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Delta Apparel (NYSEMKT:DLA)

Q3 2013 Earnings Call

April 25, 2013 4:30 pm ET

Executives

Deborah H. Merrill - Chief Financial Officer, Principal Accounting Officer, Vice President and Treasurer

Robert W. Humphreys - Chairman and Chief Executive Officer

Analysts

James Fronda - Sidoti & Company, LLC

Jared Schramm - Roth Capital Partners, LLC, Research Division

James Wilen - Wilen Management Co., Inc.

Operator

Good day, everyone, and welcome to -- everyone participating to the Delta Apparel, Inc. Third Quarter Fiscal Year 2013 Earnings Conference Call. Joining us from management today 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's executives. Such statements suggest predictions that involve risks and uncertainties, 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 than 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.

Just a reminder that today's call is being recorded.

And I would now like to turn the conference over to Delta's CFO, Deb Merrill.

Deb, please go ahead.

Deborah H. Merrill

Thank you, and good afternoon, everyone. There were 2 key factors that negatively impacted Delta's revenue and net income during its 2013 fiscal third quarter. First, the difficulties that we've been experiencing at Soffe continued through the period. And second, demand for products was delayed somewhat due to cooler weather and the unusually late spring this year.

We'll go into more detail later, but the result was that our consolidated net sales for fiscal 2013 third quarter were $120.1 million, down about 4% from our 2012 third quarter sales of $125.5 million. Net income was $1.6 million or $0.19 per diluted share, compared to $1.9 million or $0.22 per diluted share from last year's third quarter. Despite the overall decline, we want to point out that we had revenue growth in our basics segment and every one of our branded businesses with the exception of Soffe. Gross margins and operating profits also improved across-the-board with the exception of Soffe. Had Soffe performed this third quarter as it did in the prior year third quarter, we would have experienced overall sales growth of about 3% with operating profit growth of about 83% over the prior year third quarter.

In reviewing our segment results, all of our branded businesses experienced good sales growth being offset by the 30% sales decline in our Soffe business. Net sales for our branded segment came in at $52.6 million, down 10% compared with $58.5 million from last year's third quarter. The Game had a strong quarter with 15% sales growth being driven from Salt Life products. Sales for Junkfood products increased about 9% with another good showing from the professional sports licenses business. Art Gun continued its rapid growth, achieving a 60% sales increase in the third quarter and a 95% increase for the 9-month period.

Net sales in the basics segment were up slightly to $67.4 million compared with $67 million for last year's third quarter. Sales at FunTees, the private label business, grew 4% for the quarter and nearly 10% for the 9-month period. The catalog business achieved unit sales growth of 6% but this was offset by lower average selling prices, leaving sales relatively flat for the quarter. Sales in the catalog business are up over 8% for the 9-month period on unit growth of over 17%. Margins improved in the basics segment, driven primarily from the improved manufacturing performance.

For the first 9 months of fiscal 2013, overall net sales increased slightly to $357 million from $354.6 million in the comparable period of 2012. Net income for the 2013 9-month period was $5.2 million or $0.61 per diluted share. For comparison, the prior year's 9-month period includes the second quarter 2012 inventory markdown in the basics segment that was necessitated by the record high cotton costs. This resulted in a net loss in the 2012 9-month period of $7.3 million or a loss of $0.86 per diluted share.

SG&A expenses in our 2013 third quarter were 19.7% of sales, compared to 17.7% of sales in last year's third quarter. For the first 9 months, SG&A as a percentage of sales was 20% versus 18.9% in the prior year. Much of this increase was due to royalties, which we pay on our licensed products, which we experienced strong growth in this year.

Our effective tax rate for fiscal 2013 9-month period was 16.8%, compared to a tax benefit of 45.6% on our loss in the prior year period.

At March 30, receivables were $70.8 million, a 4% decrease from the prior year March resulting from the lower sales. Days sales outstanding stood at 52 days, which is consistent with the DSO for the prior year period.

Capital spending was $1.6 million during the quarter, and our depreciation and amortization including noncash compensation was $2.4 million.

We continued our stock repurchases during the third quarter using $1.5 million to buy back 103,000 shares at an average of $14.34 per share. So far this fiscal year, we've repurchased 316,000 shares at an average price of $14.31 per share. At the end of the third quarter, we had $11.2 million of our authorization remaining, which includes the additional $10 million authorization approved by the Board of Directors at its meeting in January. We believe our stock is currently trading at a price that's below its intrinsic value and such periodic repurchases are sound investment opportunities that we can pursue without sacrificing future growth plan.

