quarter are very encouraging and suggest a strong second half for the fiscal year. We’re now seeing in many of our business the results of the strategic initiatives that we’ve implemented over the last six months. Deb mentioned a number of these initiatives, but there are many others as well. Aside from receiving a 60% premium over good value on the sale of the Game asset, the sale has now enabled us to focus our resources on more strategic areas of our business that have strong growth potential. Ecommerce is an area where we’re investing resources and our second quarter has provided a glance into its great growth potential. Overall our ecommerce business grew almost 70% during the March quarter, with our B2B and consumer sides all increased in sales by over 60%. In our activewear business, our customers appreciate this easy way for them to place orders as can be seen by our business-to-business ecommerce sales growth in the second quarter of 61% and 73% year-to-date. In no other business is the value of ecommerce more apparent than in Art Gun. Art Gun facility boasts cutting edge equipment in industry leading proprietary software specifically geared to facilitate ecommerce business. Art Gun continued its characteristic high growth rate during the 2015 second quarter with 43% sales growth on a 52% increase in volume over the comparable year period. We expect this business unit to continue its rapid growth and have invested in systems that can support that growth into the future. Art Gun’s technological competencies are also being leveraged internally to enhance Junkfood's direct-to-consumer business by giving Junkfood more flexibility in its ecommerce product offerings. In the March quarter, Junkfood more than doubled its sales on its consumer side, bringing its year-to-date sales been increased to 83% over the prior year. Soffe also experienced strong growth on its consumer website, with sales increased to 66% in the March quarter compared to the prior year and positive indicator of the strength of the Soffe brand was consumers. The ecommerce side also gives us a nice vehicle to engage directly with the Soffe consumers. In the last six months we’ve given each of our ecommerce sites a facelift and just in April, we launched a refresh Salt Life site, which not only included a new design, but enhanced the customer experience with improved functionality. Salt Life ecommerce sales increased 68% in the March quarter compared to the prior year and we believe we’ll continue this growth trend, especially with the new site that was just launched. In addition to the growth seen in the ecommerce, all of our business units have shown improvements during the quarter through sales growth, margin expansion or both. In our activewear business, demand for undecorated tees remained weak overall during the quarter, but strengthened as the quarter progressed. Our June quarter is starting out strong with April sales growth and undecorated tees and full packaged products of approximately 8% over the prior year. Pricing seems to have stabilized a bit, but time will tell how the price impulse through the full strength billings would be. We’ve increased our sales force dedicated undecorated tees to gain additional strength in underserved areas of the country. We were seeing positive reaction to the new products we introduced in the undecorated tee market, including our new Snow Weather [ph] and Soft Spun tees. Prebooks were strong and we’re struggling to keep with on the shelf to service the overall demand. Our French terry and fleece product line that we introduced last season did well and we chased inventory throughout the season. We now have many new customers that have put this product into their line and we’re positioning ourselves with strong inventory positions to serve this line of business this year. We also have secured print programs using our catalog blank, which should provide a strong foundation for growth in upcoming quarters. Our private label customer base continues to expand as we win new business based on service levels, our quality and speed-to-market. In the March quarter, private label sales increased 28% over the prior year period. Based on our order backlog, we anticipate strong earnings schedules for the next several quarters on our private label products. We just completed our screen printing operations in El Salvador to service our growing private label and full package businesses. With respect to our Soffe business, as a reminder, in December we completed our transition to a new ERP that afford Soffe greater efficiency and improved customer service, by also reducing the staffing and technology cost. While this is a positive step forward, with Soffe now operating with a much more fixed cost structure, it has for a bit in a short term with vast efficient shipping operations as new processes and procedures were implemented. In addition Soffe had previously provided the screen printing and distribution for the Game’s leading apparel line. With the sale of the Game, this had to be pulled out of the Fayetteville location and cause the build disruption within the facility during the March quarter. This has now been completed and we’re already seeing the favorable results in screen printing from the elimination of the smaller print run associated with college bookstore business. We’re seeing positive indicators that the Soffe’s spring line sell-through is through the retail. There seems to be a resurgent in the iconic Soffe shorts. We had a large retailer account tell us that the Soffe shorts was the strongest sale in junior shorts on their floor and we’re chasing products now in several new stores. Soffe has launched a new marketing campaign to support a refined brand position, including a targeted consumer outreach effort to grab engagement and loyalty with Soffe’s core consumers. Soffe has started the quarter with April sales ahead of the prior year. With the actions we’ve taken over the last several quarters and what we’re seeing our customers, we believe Soffe has stabilized and is in a good position for future growth. The Junkfood team continues to be intensely created and develop a new apparel garment and graphics and as well as producing marketing programs attuned to the latest social media trend. Junkfood continues to be sort after for its creativity by customers and large consumers [ph]. Although Junkfood’s business was still down slightly with one of its large retail customer groups, this was more than offset by growth within other sales channels during the quarter, resulting in sales growth of 2.3%. The improvement in other sales channels including vertical and specialty retailers has also improved Junkfood’s gross margin which expanded by 250 basis points compared to the prior year quarter. Our flagship Junkfood store is meeting our expectations from a marketing and brand-building standpoint and its revenue continues to grow. Based upon its expanding customer base, new program, ecommerce growth and fresh product line, we anticipate stronger sales growth out of Junkfood over the next several quarters. Demand for Salt Life products continues in record level. Large national retailers are reaching out to us to get Salt Life products in their doors. Unfortunately during the quarter, disruptions from the sale of the Game put Salt Life’s sales as part of shipments were delayed as systems had to be separated and offices moved. The cool weather in February and March also hindered sales as independent and resort retailers delayed bringing in products into a longer weather, yet consumers were actually visiting their stores. We are pleased that Salt Life's spring line has been well-received and is selling well and we anticipate a strong June quarter. We’re already seeing this with our April sales for Salt Life, up over 60% compared to the prior year April. Consumer demand is grabbing retail door expansion for the brand. More independent retailers desire to carry the Salt Life brand. Our national and regional retailers are expanding in in-store shops and fixtures with Salt Life and we're getting additional interest from new national retailers to carry the line. Retail partners continue to buy into our expanded product categories including kids, ladies and performance products, further expanding the Salt Life presence in retail doors. We continue to invest in consumer marketing of the Salt Life brands. We recently launched a Salt Life YouTube channel and are seeing strong good viewership from that site. For some time we’ve been working at the grass roots to build the Salt Life brand outside of the southeast. It is interesting that during the March quarter, California had the most views to the Salt Life YouTube channel, followed by Florida, Texas, New York and Illinois. Also visits and merchandised sales coming from California on the Salt Life ecommerce site has nearly tripled over the past year. During the April month, YouTube views were up over 300% versus the entire March quarter. California still coming in as the number one viewership, then Texas, then Florida and certainly brand recognition of Salt Life is moving out of the southeast. Just to conclude we’ve made progress on a number of fronts over the last several quarters. We’ve lowered our fixed cost structure, we streamline decision making, we’ve improved our manufacturing performance, we’ve increased output at our low cost manufacturing facility, we’ve expanded branded business utilizing our manufacturing platform and we’ve initiated several additional manufacturing projects, which should lower our internal cost over the next several quarters. We anticipate increased sales across each of our business units in the back half of this year. We expect gross margin to continue to expand, not only from the leverage on higher sales, but also the lower product calls [ph] that will be flowing through beginning in the June quarter from lower call in the energy prices combined with improved manufacturing efficiencies. We’ll continue to benefit from our lower fixed cost in our administrative functions. All of this coupled with our strong April results and current backlog of orders gives us a high degree of optimism that we should see overall good sales growth and greater profitability in the back half of this year. These results should further enhance the company’s market value. However, in the mean time we believe much of Delta Apparel’s intrinsic values still goes unrecognized by the market. Simply looking at the book value of our business, which is approximately $17 per share does not take into consideration some significant tangible assets including over $20 million of recently upraised real estate in Fayetteville, North Carolina, which has no book value reported on our financial statements. This along with several other items will add nearly $4 per share in additional value. With our stock price trading in the $12 range, we’re only trading at about 60% of book value. Our sale of the Game for 60% premium over book value also indicates that the intrinsic value of Delta Apparel is significantly higher than book value. At current stock prices, we believe this creates a strong buying opportunity for anyone interested in investing in Delta Apparel stock as well a strong upside opportunity for value creation for current share holders. Operator we’d now like to open the floor to questions.

