Delta Apparel's (DLA) CEO Bob Humphreys on Q3 2016 Results - Earnings Call Transcript

| About: Delta Apparel, (DLA)
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Delta Apparel, Inc (NYSEMKT:DLA) Q3 2016 Earnings Conference Call August 8, 2016 4:30 PM ET

Executives

Bob Humphreys - Chairman & Chief Executive Officer

Deb Merrill - President & Chief Financial Officer

Analysts

Nick Meyers - Roth Capital Partners

Lynn Parry - Wilen Management

Operator

Thank you and good afternoon to everyone participating in the Delta Apparel's Fiscal 2016 Third Quarter Conference Call. Today’s conference is being recorded. Joining us from management are Bob Humphreys; Chairman and Chief Executive Office; 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. Please go ahead.

Bob Humphreys

Good afternoon and thank you all for joining us for Delta Apparel’s third quarter earnings conference call. We have just completed yet another quarter of solid profitability despite persistent profits in the retail apparel market place. The results of the quarter demonstrate that our continued focus on the efficiently, cost savings and net income growth that began nearly two year ago now allows us to complete from a position of strength even when the marketplace is weak. As we announced in May, our focus on our manufacturing fashion strategy has involved into the rigorous manufacturing realignment that will reset our fix manufacturing cost and is expected to bring an annual cost saving of about $8 million or $0.70 per diluted share.

We should begin to realize the savings in the first half of fiscal 2017 and expected to be fully annualized by our fiscal 2017 year end. We begin to realignment initiatives with the expansion of our Honduran textile and sew facility, which brings greater efficiency to those operations, increases capacity, leverages fix cost and gives us the added advantage of utilizing greatest dyeing fishing technology. All of the manufacturing equipment for this expansion has been received and the vast majority of it has been installed. We began operating the new equipment in June and should be at full production levels by the end of calendar 2016. Concurrently, we have been expanding our sew capacity in Honduran and El Salvador as well as modernizing our El Salvador screen-print operation so that we can more efficiently produce blank and full package program all with customers.

In July, we closed our domestic textile operation in Maiden, North Carolina and are in negotiations with a contract to sell the real estate and certain equipment used in that operation. While it was a difficult decision to close the facility that resulted in the loss of jobs for our employee player, we are pleased that the potential new owner plans to continue using as a wet-processing facility and will provide a new screen with installment opportunities in the Maiden community. We have successfully partnered with contractors in the U.S. sourced fabric for USA led products.

In May, we consolidated our Mexico sew operation again sourcing in-country fabric supported and are currently in the process of modernizing the screen-print operation layer to increase efficiency in short and lead times in our catalog full package programs. More than half of this expense for our manufacturing realignment $0.18 per diluted shares was reflected in our third quarter earnings. And we expect the remainder of that $0.12 per diluted share to be taken in the fourth quarter.

In addition to our manufacturing initiatives, we are also working to improve top-line growth by focusing on our business units with the highest immediate potential. Salt Life continues to gain consumer penetration and many of those consumers now consider Salt Life their go to lifestyle brand. With strong sale through of Spring 2016 line, Salt Life continued its double-digit growth trend with 45% growth over the prior year quarter, bringing this year-to-date 2016 growth to 30%. Salt Life direct-to-consumer sales led the way with 80% growth on its e-commerce site. We expect the new Salt Life store in San Clemente, California will drive consumer enthusiasm for the Salt Lifestyle that has made the brand so successful, and we plan to open few stores each year for the next several years to continue to expand our customer reach.

To that end, we plan to start selling Salt Life products at our Junkfood store in Venice Beach, California, beginning with the Spring 2017 line which includes some new California-centric design. We are also leveraging cross-selling opportunities inherit in our Art Gun business unit which has solidified its leadership position in the digital printing market place. For example, Art Gun also utilizes catalog blanks supplied by our Delta business unit as a garment its customers. In addition to providing services to e-retailers, Art Gun also increasingly provides digital printing fulfillment services to other parts of our business with over 20% of Junkfood's e-commerce business now being produce through Art Gun.

We have implemented many changes over the past few years all intended to drive the sport the high margins and greater profitability. The past five quarters stand as evidence that our strategy is working and we anticipate that our quarterly performance will continue to improve as the expense reductions and efficiency gains from our manufacturing initiatives are seen in our results. We are also focused on improved in top line growth that full year supporting the potential within our existing business units, continuing to stay on top of the latest trend and providing high quality apparel to this sized consumer. As well as evaluating strategic acquisition opportunities that will further enhance our growth. I believe that today, we’re in very good position to do all of this.

