Delta Apparel's (DLA) CEO Bob Humphreys on Q4 2016 Results - Earnings Call Transcript

| About: Delta Apparel, (DLA)

Delta Apparel, Inc (NYSEMKT:DLA)

Q4 2016 Earnings Conference Call

November 29, 2016 8:30 AM ET

Executives

Bob Humphreys - Chairman and Chief Executive Officer

Deb Merrill - Chief Financial Officer and President, Delta Basics

Analysts

Dave King - Roth Capital Partners

Jamie Wilen - Wilen Management

Operator

Ladies and gentlemen, thank you and good afternoon to everyone participating in Delta Apparel's Fiscal 2016 Fourth Quarter Earnings 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 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, for an overview of Delta Apparel’s results.

Bob Humphreys

Good morning and thank you all for joining us on the call this morning and your interest in Delta Apparel. We are pleased with our fourth quarter financial and operational results, and are inspired about what our actions during the quarter mean for the future of our company. It was the quarter of net sales growth, margin expansion and profitability that yielded a strong finish for our 2016 fiscal year. Here are some of the highlights.

All of our business units, with the exception of Junkfood, had net sales growth during the quarter. I’m happy to say this includes Soffe which achieved 8% sales growth. We had double-digit sales growth in Salt Life and Art Gun. We fully implemented our manufacturing realignment and did it at a cost that was about $0.01 per share, less than what we had anticipated. We completed the sale of the real estate and equipment associated with the Maiden, North Carolina textile facility. We finished the installation of new equipment at our Honduran textile facility and are rapidly reaching our output goals there.

We opened a new Salt Life retail store in San Clemente, California. We opened a new third party distribution center in Chicago that will provide one to two day shipping throughout the Midwest. We completed the acquisition of Coast Apparel, a young brand with excellent potential for long term growth. For comparison purposes, I need to mention that in 2015 our fiscal year comprised 53 weeks and therefore our fourth quarter included 14 weeks of sales whereas this fiscal year hedges 52 weeks and our fourth quarter included 13 weeks of sales. Our net sales growth percentages are based on 2015 net sales reduced for the extra week of revenue.

On an adjusted basis, we had sales growth in the fourth quarter of 2.5% with pretax earnings adjusted for the $1 million of manufacturing realignment expenses also increasing from the prior year’s fourth quarter. Our concentrated actions during the quarter carry significant that should stand well beyond this fiscal year. Our manufacturing realignment, for example, should generate annual savings of $8 million that will begin in fiscal 2017 and be fully annualizing in the second half of the year. We anticipate expensing about $3 million to complete this initiative both with powerful planning and deliberate action we were able to reduce the cost to $2.8 million or $0.29 per diluted share, $1 million of that or $0.11 per diluted share was in our fourth quarter. We now have additional new state-of-the-art equipment installed in our Honduran textile plant producing inventory at a lower cost than before.

During this year, we also began producing open-width fabrics in that same textile facility expanding our internal production capabilities and reducing our reliant on sourced fabric. This initiative alone is expected to lower inventory cost and improve gross margins annually by about $2 million with those savings being recognized in fiscal year 2017.

Salt Life had a very solid quarter and finished the year strong with demand continuing to grow particularly in performance and juniors product. Salt Life’s flagship store in Jacksonville Beach, Florida continues to attract consumers growing revenue nearly 20% this year, its fifth year of operation, a tremendous achievement for any apparel retailer in the current environment. We believe our new San Clemente, California store that opened in September will also perform well and allow us to directly connect with consumers in California.

We had strong attendance at the store’s grand opening where we also kicked off with the pacific power board games that took place in Doheny State Park in Dana Point. This is the second year that Salt Life was the presenting sponsor of the games. We will continue to enhance Salt Life’s presence in California opening a second California location in Huntington Beach in early calendar 2017 and will be showcasing the Salt Life spring 2017 line in the Junkfood store in Albuquerque. We look forward to further strengthening [indiscernible] great beach community.