[Operator:]

Thank you. [Operator Instructions] We do have a question from Mike Hughes with SGF Capital.

[Mike Hughes:]

Yeah, referring back to the investor presentation you did at March and there’s a fly that just shows getting that down to about the $90 million level that and then trailing EBITDA being at three and a half times or less. Is that still a good working assumptions that would fly up on EBITDA number for the year north of [ph] $20 million excluding the gain on the Game business?

[Deborah H. Merrill:]

Yes, that would still be a good working model.

[Mike Hughes:]

And then just one follow up on that, the gross margin expansion that needs to happen in order for you hit that EBITDA number. How much of that would come from the lower cost cut and slowly, really which I feel most is going to benefit the basics business.

[Deborah H. Merrill:]

Yes, you’re correct. We should see margin expansion in that activewear business, as we saw already in the March quarter, although that was really more from volume and mix change. But starting in the June quarter, for a portion of that June quarter we will have the lower product cost flowing through there and then our September quarter should further expand those gross margins as we’ll have a full quarter of the lower product cost. But at the same time we still continue to anticipate continuation of our gross margin expansion in our branded businesses that we’ve seen in each of the first two quarters. We would expect that to continue as well in those business units. So I think you’re going to get certainly your biggest dollar impact from that gross margin expansion will come from the basics, but we do anticipate both basics and each of the branded units to continue there with margin expansion as well.

