Earnings Transcript for DLA - Q4 Fiscal Year 2023

Operator: Thank you, and good afternoon to everyone participating in Delta Apparel, Inc.'s Fiscal Year 2023 Fourth Quarter and Full Year Earnings Conference Call. Joining us from management are Bob Humphreys, Chairman and Chief Executive Officer; Justin Grow, Executive Vice President and Chief Administrative Officer; and Nancy Bubanich, Vice President and Chief Accounting Officer. Before we begin, I would 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 projections and 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 annual report on Form 10-K and quarterly reports on Form 10-Q. These documents identify 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 except as required by law, the company does not commit to update or revise any forward-looking statements, even if it becomes apparent that any projected results will not be realized. I will now turn the call over to Mr. Humphreys.

Bob Humphreys: Good afternoon, and thank you for joining us today. As always, we appreciate your interest in Delta Apparel. Before we review our results for the full year and fourth quarter, I want to take a moment to express my gratitude to our teams throughout the various countries in which we operate our business. This has been a very challenging year for our company with many of these challenges driven by market dynamics outside of our control. I am proud of the decisive steps we took across our business with respect to things within our control, such as reducing working capital, controlling costs and above all maintaining the high service levels that have been key to our growth and success over the years. Our employees remain steadfast in their commitment to meeting our customers' needs each and every day. Thanks to their hard work and flexibility, we were able to navigate what was truly a unique operating environment and enter our 2024 fiscal year better-positioned to drive sustainable, long-term growth as conditions improve. As you saw in our press release, we registered full fiscal year sales of $415.4 million, a contraction of 14% from our strong performance in the prior year, when the apparel industry enjoyed a seller's market full of retailers looking to accumulate inventory in the wake of COVID-related supply chain delays. As I am sure most everyone on this call knows, this year market conditions presented a much different and more difficult picture for both the apparel industry and our company. These conditions were driven primarily by two distinct and thankfully temporary trends, historically high cotton prices and extremely shallow demand due to high inventory levels across the supply chain. When cotton prices trended above historical averages, we made a strategic decision to purchase less cotton and reduce our production levels to align with what we anticipated to be a challenging demand picture in the first half of our fiscal year 2023, particularly in the mass retail supply chain. We originally expected customer demand to stabilize and improve in the second half of the year. However, when the softness in the mass retail supply chain spread to other channels and exhibited more depth than anticipated, we decided to further curtail our production levels to maintain balance with the declining demand. The collective impact of the elevated cotton costs and expenses incurred to reduce production throughout this year is hard for us to overstate. If you compare the average price of cotton over the last decade to what our cost was during the year, the excess amounted to a headwind of approximately $26 million. Additive to that, we incurred roughly $8 million in excess cost associated with our production curtailment activities, with most of that being driven by the lower absorption of our fixed cost due to less volume and the payment of temporary unemployment benefits to idled employees at our offshore locations, that's roughly $34 million in additional costs for the year. During the year, we also embarked on a longer-term initiative as designed to optimize our cost structure and better position our company to generate higher returns on the capital we invest in our business. Many of the decisions we made in connection with this initiative were difficult, but they were the right actions to support the business for the long-term and will result in meaningful annualized savings, as well as a more efficient operating structure. Among the actions we took include

Justin Grow: Thanks, Bob. Before taking a closer look at our individual business units, I would like to note that, in addition to the steady progress across our business during the year and fourth quarter to streamline our cost structure and reduce inventory, the team also made substantial progress in managing down our debt levels. We finished the year with an approximately 17% reduction from our most recent high in February 2023 and expect to finish fiscal '24, nearly 40% below February levels. We recently entered into agreements to sell and leaseback several properties within our real estate portfolio, including our campus in Fayetteville, North Carolina and our distribution center in Clinton, Tennessee. The sale leaseback of these properties is something we have seriously considered at various times throughout the years and we believe the time is optimal to monetize these valuable assets and create value for our shareholders. We expect to realize aggregate gross proceeds of approximately $31.5 million from these transactions, assuming they close in or around January '24 as currently expected. We will simultaneously lease back these properties from the respective purchasers and continue our operations there uninterrupted as a tenant going forward. Now turning to our activewear business, which is organized around three key go-to-market channels