Our experience and success in nurturing and growing young brands and start up businesses like Salt Life and Art Gun have proven the benefit of early stage investment in high potential brands and business expansion, and we will apply this experience to our most recent acquisition Coast Apparel. This young company with sales of less than $1 million has excellent growth potential and is a good fit in our brand portfolio. Primarily marketing direct to customer, Coast Apparel should receive a boost from Delta Apparel’s digital marketing expertise.

Our team is already at work to enhance the functionality and merchandising on the coastapparel.com site in order to improve the consumer experience and grow ecommerce sales. In early calendar 2017, we will also be opening a new coast store on Main Street in Greenville, South Carolina to showcase the coast brand. We are excited about coast geographic versatility across regional market which we believe can be levered by the strength of Delta’s marketing, merchandising, manufacturing and sourcing capabilities.

We continue to evaluate other such acquisition opportunities, large and small, to further enhance our growth. These acquisitions may further expand our brand portfolio, broaden our product line, increase production on our manufacturing platform or enhance our go-to-market strategy.

In May, we executed and amended and restated U.S. credit facility that gives us financing flexibility for the next five years and the debt cost us 50 basis points less than our previous agreement. To give us additional flexibility to access capital markets in a timely and cost effective manner, we also just renewed our universal shelf filing increasing it to $150 million.

All of our activities throughout fiscal 2016 and particularly in our fourth quarter had built a great deal of positive momentum as we begin fiscal 2017. Although, the retail apparel market is not as strong as we would like, we believe we have positioned Delta Apparel to have a solid year with continued sales and profit growth.

I will now turn it over to our CFO, Deb Merrill, who will explain how that looks from the financial perspective. Deb?

Deb Merrill

Thank you, Bob, and good morning. As Bob indicated it was a good quarter, sales for the 13-week fiscal 2016 fourth quarter were $114.4 million, compared to $120.2 million in the prior year’s 14-week quarter. Adjusting for the one additional week in the prior year period, we had net sales growth of 2.5% in the 2016 quarter.

During our fourth quarter, we expensed $1 million of cost associated with the manufacturing realignment with all but $78,000 of this being included in our cost of sales. Gross margins excluding these expenses increased in each of our two segments. However, due to a stronger mix of basic sales, overall gross margins were down just 20 basis points.

While 2016 fourth quarter operating margins, excluding the manufacturing realignment expenses were on par with the prior year at 4.3% of sales, adjusted earnings were $0.40 per diluted share compared to $0.53 per diluted share in the prior year quarter. The prior year earnings were favorably impacted by the earnings associated with the additional week of sales and a sizable tax benefit compared to tax expense this year with these two things adding about $0.15 of earnings in the prior year fourth quarter. Thus, on an adjusted comparative basis, this year’s fourth quarter earnings improved by $0.02 per share.

For the full 2016 fiscal year, net sales were $425.2 million, down about 0.5% from the prior year adjusted for the shorter sales period, the sale of The Game business and the discontinued Kentucky Derby licensed business from which we voluntarily withdrew. For the 53-week fiscal 2015 year, we reported net sales of $449.1 million.

Gross margins, excluding the $1.1 million of manufacturing realignment expenses that are in cost of sales, were 22.2% for the year, a 250 basis point improvement from the prior fiscal year.

Operating profit for fiscal 2016 was $16.3 million or $19.2 million excluding the manufacturing realignment expenses bringing operating margins to 4.5% of sales. This compares to operating margins of $10.5 million in the prior year after excluding the $5.6 million gain including related expenses on the sale of the gain or 2.3% of sales.

Adjusted earnings were $1.41 per share, 147% increase from the adjusted $0.57 per share in the prior year.

Total capital spending for the quarter was $3.6 million, bringing total capital spending in fiscal year 2016 to $14.7 million. During the year, we invested about $2 million in the open-width project, about $6 million on the manufacturing expansion and about $3 million on screen and digital print equipment with the remaining spent on e-commerce, IT and system enhancements and other projects. We expect total capital spending for fiscal 2017 to be approximately $10 million.

Depreciation and amortization, including non-cash compensation was $11.9 million for the full year and $2.7 million in the fourth quarter.