Total debt at March 30 was $112.9 million compared to $132.6 million a year ago. Lower working capital requirements, primarily as a result of lower cotton prices, were the principal reasons for the decrease in debt level.

Cotton prices continue to require careful scrutiny. While they've come down significantly from the highs and are more in line with historical levels, they are still somewhat volatile. Speculation in the market, coupled with actions in China, contribute to the volatility we are seeing in the cotton market. Due to these factors, we have taken steps to hedge our cotton position for the upcoming year.

As mentioned when I started, the difficulties that we've been experiencing at Soffe and the unusually late spring this year have hurt our ability to meet our sales and profitability goals. While spring appears to be finally here, it may not have come quickly enough to bring the fourth quarter in line with our earlier estimates. This, coupled with the third quarter results that did not meet our expectations, necessitates that we reduce our guidance for the 2013 fiscal year.

We now believe revenue will be in the range of $490 million to $495 million, and earnings will be in the $1.05 to $1.10 range. As a bridge for everyone to help understand this change in outlook, if you adjust for the sales and profitability decline in Soffe year-over-year, we would be looking at sales at over $520 million or 6.5% sales growth and earnings per diluted share of approximately $1.80 for this year compared to last year.

As I turn the call over to our Chairman and CEO, Bob Humphreys, he'll provide more details on the Soffe business and our plans going forward.

Robert W. Humphreys

Thanks, Deb. And thank you all for your interest in Delta Apparel. As you've heard, the 2 factors that had the greatest negative impact on our third quarter were the late spring with cooler-than-expected weather and the poor performance in our Soffe business. There's little we can do about the weather, but there are many things that we're doing about Soffe so I'll discuss that first.

Soffe's difficulties primarily stem from a high degree of turmoil that is occurring in the retail industry and our failure to make adjustments in our go-to-market strategy and operations in a timely fashion. Retailers working to stay profitable in the face of persistently sluggish economy are making adjustment in their buying patterns, which are having a direct effect on Soffe's sales and marketing success with these customers. Specifically, some large retailers are shifting to a strategy that emphasizes private label products. Historically, we've seen this strategy isn't as effective for Soffe consumers, but only time will tell how customers react to this shift. If these retailers eventually revert to their previous branded strategy, Soffe's branded products could be brought into their marketing plans. That being said, we're not waiting for that to happen. Instead, we have realigned our merchandising and marketing and sales leadership, so we're now focused on expanding the retail customer base and replacing the business we lost.

Realizing this won't happen overnight, we're taking immediate steps to reduce our costs and make Soffe profitable at current volumes. We see a number of things that we believe will happen to have Soffe better positioned as we begin fiscal 2014. First, we'll have lower-cost inventory on hand to shift to our customers, driven by lower raw material costs and improved manufacturing performance. Excess costs associated with the college bookstore business are being eliminated with the consolidation of this sales channel in To The Game operations. We have evaluated the entire cost structure of the business and are making adjustments to support the current sales level. In addition, we're implementing the lower cost operational platforms at Soffe that are now established in our other business units.

Moving past Soffe, the rest of our business did well, especially when you consider the additional challenge they face from the unusually cool weather. In our branded segment, Junkfood grew more than 9% with strong margins. One of our most innovative businesses, Junkfood brings new meaning to licensing with products that help businesses connect with their consumer's desires. We also have introduced to the premium department store a fashion line called Straight [ph] Heart [ph] that is free of graphics, but focuses on the fashionable Junkfood silhouettes and fabrics. These products will be available soon.

The Game, which grew nearly 15%, was driven by good performance from Salt Life products. The new footwear line is in stores this spring, along with new products made from our performance fabric, UVapor [ph], which provides UV, moisture and odor protection for the more active beach lifestyle.

We're also continuing to consolidate our college bookstore business under The Game. When completed around the end of this year, the consolidation will provide some strong sales and marketing advantages for us while lowering our operating costs.

Art Gun has continued its growth in the third quarter and continues to expand its customer base and improve profitability. We expect Art Gun to generate an operating profit for us for the full fiscal year.

Our basics segment had a slight sales increase over last year's third quarter, continuing first and second quarter growth that put it up nearly 9% year-to-date. Our basics segment recently came out with a new performance product called Delta Dri, which has already proven to be a winner in the marketplace and we expect good things from this product down the road. We continue to gain new customers, utilizing our catalog lines and printing capabilities to provide a full package product to customers.