Nancy Bubanich: Thank you, Justin. Please note that, as we did on our call last quarter, we will discuss a variety of financial measures that are adjusted to account for the cost impacts of the inflationary pattern and production curtailment activities as well as strategic cost optimization initiatives Bob referenced earlier. In addition, during the fourth quarter, we concluded that the goodwill associated with our DTG2Go business was impaired, and we recorded a non-cash charge of $9.2 million in fiscal year 2023. We will discuss non-GAAP measures such as adjusted gross margins, adjusted operating income and adjusted net income, as we believe it is important to evaluate our operating results for this quarter and the full year in light of the impacts of these unique events. Listeners may access a reconciliation of those measures to gross margin, operating income and net income on the most directly comparable GAAP measures on the Investor Relations page of our website, www.deltaapparelinc.com. For the fourth quarter ended September 30th, 2023, net sales were $91.4 million compared to the prior year fourth quarter net sales of $115.5 million. Salt Life group segment net sales were $12.5 million compared to the prior year fourth quarter net sales of $14 million. Net sales in the Delta Group segment were $78.9 million, compared to $101.5 million in the prior year fourth quarter. Gross margins were 11.2% compared to 18.7% in the prior year fourth quarter, driven primarily by production curtailments and inflationary cotton costs. Adjusting for these cost impacts, fourth quarter gross margins were 15.9%. Delta Group segment gross margins for the quarter were 4.8% compared to the 14.1% in the prior year period. Adjusted for the production curtailment and cotton cost impacts, Delta Group segment gross margins were 10.3%. Salt Life Group segment gross margins for the quarter were flat at 51.7% versus 51.8% in the prior year period. Selling, general and administrative expenses decreased favorably from $19.8 million in the prior year fourth quarter to $17.1 million, while SG&A as a percentage of sales increased over the prior year period to 18.7%. Operating income declined year-over-year from $2.2 million or 1.9% of sales to an operating loss of $17 million or 18.6% of sales. Adjusting for the production curtailment and cotton cost impacts as well as the non-cash impairment charge on the goodwill in the DTG2Go business, fourth quarter operating loss was $2.1 million or 2.3% of sales. Delta Group segment operating income for the quarter declined from $4.8 million to a loss of $15.2 million. Adjusted for the production curtailment and cotton cost impacts of the non-cash impairment charge, Delta Group segment operating income was a loss of $295,000 or 0.4% of sales. The Salt Life Group segment experienced an operating loss for the quarter of $400,000, compared to operating income of $1.2 million in the prior year period. Net income declined to a loss of $16.4 million or $2.34 per share from a loss of $281,000 or $0.04 per share. Adjusting production curtailment and cotton cost impacts as well as the non-cash impairment charge, fourth quarter net loss was $5 million or $0.72 per share. Net income for the quarter was significantly impacted by the elevated interest rate environment with our interest expense for the quarter essentially doubling over the prior year quarter. Net inventory as of September 30th, 2023 was $212.4 million, a sequential decrease of almost $47 million or 18% for December 2022 and a year-over-year decrease from inventory of $248.5 million as September 2022. The inventory decrease was a part of our team's excellent execution on a high-priority working capital efficiency initiative. Total net debt including capital lease financing and cash on hand was $165.3 million as of September 30th, 2023, an approximate 15% reduction from $194.3 million at March 2023 and year-over-year decrease from $170.6 million at September 2022. Cash on hand availability under our U.S. revolving credit facility totaled $14.2 million as of September 30th, 2023, a decrease of $13 million from December 2022 and a $20.4 million from September 2022, with the decrease from December 2022 principally driven by investments in the business to support working capital needs as well as the higher interest expense. We had no capital spending during the fourth quarter compared to $2.1 million during the prior year fourth quarter. For the full year ended September 30th, 2023, net sales were $415.4 million, compared to the prior year net sales of $484.9 million. Salt Life Group segment net sales were $59 million compared to the prior year net sales of $60 million. Net sales in the Delta Group segment were $356.3 million compared to $424.8 million in the prior year. Gross margins were 13% compared to 22.4% in the prior year, driven primarily by the production curtailment and cotton cost impacts coupled with the impacts of the strategic actions we undertook to better optimize our overall cost structure. Adjusting for the collective cost impacts of the production curtailment, cotton and strategic actions, gross margins were 21.2%. Delta Group segment gross margins were 6.1%, compared to 18.3% in the prior year. Adjusted for the collective cost impacts of the production curtailment, cotton and strategic actions, Delta Group segment gross margins were 15.6%. Salt Life Group segment gross margins increased to 54.6% from 51.6% in the prior year period with an increase driven primarily by a more favorable mix of higher margin direct to consumer sales. Selling general and administrative expenses decreased favorably from $79.5 million in the prior year to $73.7 million, while SG&A as a percentage of sales increase from 16.4% to 17.8%. Our equity investment in Green Valley Industrial Park in Honduras, where our textiles facility is located, provided dividends during the year of approximately $1.6 million and continues to generate profits recorded in other income that provide excellent return on our investment there. Operating income declined year-over-year from $31.8 million or 6.6% of sales to an operating loss of $29.4 million or 7.1% of sales. Adjusting for the collective cost impacts of the production curtailment, cotton and strategic actions, as well as the non-cash impairment charges. Operating income was $18.4 million or 4.4% of sales. Delta Group segment operating income declined from $37.5 million to a loss of $26.2 million, adjusted for the collective cost impacts of the production curtailment, cotton, and strategic actions, as well as the non-cash impairment charge, Delta Group segment operating income was $21.7 million or 6.1% of sales. Salt Life Group segment operating income was $6.2 million or 10.4% of sales, compared to $8.2 million or 13.6% of sales in the prior year. Net income declined from $19.7 million or $2.80 per diluted share to a loss of $33.2 million or $4.75 per share. Adjusted for the collective cost impacts of the production, curtailment, cotton, and strategic actions, as well as the non-cash impairment charge, net income was $3.3 million or $0.47 per diluted share for the full year. Net income for the full year was also significantly impacted by the elevated interest rate environment with our interest expenses a period essentially doubling over the prior year. Now, I'll turn the call back over to Bob.