During the quarter, we repurchased 103,778 shares of Delta Apparel stocks at an average cost of $16.63 per share for a total cost of $1.7 million. This brings the total spend during fiscal 2016 on share repurchases to $3.5 million for 217,568 shares at an average cost of $16.28. At fiscal year end, we had 9.1 million remaining on our board authorization for share repurchases. We believe that the intrinsic value of the company is significantly higher than its current share price range and currently plan to continue share repurchases.

Our total debt at fiscal year-end was $115.8 million compared to $102.2 million a year ago. The increase was driven by the higher capital spending, the expenses associated with the manufacturing realignment and inventory investments principally in our Activewear business where this past year we believe we did not have appropriate inventory levels to service customers in our [indiscernible] catalog business.

We are currently levered at 3.7 times trailing EBITDA, much improved from a year-ago and expect leverage to be closer to 3 times a year from now. We have good availability on our U.S. credit facility and with our current availability, are not subject to any financial convents.

In summary, we believe we are a strong and growing company. Even in the current soft retail environment, we have seen areas of strong top line growth in our business. Our gross margins are solid and expanding our operating margins are increasing. We are lean and agile and possess the financial power to invest in future growth opportunities when and where we find them.

Now, I will turn it back to Bob for some final comments.

Bob Humphreys

Thanks, Deb. Although we anticipate the retail environment will continue to be a challenge, we believe that Delta Apparel is positioned to continue its sales growth during fiscal 2017. We do have some headwinds that come from the prior year, including lost revenue from the Sports Authority store closing and the effect of Hurricane Mathew, which is impacting our first quarter fiscal 2017.

Our overall top line growth maybe in the low-single-digit, but we do expect double-digit performances to continue in Salt Life and Art Gun. We have new exciting product lines across our different brands and anticipate strong demand as we introduce our 2017 spring line. Growing demand combined with cost reduction initiative that we implemented over the past two years and our ability to lever fixed cost across higher volume to result in continued growth expanded margins and higher profits in fiscal 2017 and beyond.

Now Deb and I will be happy to answer any questions that you might have. And Shannon, you can open up the call for questions.

Question-and-Answer Session

Operator

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

Dave King

Good morning, Bob and Deb.

Bob Humphreys

Good morning.

Deb Merrill

Good morning.

Dave King

I guess a few questions on the branded side, maybe Salt Life, maybe some – that’s fairly new in terms of the store in San Clemente. Can you talk a little bit about that, first, performing? What are your learning so far? What are some of the highest volume items in that location in terms of – does that differ at all from Florida in any way? And then maybe as you think about expanding with Huntington Beach, et cetera, can you maybe just talk about overall kind of store build out kind of plans looking forward? Thanks.

Bob Humphreys

Okay. That’s a good question. So I would just say, we had a great store opening at San Clemente, we had a lot of traffic there, so we are certainly happy with where we are. I [indiscernible] up to a few weeks ago and now are getting into the holiday season and we will see how that goes. Obviously, it is a branding exercise and building the brand in California, which is paramount to us. We have specific graphics design for that market, specific to the west, and interestingly enough, our head designer for Salt Life happens to live in San Clemente, so she certainly understands the California, Bob. We expect to do the same thing in Huntington when we get it opened. And so, I’d say, six to nine months from now, we will be able to look at data that shows more of what’s selling there and compare that to what we sell, our e-commerce side that goes to California, et cetera, et cetera. So our hope would be to then open one more California based Salt Life store in fiscal 2017 and then that would be a time for us take pause and evaluate how we are doing there, see if we need to tweak our model or our strategy in California and then we expect to open one East Coast Salt Life store there as well.

Dave King

Okay, perfect. That’s very helpful, Bob. And then maybe switching gears to Coast a bit, the recent acquisition, can you talk about some of the opportunities there, it sounds like it’s more digital in retail, if I – I heard your comments perfectly, but maybe is there a wholesale opportunity for that, how are you approaching that if so, maybe some color there would be helpful.