Looking behind the numbers, there are a lot of good things to report. For example, with the exception of Soffe, operating profit improved in the third quarter in all of our business units; in fact, it nearly doubled. Gross margins have improved overall, primarily due to increased manufacturing efficiencies. We're continuing our manufacturing expansion within our existing facilities and expect to have new equipment installed and the completion of this project around the end of this calendar year. While we still have some additional costs related to our manufacturing expansion and books for consolidation over the next couple of quarters, these activities should result in a lower-cost platform going forward. In addition, because of the actions we have taken regarding Soffe, we expect soon to have it realigned with market demands so it, too, should be contributing to the overall success of Delta Apparel.

So far, this fiscal year has presented us with a number of challenges, not the least of which has been a continuing soft economy and unusual weather. We have met these head on with solid solutions, the benefits of which should become apparent in the upcoming quarters. As we move through the remainder of fiscal 2013 and into fiscal 2014, we have 3 areas of primary focus: the first is to reinvigorate the Soffe brand and business operations, returning it to the profitably that we have historically enjoyed with this business; the second is the support of growth in our basics segment with the expansion of our manufacturing capacity within our existing facilities; and the third is the continued development end expansion of our brands. We believe that this focus will allow us to continue on our path to growth and drive operating margin improvement needed to meet our longer-term profit goals.

At this time, we're going to open up the call for questions. Lori, if you could manage the questions for us. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll go first to James Fronda at Sidoti.

James Fronda - Sidoti & Company, LLC

Why is it that you think the, I guess, the Soffe brand just isn't selling as well as the other brands?

Robert W. Humphreys

Well, I think the first driver of that is they're big department store customers, Penney's and Kohl's really changed strategies and I'll have to comment on Penney's. There, where we lost juniors business but believe we'll be rebuilding that with some girls product. And Kohl's moved this basic product line to a private label category. And so that was significant volume with those 2 customers. And then when you start looking, we just feel like we probably lost touch with the marketplace a little bit, was not as quick to react and really have a higher cost platform there that what we've developed at our other business units. So I think those are the primary drivers.

James Fronda - Sidoti & Company, LLC

Okay. And do you think you could, I guess, fix this by next quarter or would that have to wait till sometime in fiscal '14?

Robert W. Humphreys

No, I think we'll continue to be well below our historical performance at Soffe in our fourth quarter. And the fall business is a smaller part of the Soffe business, so I think where we're really focused is for spring of next year. We brought in some new merchandising talent and product development and design. We have -- we've done the focus groups and what have you. We're excited about what our spring offering is going to be. That's what we're really focused. We brought back in Rod Wagenseil who used to be over sales at Soffe. We had moved Ron out to the West Coast to run our Junkfood business some years ago and that's really when we start seeing that decline in the overall sales growth at Soffe. So we're happy to have Ron back full-time, really focused on all the sales and marketing and merchandising efforts of that business for us.

James Fronda - Sidoti & Company, LLC

Okay. But if it's not until next spring, then I guess it'll probably negatively weigh on sales for the next coming quarters then, right?

Robert W. Humphreys

Yes.

James Fronda - Sidoti & Company, LLC

Okay. All right.

Robert W. Humphreys

Less significantly as we go into fiscal '14. It's really [indiscernible] last year. But still we would expect it to be below the prior year level.

Operator

And moving on, we'll go next to Jared Schramm at Roth Capital Partners.

Jared Schramm - Roth Capital Partners, LLC, Research Division

You mentioned returning Soffe to historical profitability levels. Could you just give us some maybe a little bit better in-depth as far as initiatives specifically that you think will take you there?

Deborah H. Merrill

From a profitability standpoint, I would just kind of repeat some of the things that Bob had mentioned. Some is our fiscal '13 did have higher cost inventory product in it that will not be in it in '14. So that would definitely flow through in fiscal '14 results. We have -- are moving and in the process and it will finish by the end of the year the college book for business where we have some excess costs in that business, and as we consolidate that with The Game business, those excess costs are being removed and taken out. So that would certainly be a piece that will come through in fiscal '14. And then we have already and have already been for the last couple of quarters that we've talked about really looking at the overall cost structure of that business and started taking steps in evaluating what we need to do in order to rightsize that business for the current sales level. So that's being worked on. So some amount of that you'll see the benefit in fiscal '14. And then, as Bob mentioned, we are looking at the low-cost platform that we have in our other branded businesses. That's performing well in that operational platform. And we will be implementing that at Soffe. Now that's probably something we're not going to see that much benefit in '14, but certainly in '15. You'd see a big benefit of that coming more in '15. So the combination of those, that's not going to get it to the peaks of where Soffe was, but will at least get that back near the fiscal '12 levels. So kind of take back what we lost this year. And then the continuation of that and then having those sales and marketing and those things come in should then get that back on the path to the performance levels we'd enjoyed prior to '12.