Bob Humphreys: Thanks, Nancy. Fiscal 2023 was a transition year for us in many respects, particularly for our Delta Group Segment, but it was also very productive if you look across the company and see what we did to streamline our cost structure and better position ourselves and our business for the long term. Our activewear business is leaner from a fixed cost and working capital perspective, and DTG to go has completed the work necessary to take another step forward in its progression with technology, quality and service offerings that are quite unique in the marketplace. We see those businesses continue to capitalize on the growing synergies they share, and for both to grow and gain market share in fiscal of 2024. We also see Salt Life taking another step forward in fiscal year 2024, and believe that business is poised for continued revenue growth driven by direct-to-consumer channels. We will continue to closely manage our cost working capital and debt levels and focus our investments in areas that should return the most value for our shareholders. These efforts along with the structural changes we have made across our business position us for steady operating improvement, as we move ahead and market conditions continue to level out. Based on our current view for fiscal year 2024, we anticipate net sales in a range of $400 million to $415 million and operating profit margins between approximately 2% and 3.5% with gross margins sequentially increasing into the low to mid 20s, improving operating margins beginning in the second quarter and revenue growth in the back half of the year. And now operator, you can open up the call for any questions we may have.

Operator: [Operator Instructions]. And our first question comes from the line of Dana Telsey with Telsey Advisory Group.

Dana Telsey: Hi, good afternoon, everyone. Bob, as you think about this year, and Jason and Nancy, as you think about this year and how the fourth quarter ended, can you at all give some contextualization as to what the level of demand is going forward, even as we go through the first be second quarter from the customer base of Delta Group and how that's shifting or changing? And then unpacking the gross margin, given the production curtailment and the cotton costs, when do we see some normalization or should the magnitude of what the gross margin impact was this quarter? Does it continue? How do you think of it moving forward? And then lastly, as you looked at expenses structure of the business and the changes you have made, as we go through 2024, how do you see that operating income and operating margin develop? Thank you.

Bob Humphreys: So on a demand standpoint, in the fourth quarter, our business remain choppy, depending on the particular market segment. We are seeing some areas that are still strong, like our ad specialty business, in our e-retailer business, in our basic activewear group. Our specialty business is strong and growing and there are other channels that are slower, and that would include regional screen print and retail licensing. Now having said that, our business meetings with our retail licensing customers have indicated that, their business is improving over time and that we will be receiving more business as we go into the new fiscal year. As you saw in our Salt Life business, our wholesale business slowed down in the fourth quarter like we have seen with many of their competitors as well. So it does seem like the consumer is getting a little bit fatigued in buying, where we have customers in our stores, obviously, we have a lot of data. The purchase, what a customer is there is more product and higher average selling price, but less foot traffic in those retail doors. As we look into our first quarter, which is well underway now, in general, we are seeing the same conditions continue. We are off to a good start in our DTG2Go business in the quarter and the important holiday season. Our output is high, our quality is good, very good. And our labor utilization rates are some of the best that we've ever seen in that business. So we've got some more to go but are encouraged with our progress in our DTG2Go business as we go into the first quarter

Dana Telsey: Got it.