Bob Humphreys

Sure. And so, Coast was started by some folks in Greenville kind of following another kind of beach life style brands, it’s had some wholesale business that they to some degree advocated just not really understanding how to service that marketplace. So we will rekindle some of that, but obviously with today’s quickly changing landscape with retail, we think it’s a great opportunity to be focused on direct to consumer and e-commerce strategy is with this brand, we were excited about the little bit more sophisticated our product level than what we really go-to-market with our Salt Life business. And interesting, we had some great office space in downtown Greenville that we are going to convert to a little retail store for Coast is probably as good for places you could be in Greenville for retailers, main street level. And you may have seen, you probably did notice just about three weeks ago Wall Street Journal had, I believe it was 20 places in the world to visit in 2017 and Greenville, South Carolina was the only U.S.-based place. So having [indiscernible] here, we are getting to be too many people for me, but it should be great for our little Coast store.

Dave King

Okay. That’s great color. Thanks for that. And then maybe on the Soffe side, can you talk a little bit about the improvement there? Is that mainly new accounts? Did I interpret that correctly? And then what was it may be expanding line with some of those strategic sporting goods channel, better sell-through, just any color there would be helpful.

Bob Humphreys

I’d say the good news is fairly broad based. Some of the strategic sporting good stores we are expanding with one or two in a major way, so we are excited about that and really encouraged that [indiscernible] current Soffe product. Our Soffe business on Amazon is growing rapidly. Our military business is solid and there is some pockets of growth there and some new programs that we are taking on. And we’ve had success in growing our B2B business particularly in the independent sporting goods market. So I’d say still plenty of work to do to get the revenue and momentum back that we would like at Soffe, but it was nice to see some growth and feel good that we are in a position improvement going into fiscal 2017.

Dave King

Yeah, absolutely. Okay, fantastic. And then maybe lastly, Deb, I didn’t want to leave you out. In terms of the operating margins by business, just to understand that one line of cost, but I think we are selling in cost of goods sold, is that also mainly on the basic side, I’d assume then in terms…?

Deb Merrill

Yeah, the 100% of that is on the basic segment. And so within that you’ve got about $1 million in cost of sales and about $1.7 million on the restructuring line, but all within basis.

Dave King

Okay, perfect. All right, thank you so much. And good luck with fiscal 2017.

Deb Merrill

Thank you.

Bob Humphreys

Thank you.

Operator

[Operator Instructions] We will take our next question from Jamie Wilen of Wilen Management.

Jamie Wilen

Hi, fellas, really nice quarter and a great fiscal year. I want to start with Salt Life, I love Dave’s question about how the difference can be between West Coast and East Coast as you are growing this brand. Just wondering from – you sell a lot of decals across the country, do you chart the number of decals that are being sold on the West Coast versus the East Coast, and how are things taking hold there?

Bob Humphreys

We don’t chart that on a month-to-month basis, we could probably take a look at it from an e-commerce standpoint.

Jamie Wilen

Okay. And the retail stores…

Bob Humphreys

[indiscernible] Salt Life, decals across the country.

Deb Merrill

And the exciting thing is, is that we see them all across the country and have people telling us about seeing them all across the country as well.

Jamie Wilen

It is truly amazing you see them in the most unusual places that are not close to any water, but it’s a wonderful thing to see.

Bob Humphreys

Yeah, we had a board member, who was in the Paris airport a few weeks ago and took a picture of a guy wearing a Salt Life shirt, so we are in Paris, so it’s all good.

Jamie Wilen

I saw one in the Colosseum in Rome. But on the retail side, the store in Jacksonville, I assume, is profitable?

Deb Merrill

Yes.

Jamie Wilen

Okay. Even though you are opening up to be more of a sales center, it is generating profits. And did you say you were going to open up one more store in Huntington in this fiscal year and then in fiscal 2018 one on the East Coast, United States, is that what’s your plan was?

Bob Humphreys

So, we’ve got – the Huntington store, the lease is signed, the build out is being done and it will open in early 2017. In our plan, we have one more California store that we will open in California, but we don’t have a site picked so that may or may not ultimately happen in fiscal 2017.