Jared Schramm - Roth Capital Partners, LLC, Research Division

Okay. You mentioned hedging cotton prices. Is this the new normal, you think, as far as volatility is concerned with cotton pricing?

Deborah H. Merrill

I would probably say yes. I mean, I don't see anything that's going to change the factors of it not being just based on the fundamentals of cotton anymore. But having the impact of China, having the amount of speculations in the marketplace, I don't see those kind of factors going away. So I think you probably will see continued volatility in cotton in any kind of near-term outlook and that's why we've now taken further strategies to hedge those positions and be more aggressive in those hedging transactions just so that we can try to put ourselves in the best place we can on cotton costs.

Jared Schramm - Roth Capital Partners, LLC, Research Division

Okay. And turning to Art Gun, obviously strong performance during the quarter. What are some key elements you think that drove that 60% gain and where do you see the outlook for that brand specifically in the next year or 2?

Robert W. Humphreys

Really, what's driving that is our virtual inventory model, and we're partnering up with people who run websites that either have art or allowing others to develop art and put them out there or have other inventories that they don't want to speculate on. And it's allowing their customers to come through us. They pick the silhouette, they pick the art and we print it and send it to their customer wherever that might be.

Deborah H. Merrill

Worldwide.

Robert W. Humphreys

Yes, worldwide. We're shipping to about 40 countries now. So I think we're adding new customers. And obviously, the phenomenon of people wanting personalized garments continues to expand. People buying stuff through the Internet continues to expand. And people trying to figure out not to have inventory that's not sold continues to resonate with people. So we see further ability to grow that. We operate it now 24 hours a day 7 days a week really as a service model so we can react very quickly to orders as they come in.

Jared Schramm - Roth Capital Partners, LLC, Research Division

And is that virtual inventory model something you're looking to replicate across other lines in the branded segment?

Robert W. Humphreys

Yes, we've put some Junkfood art out there. That's our first real site to try to harvest the consumer, ourselves. And Junkfood is known for its art, so we can put out generic art where we don't have royalties or old favorites and different stuff, so we'll continue to do those sorts of things.

Jared Schramm - Roth Capital Partners, LLC, Research Division

And as well looking to Salt Life, where does that stand as far as a product development outlook is concerned, I guess, today? And then again where do you see that now and in 2 years from today?

Robert W. Humphreys

It started as principally T-shirts 18 months or so ago, 2 years ago, when we got started and we've obviously expanded the product offering. As we do it, we've taken out to the marketplace and judged the interest level, are they ready for more sophisticated product and what have you. So it's becoming like a full line of product from board shorts to hoodies and long-sleeved stuff. I mentioned the UVapor [ph] product that we developed, which has been very popular. So we just introduced the footwear. We're the licensee for that as well, and so that's in the marketplace for the first time and it continues to grow with our customer base. And we continue to add new doors and have retailers that are interested in putting their product in their stores.

Jared Schramm - Roth Capital Partners, LLC, Research Division

Okay. And lastly, turning to guidance. How big of an impact would you say would further kind of colder weather and what negative impact would that have we can quantify that on the forward-looking guidance? Is that baked in now that we're assuming warmer weather this colder spring and longer development's taken its toll already and the outlook now is really just going to be negatively weighted towards Soffe, or is there some weather negatively built into the guidance looking out for '13?

Robert W. Humphreys

There is weather negativity built into the guidance. And we've obviously challenged our thinking on that and hope we have enough built in. But we saw business slow up really in February. And while we had very good results in all of our operating units except for Soffe, the fact of the matter is they did slow up and we're not as good. I mean, our first couple of quarters, Soffe's business was below the prior year, too. But our other businesses were growing and improving profitability and masking that on a consolidated basis. And we saw that really strong growth slow up some in the third quarter. And this spring we're selling more product. This is our strongest quarter, but you can still see some slowness out there in the marketplace and weaker demand than we would have expected based on how our first 7 months [indiscernible].

Operator

[Operator Instructions] And we will go next to Jimmy Wilen at Wilen Management.

James Wilen - Wilen Management Co., Inc.

I might as well start with Soffe as well. Obviously, the J.C. Penney and the Kohl's business has been tough for you, but is the rest of the Soffe's business also trending down as well in other places?

Robert W. Humphreys

Well, it varies. I mean, our what we call strategic sporting goods stores, which are the larger chain sporting businesses is down slightly but not very much. It's been performing pretty well for us. It was up in some quarters, I believe. Our independent sporting goods business has been trending down for years as those businesses have changed. Now, you may recall we recently went live with a new B2B business platform, we've been promoting that and in the last 4 or 5 weeks have started seeing higher order activity on that B2B site. The military business is kind of mixed. One month up, one month down, but we feel good about our position there.