I’ll turn the call over to Deb Merrill to give us more details on our third quarter results. Deb?

Deb Merrill

Thanks Bob. Over all we had a very good quarter and exceed analysts' expectations. Our earnings for the quarter included in $0.18 restructuring charge from price of a $1 million of non-cash imperilment on fixed assets and certain inventory as well as about 600,000 in severance and 200,000 in startup cost, all related to the manufacturing realignment Bob touched on. Including the charge, earnings for the 2016 third quarter were $0.32 per diluted share and net income of 2.5 million.

Excluding the charge, we would have achieved net income of about 4 million or $0.50 per diluted share on net sales of 111.6 million. This compares to a net income for the prior year of third quarter of 4.4 million or $0.55 per diluted share on net sales of 120.5 million. While net sales in our 2016 third quarter were unfavorably impacted by continued weakness in the retail environment and by the absence of the Kentucky Derby license, which we did not seek to review for this year, gross margins continued strong in most of our business units resulting in a 150 basic point overall margin expansion quarter-over-quarter.

For the first nine months of fiscal 2016, net sales were 310.9 million compared with 328.9 million in the prior year period, which included about 13 million in sales attributed to the since-divested The Game business and since discontinued to Kentucky Derby license. Net income increased to 6.7 million or $0.84 per diluted share compared to 3.9 million or $0.48 per diluted share in the prior year period.

Now looking at other segment, gross margin expansion of 210 basis points resulting from a stronger product mix and continued manufacturing efficiencies drove the third quarter operating profit for the basic segment to 5.4 million or 7.5% of sale. Net sales in the basic segment were 72.1 million, 8.8% lower than the 79 million reported in the prior year’s third quarter. Although Activewear sales were down 10% comparatively for the quarter, the business continued to migrate to a more profitable product mix with over a 100% growth in the fashion basic including our Delta drive performance product, Delta soft line and a variety of Fleece and French Terry garment as well as nearly 50% increase in our catalog full-package products.

We expect the growth in these areas to continue in future quarters. These products have higher selling prices and on average carry margin nearly 1,000 basis points higher than those of basic tees. This sales growth was not enough though to fully offset lower units' sales of basic tees which were hindered by inventory constraint and $1.8 million reduction in our private label sales. While there has been a slowdown from lower callout and in over inventoried environment within several international brands, our private label business is experiencing strong growth from on trend regional brands as well as new customers acquired mid 2015.

Art Gun delivered strong net sales growth of 28% for the quarter driven from a 38% increase in unit sold. In addition to strong top line growth, Art Gun posted a record quarterly operating profit. Art Gun is launching several new customers that we expect will drive good growth in the fourth quarter into fiscal 2017.

Branded segment net sales for the third quarter were 39.5 million, virtually flat with the prior year period after adjusting for the 2.2 million of Kentucky Derby sales that didn’t reoccur in 2016. The branded segment produced operating profit of 2.7 million or 6.7% of sale. Salt Life continued its double digit growth trend with 45% growth over the prior year period.

The new Salt Life distribution center functioned extremely well, efficiently handling record high shipment levels during the quarter. Strong demand for the Salt Life continues and we believe that its continued double-digit growth trend will be accompanied by leveraged-cost efficiencies that should drive further improved margins in future quarters.

Soffe sales declined 1.6 million for the quarter primarily due to the soft retail environment. However, Soffe has experienced notable growth with amazon.com and its own e-commerce websites, including a 33% sales increase from its recently relaunched B2B site and a 14% increase from its B2C site. We anticipate continued strong growth in Soffe’s e-commerce business over the next several quarters. Additionally, Soffe’s improved product line enhanced customer service and solid in-stock position continue to be instrumental in gaining floor space at key strategic sporting goods stores, which should further bolster Soffe’s return to growth.

Junkfood’s specialty business performed well during the quarter with sales growing 15%. However, that growth was insufficient to overcome sales declines at a national retailer that negatively impacted Junkfood’s business. That impact combined with lower-than-expected boutique sales, resulted in a 1.7 million decline in net sales for the quarter.

Looking at the balance, receivables were down from a year ago from the lower sales level and improved day sales outstanding. Inventory levels increased from a year ago to 167.1 million. The increase was due to higher in-stock finish goods to support the expanded product lines and to better service our customers. Total debt at quarter end was 122.3 million and included an increase in our Honduran debt which is not guaranteed by the U.S. entity and was used to finance the capital expenditures to increase capacity in our Honduran operation.