Deb Merrill

In fiscal 2017.

Bob Humphreys

And then we will likelihood open another store in Florida, probably an outlet store in fiscal 2017, and we’ve had a little outlet store back from our acquisition of The Game years ago in Columbus, Georgia that we are evaluating, moving that location and rebranding it as Salt Life store.

Jamie Wilen

And when you do these stores, are putting Junkfood and Coast stores, or just going to be strictly Salt Life?

Bob Humphreys

They are going to be primarily Salt Life and Salt Life branded stores. As we get to that, we may augment them with some other brands.

Jamie Wilen

On the Soffe side, are you looking for sales growth now in 2017 even cycling through what you did earlier in the year with the Sports Authority?

Bob Humphreys

That is our plan. There is some uphill climbing because of the Sports Authority lost business, but if we can come in with some slight sales increase having given up the Sports Authority business, we will feel like a reasonably good job done there.

Jamie Wilen

Okay. And on the margins on Soffe similar to what they were in the good old days or have they changed the business model?

Bob Humphreys

They are not – and for a number of different reasons, none of which we like obviously but one of our focus point on Soffe is strategies to rebuild some of that lost gross margin.

Jamie Wilen

Okay. Are there any residual financial effects of the Sports Authority bankruptcy? I know we had some receivables in question, have we addressed them on the income statement or is it still hanging up there?

Bob Humphreys

So we have collected all the receivables from the Sports Authority and we are in litigation with them. We have the money and we are in litigation with them over being preferential treatment licensing.

Jamie Wilen

Okay. And then on the manufacturing synergies, have we taken all the cost that we are going to be taking for that? Is that all done on the income statement?

Bob Humphreys

Yes.

Deb Merrill

It is, yes.

Jamie Wilen

Okay. And no transitional impacts from everything – from the location we sold in Maiden, North Carolina, everything is done there as well?

Bob Humphreys

That’s correct.

Deb Merrill

Yes.

Jamie Wilen

Okay. And in total, you were looking at, I believe, $7 million of cost reductions on an annual basis once they are fully realized, is that the right number?

Deb Merrill

Yes, it was about $8 million.

Jamie Wilen

Okay. And as that transition in, how much do you believe will get in fiscal 2017 and will we be at the full run rate in fiscal 2018?

Deb Merrill

So, yes, we will be at the full run – we are expecting to be at the full fiscal run rate in fiscal 2018. Those will start in fiscal 2017 and we will start to see a little bit of that in the March quarter, but really didn’t start seeing it in the June and September quarter. So by the time you are looking at the back half and really the September quarter, we will be at that full run rate, so that then in fiscal 2018 the full amount should come through in the fiscal year.

Jamie Wilen

Okay. But in the higher volume quarters towards the end of the year we’ll be achieving those manufacturing efficiencies?

Deb Merrill

Yes. And we are seeing the benefits of those coming through now, but because we are still – and we are right on our track and goal for our production levels and we’ll be increasing those production levels through the end of calendar 2016 and so that’s why the full amount don’t really start rolling out because we are just seeing those now and those will start hitting our P&L in the back half of the year and then be at those full levels by the time we get to the fourth quarter and then we will be running at those levels to achieve the full amount in 2018.

Jamie Wilen

Got you. And last two, the expected tax rate for next year is?

Deb Merrill

I would anticipate that being in the kind of low-20% range.

Jamie Wilen

Okay. And I very much applaud the buyback program, it’s a wonderful thing for all the shareholders and just wanted to see what was your shares outstanding at fiscal year end.

Deb Merrill

I believe it was like 7.7 million shares.

Jamie Wilen

Okay. Outstanding job of running the business for the shareholders. We greatly appreciate it. Thanks.

Deb Merrill

Thank you.

Bob Humphreys

Thank you.

Operator

[Operator Instructions] And it does appear we have no further questions at this time.

Bob Humphreys

Okay. Well, thank you all for your interest in Delta Apparel and joining us this morning and we look forward to updating you on our first quarter results here in just a couple of months. Take care and have a good week.

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