[Mike Hughes:]

Okay, so at this point you’re still unplanned with where you thought you would be back when you did that presentation in March, I think in the West Coast Conference, is that correct?

[Deborah H. Merrill:]

Yeah, but I would say that we’re still on trend with that.

[Mike Hughes:]

Okay. Thank you very much. I appreciate it.

[Operator:]

[Operator Instructions] And we do have a question from Jamie Wilen with Wilen Management.

[Jamie Wilen:]

Hey, fellows. Nice quarter. Just I want to start with the cost structure. When you sold the Game, was there anything in this quarter of the expenses that would all go into discontinued operation [ph] of the Game on sale. You talked about, something about some selling expenses that sounded like they were in current operations.

[Deborah H. Merrill:]

Yes. Jamie unfortunately the way that that had to be recorded for some of the indirect expenses from that because we did not sell certain of the assets and we only sold certain assets and because those were split they were indirect cost associated with that. So there was about $800,000 of expenses sitting in cost of sales that reduced our reported gross margins by about 60 basis points and there was about $1.4 million of expenses of indirect expenses that had to be recorded in the SG&A line. So that increased our SG&A expenses by about a 100 basis points and then there was the $7.7 million, which was the direct gain and direct selling cost that was on that line of the financials. So it all nets to the $5.6 million net gain, but you’re correct. When you look at the financials we do have a unfavorable impact in our gross margin and in our SG&A cost because those indirect expenses had to be recorded on those line items.

[Robert Humphreys:]

But Jamie, those will be ongoing indirect expenses. They [indiscernible] at that quarter.

[Jamie Wilen:]

So the profit from operations that you had quoted was actually the profit from operations by the time you got through with all this stuff?

[Deborah H. Merrill:]

Correct and so you can think of it that, yeah - everything related to that is recorded in this quarter, which yielded the $0.43 net gain from that transaction.

[Jamie Wilen:]

Okay. You had talked about overhead reductions last year being somewhere I think in the $7 million variety. I think you said, you $1.2 million this quarter, when are we going to start to see the full impact of all those overhead reductions?

[Deborah H. Merrill:]

I think, I mean as of right now the headcounts are fully taken out of those. So I think the June quarter will be the full quarterly impact of those reductions.

[Jamie Wilen:]

Okay. On to Salt Life, I’m always amazed seeing the diversity of the brand. When I go around the town I saw a Mercedes parked next to a pick truck both with Salt Life decals on the back. When you go into the market, how are you hitting both the high end and the low end? It seems like, you’re just a low end product, how are you hitting all different economic groups, male, female et cetera?

[Robert Humphreys:]

Well, I think it starts with kind of your brand idea and presence and then we’re being careful to instill that into our merchandising and product development efforts that - we have products that appeal to a lot of different socioeconomic groups and a lot of different types of activities that do have that core spread of Salt Life participation, living, wanting to be at the beach and what have you. And I think is our six best of that so far and I think we mentioned maybe on our last call the really encouraging results we got from a - it’s faced a consumer survey, but anyway today we’ve been able to that and it’s not making one part that group shy away from the product. So I mean, truly from people wanting service tumblers with Salt Life on them to have their summer drinks to people who want performance products to go fishing and to bored shores [ph] and kind of everything in between. So far its resonating well and I give a lot of credits for that our design group and just to lead that effort that has an ability to kind of hit those phase levels.

[Jamie Wilen:]

Did you quantify the number of doors that Salt Life is now in versus where they were a year ago?

[Robert Humphreys:]

We did not, maybe we’ll do that on our next call. We had a lot of new information on Salt Life, particularly with the YouTube channel and ecommerce sites that we concentrated and did not go and reconcile the door count.

[Jamie Wilen:]

Okay and lastly, branded goods this quarter had operating margins of 15% as the best number in a long time, what is - is there an operating margin target that you’re looking at on the branded side?

[Deborah H. Merrill:]

So Jamie, I mean I would say that yes. We’re pleased that that continues to improve, we’ve been able to improve our gross margins coming in that business and that’s obviously as the overhead cost are being allocated in there and some obviously are overall headcount reductions across both our business units and our corporate overhead structure has certainly helped with that. Now, we would certainly look for that to continue to improve, so that’s certainly not where we would like it overall, but it’s certainly improving. The other thing that you can see in there is that all of that gain is also in that, when you’re looking at those operating margins this quarter, so just be aware of that as well.

[Jamie Wilen:]

Okay. Sounds like you had a great April and hope for continued success looking forward. Thanks.

[Operator:]

[Operator Instructions] We’ll move next to David King with Roth Capital Partners. And Mr. King, you’re line is open. Please release your mute function. We’re not able to hear you. And once again Mr. King, you’re line is open now. Please release your mute function. And we’re not hearing a response from that line at this time. And there are no further questions in our queue. I’ll turn the call back over to our speakers for any final or additional comments.

[Robert Humphreys:]

Okay. Well, thanks everyone for joining us and we’ll look forward updating you on our June -