Capital spending for the third quarter was 4.4 million and 11.1 million year-to-date with suspending principally related to the purchase of equipment for the Honduran expansion. Depreciation and amortization including non-cash compensation was 3.2 million in the quarter and 9.1 million for the nine month period.

Now, I will now turn the discussion back to Bob for a final comment.

Bob Humphreys

Thanks, Deb. We believe Delta Apparel will continue to make solid progress over the next several quarters while our recent initiatives have focused a great deal on improving margins and in strengthening our bottom line. We are confident that the strength of our own trend quality products and solid marketing program will bring renewed bigger to our top line as well. Our fourth quarter has gotten off to a good start in July with record shipments of basic tees, record shipments of Salt Like branded products, record shipments from Art Gun and record e-commerce shipments. We’re encouraged with these brands and expect the good finish to fiscal 2016 with further progress to come as we go into fiscal 2017.

At this time, I would like to open up the floor to any question anybody might have.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] We will take our first question from Dave King with Roth Capital Partners.

Nick Meyers

Hello, guys, this is Nick Meyers on for Dave King. So first as on in terms of revenue impacts this quarter, I know you've already mentioned Kentucky Derby was 2.2 million, are you able to identify other various factors whether that's the one last week you had or TSA, anything in regards to that?

Bob Humphreys

As per number things and then Deb, I'll let you maybe give a little more detail, but we have one more, one last week actually in the fourth fiscal quarter, so I was working every quarter as the prior year. As I said, the TSA bankruptcy had an overall bad effect on the whole sporting goods industry where people slowed up and waiting to see where those inventories would ultimately go. There are people definitely got in a cautions mode with that of lower spending on apparel and general and lack of any real trends or hard license that were really driving business. So then obviously there we connected the consumers directly like Salt Life, core sample we had really strong growth. So as usual going on business, we got through a lot of different distribution channels and they're not always up with the overall mix as good and we had some they were up and some they were down.

Nick Meyers

How should we be thinking about modeling any further impact from TSA over the next couple of quarters?

Bob Humphreys

Well, I think TSA is going the way as we in the industry knew it, so that was a significantly Soffe's business, so we won't enjoy that in the upcoming year. But at the same time, we’re going up with the number of sporting goods retailers and other parts of the marketplace. So we think that's on our current outlook that we will replace at TSA business at Soffe, but we’re directly impacted. And we'd hope that over the next quarter or two, the TSA inventory overhang, so obviously the inventory they have it, they closed out in the inventory that people had in the pipeline for TSA will work through retail in the ordinary way and then the next quarter or two that marketplace will back to get balance.

Nick Meyers

Perfect, that’s good color. Thank you. And then broadly speaking, it seems like multiples getting paid and some brand has been fairly robust recently, can you talk about whether you like to maybe take advantage of that in anyway and then conversely what’s your current appetite for acquisitions?

Bob Humphreys

Well, we don’t have any plans to take advantage of it anyway. I wouldn’t say these points, so really no comment on that. But I think we’re as we mentioned earlier getting into a position where acquisitions are becoming something that we have some time and energy for. A couple of years ago we acquired Salt Life and reduced our borrowing ability to do that, and now in much better shape unless 10 points. Also during that time, we went to work on some cost areas and SG&A and manufacturing and are seeing that major project come to an end and send to be showing up on our bottom line, all the rest of its showing up on our bottom line. So, we did feel like we are at a point time where we did digest right type of acquisitions, but we will continue to be selective as we have over the year and look at things that we think for price right and meet our criteria being accretive in businesses that we understand that we can [indiscernible] company and bring some value too.

Operator

Thank you. [Operator Instruction] We will now take our next question from Lynn Parry with Wilen Management.

Lynn Parry

If I repeat some of these or actually question that might have already been answered, we had a couple of [power bombs] here. And on the call, you did probably look into how many stickers have been through sold on the business, do you happen to have any idea how many that was?

Deb Merrill

We did look that up and that is well over a 1 million on the decals have been sold, simply since we started operating the business. So, we would hope and believe that most of those are out there on vehicles and further supporting us Salt Life brand.

Lynn Parry

They are on mind for sure, I am glad. That's a great incredible. It's incredible. Is the increase of Salt Life turbine due to an increase on a number of door or sell through on existing doors and also does this brand have the ability to go beyond the U.S. borders?