James Wilen - Wilen Management Co., Inc.

Historically, haven't you gone through this with a number of change where you have their business, they try to switch to a private label and then eventually they come back to you? Or is this the first time for Kohl's doing this or they've done this before with you?

Robert W. Humphreys

Well, I don't think -- Kohl's has a number of retailers have tried to take the Soffe short and make it private level. And that has not proven very successful at all for people. They generally lose significant amount of business and in several cases they have come back to us and put the Soffe product back in.

James Wilen - Wilen Management Co., Inc.

Okay. When did they switch to private label? Which month did you stop shipping them?

Robert W. Humphreys

Really, for this spring season. So it would have -- it started having a big impact in the third quarter.

James Wilen - Wilen Management Co., Inc.

Okay. You mentioned you're hedged for cotton prices. Are you hedged for the entire fiscal '14 now at this point?

Robert W. Humphreys

No, not all the cotton that we would consume. But we have changed and fine-tuned some of our strategies just looking back retrospectively on what's happened in the cotton markets in the last couple of years. We had some different strategies back years ago that we used when we were thinking things were more volatile and so we've just taken a harder look at some of that stuff and trying to take some of the runaway potential off the table.

James Wilen - Wilen Management Co., Inc.

Got you. But cotton prices for the last year have been relatively stable compared to what they had been over the previous 2 and 3 years?

Robert W. Humphreys

Well, yes. Relatively, that's true. But just like the July contract, it's the current kind of at-once contract, has been up and down about 14% or 15% in the last 4 or 5 weeks. And so, yes, that's an $0.11 swing on from probably $0.91 or $0.92 down to about $0.80. So that's a significant change in costs of our products.

James Wilen - Wilen Management Co., Inc.

And when did you lock in your prices?

Robert W. Humphreys

Well, we're not going to go to exactly where we are on cotton. You don't lock them all-in any one day. But so far, we think so good on what we've done from a cotton standpoint. But if it drops $0.20 to mark, then we didn't do as good as we thought. But the fact of the matter is, we have some hedging strategies out there. So if it does, we'll participate in that downside.

James Wilen - Wilen Management Co., Inc.

Okay. A couple of things. The shares outstanding at the end of the quarter, could you tell me that?

Deborah H. Merrill

Yes. Shares outstanding at the end of the quarter are about 8.3 million basic shares outstanding.

James Wilen - Wilen Management Co., Inc.

Okay. 8.3 million even though...

Deborah H. Merrill

I'm sorry, James. I was wrong. Yes, the weighted average is 8.3, shares outstanding is 8,150,000.

James Wilen - Wilen Management Co., Inc.

8,150,000, okay. And going forward, next fiscal year, what kind of tax rate do you think you would anticipate paying?

Deborah H. Merrill

Right now, I would say to think about that in the low to mid-20s like 23% to 25% tax rate.

James Wilen - Wilen Management Co., Inc.

Okay, okay. And lastly on the Salt Life expansion. You're heading into the West Coast, how successful or unsuccessful have you been in your initial foray out there?

Robert W. Humphreys

We think we're right on plan. We are now opening doors. The people are sending us photos of Salt Life stickers that they're seeing on the interstate and that's always encouraging. So we've got feet on the ground making calls and telling the Salt Life story. We've got a professional paddle boarder who happens to live on the West Coast who is one of the Salt Life paid athletes who's doing a lot of appearances and telling the story as well, so we think we're doing the right things to build the grassroots demand out there.

James Wilen - Wilen Management Co., Inc.

Okay. And as you put in footwear in the West Coast expansion, you want to hazard any guess as to what kind of growth rate or top line you can get just from Salt Life in fiscal '14?

Robert W. Humphreys

Not yet. But as we finish putting together our business plans and talk about what our outlook is come July, then perhaps we can add a little color there.

James Wilen - Wilen Management Co., Inc.

Okay. And the last thing. You're lowering your guidance by about $15 million on the top line, but on the bottom line it seems like you're lowering your guidance by $4 million. Is that just the incremental profitability once you've covered your fixed overhead is huge in both directions?

Deborah H. Merrill

Correct.

Operator

[Operator Instructions] And it appears we have no further questions at this time. I'd like to turn the call back over to our speakers for any additional or concluding remarks.

Robert W. Humphreys

Okay. Well, thank you for your interest today and we look forward to giving you a further update in just a few months.

Deborah H. Merrill

Thank you.

Operator

And once again, ladies and gentlemen, that does conclude our conference for today. I would like to thank everyone for your participation.

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