Bob Humphreys

So, Lynn, we are selling beyond the U.S. borders now certainly the Caribbean, the Bahamas area. We recently took on a Canadian distributor that has already opened a number of doors up there and they're in the kind of ocean lifestyle business with our goods already. So feel good about that. The growth was really coming from everywhere we take Salt Life, so we haven't expanded product line, and as we add new powerful products to our product line they're retailing well. We have a lot of really leading edge performance product that are resonating with consumers. We are opening new doors, but at the same time that will not over saturate areas that already have a good retail footprint Salt Life products. And then obviously our e-commerce business for Salt Life is on fire and our whole social media partner of Salt Life in on fire with increased participation player. So, that’s all going well and then I would say that the back staff of that as you may recall this past -- a year ago we were opening up our new DC in Maiden, North Carolina. And so we did a really nice job of expanding our service levels particularly for this quarter. We are really reaching our stats. We had products. We were getting it out the door. We had a huge effort from our management and on the floor employment team, getting that done. And it's really helping us as we go into this quarter two as we're being very successful with quick timely orders and that sort of thing that pretty help our retailers for their industries and restocking in and gain that extra turn of sales.

Lynn Parry

Great, do you happen to know with percentage of Salt life sales are through e-commerce? And has that increased or decreased throughout the year?

Bob Humphreys

I think we do that -- we disclose our e-commerce sales in total. I don’t think we do that by brand.

Deb Merrill

We don’t do it by brands. Overall we're about, I'd say about 5% of overall kind of going through our e-commerce site that both are to be and be the needed wide on. That’s answer of your question. You asked, it is growing rapidly and becoming a larger percentage of the overall sales. As Bob mentioned on e-commerce sales for Salt Life were up 80% on during the quarter and the overall was up 45% during the quarter, and we've seen that in the last two quarters as well. So overall year-to-date I would say, we’re up above 70 some percent on that website over a year ago.

Operator

[Operator Instructions] There is no further question. My apologies, we’re now taking a follow-up question from Lynn Parry with Wilen Investment Management Corp.

Lynn Parry

On this Soffe, are you performing at breakeven levels?

Bob Humphreys

No, we’re making money.

Lynn Parry

Great. Okay and what's on the horizon for the next fiscal to increase sales, to increase gross margins, some reduce expense to earn on reasonable return?

Bob Humphreys

Do you know Soffe specially?

Lynn Parry

On the Soffe, yes, please.

Bob Humphreys

So, we think Soffe has turned the corner, obviously the TSA bankruptcy early this fiscal year push us back a little bit. But we have been working through that. We think it in ordinary manner. We’re growing in a number of our channels of distribution. We have expanded to all the big stores, in every location, so that's been a right way for Soffe. Our Intensity Athletics brand within Soffe is getting some expanded placement, so we feel good about that. Our direct business that goes to independent sporting goods store, there is up double digits, as Deb mentioned, our B2B website in Soffe that we just upgraded is also growing very nicely. So our core business at Soffe is growing and then they're now enjoying a much lower cost structure from the especially just year or two ago, so just a little bit more sales really has a big impact on Soffe's bottom line now, and we’re even positive and expect that to continue and grow going in to fiscal ’17.

Lynn Parry

Okay. Great. And then I have just one final question. As the cotton prices have risen, what do you think the effect will be on your margin, near or longer term, basically your inventory position and many movements in the selling prices?

Bob Humphreys

Well, again, when cotton prices go up, it ends up being relatively far on in the future before it really starts flowing through our cost of sales. So, I would say future cotton taxes, so again that’s kind of December forward for most of the industry have moved up to more what I would consider the higher end of average where we started being in the middle to lower end of average for the last 15 or 18 months. And so, I do think there is an area that the industry can digest and with occurrence of supply and demand balance, I would expect pricing to move up along with those cotton prices. That will take, sometime is that really starts flowing through and impact on people's actually costs.

Operator

Thank you. And that thus conclude today’s question and answer session. I’d like to turn the conference back over to Bob Humphreys for additional and closing remarks.

Bob Humphreys

Okay, we thank you all for joining us and your interest in our company and the questions. And we look forward to finishing up fiscal '16 here and just a couple of more months and giving you an update on how the year ended and obviously we're looking forward to fiscal '17 with our new manufacturing initiatives under our belt and watching some of these brands continuous to grow. So thank you very much.

Operator

Thank you. And that does conclude today's conference. Thank you all for your participation and you may now disconnect.

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