Nancy Bubanich: I believe you asked about the cotton as well. And if we're through that -- so we are through miss of our higher price cotton, and we'll start seeing that impact on our P&L as we move into FY ‘24 with lower price cotton flowing through our cost of sales. And as far as, I think you also asked about production curtailment, or did you operating margin?

Dana Telsey: Yes.

Bob Humphreys : Yes. So the operating margin will sequentially improve as we go through the fiscal year. We still have some excess cost on our balance sheet that we'll roll out in the first quarter, some in the second quarter, and that will be behind us. We've expense those where we can through gap and the things that have to follow the inventory, obviously, we'll do so. And as Nancy spoke to on cotton, the cotton that we've been bringing into our business for the last several months is what we would call market price cotton, but it still has to roll through cost of sales, which we'll start seeing the benefit of that in the second quarter and on out through the rest of the fiscal year.

Operator: Our next question comes from the line of Jamie Willin with Willin Management.

Jamie Willin : Hey fellas, when you give out that forecast for revenues for next year, prior to that you've talked about, you're expecting growth in Salt life. You're expecting growth in DTG2Go, but when you, those overall numbers come out, it doesn't look like a major increase for this year. Can you explain that dichotomy?

Bob Humphreys : Well, we're not expecting strong overall growth at Salt Life with the current wholesale business environment, growth, but not strong growth and DTG2Go, we'll have growth sequentially in the second, third, and fourth quarter. Our first quarter last year was a large DTG2Go revenue quarter that we did not operate efficiently. And so, we took a different stance this year, and are not operating as many shifts as we have in prior years, but we think a lot more efficiently and we'll have a strong rebound in operating profit EBITDA in DTG2Go this fiscal year compared to last year.

Jamie Willin : Okay. On the Salt Lake wholesale side, have you gained or lost any major customers there?

Bob Humphreys : We have not gained or lost any major customers. There are accounts that we chose to quit shipping last year when their margin requirements changed or other give backs that they wanted. We just didn't feel like it was a business that was additive to the brand. And we see more and more lifestyle brands doing that. So retailers get under pressure, they ask for more and more, and if we're not going to make money at it to keep our brand integrity, then we walk away from that business.

Jamie Willin : Got it. The curtailment costs that you have detailed of $8 million. How much of that has already been expensed, and how much will go into 2024?

Nancy Bubanich: Yes. Those have all have been expensed.

Jamie Willin : Okay. But there is still a little bit more to come?

Bob Humphreys: Yes. There is more stuff to roll out in the first quarter.

Jamie Willin : Okay. And on the inventory side of the business, when you are looking at $400 million of revenues, what is the optimal inventory that you should carry to operate efficiently?

Bob Humphreys: We should turn our inventory 2.5x a year, and we expect to be at about a two turn by the end of this fiscal year. In fiscal '22, I believe, we turned our inventory about 2.4x. So obviously, that deteriorated dramatically as business slowed down and we have taken steps to improve that and it has been improving. And obviously with our manufacturing reset and eliminating facilities in Mexico that will allow us to better manage that, and we should be able to operate with less inventories, both in process and finished goods.

Jamie Willin : Okay. On the sale leaseback transaction, I assume it will close prior to year end. And how much of a gain are you looking to record from that?

Justin Grow: Hey, Jamie. This is Justin. So on the sale leaseback, we are looking at January for both of those transactions. So a second quarter event for both of those properties, hopefully. And looking at aggregate proceeds coming in of about $30 million to $31 million, about $31 million, $31.5 million.

Jamie Willin : Without much tax leakage?

Justin Grow: Without much tax leakage, that's correct. We do not have those on the books for much at all. So not looking at a big tax leakage there.

Jamie Willin : Okay. And lastly on Salt Life, what is the outlook for new store openings over the next 12 months?

Bob Humphreys: So we have one more that will be opened in Virginia in our second quarter. We don't have any other leases signed. So, we always are looking at locations and negotiating on locations, but there are no other leases signed at this time.

Jamie Willin : Okay. And one last on Salt Life. From the royalty payments you are going to get, you said you are going to -- they're going to be double in 2024 what they were in 2023. What other royalty arrangements do you have that you are receiving income on Salt Life?

Bob Humphreys: So we have the restaurants and we have [indiscernible] and then now we have the home furnishings.

Jamie Willin : Okay. And they will be first to be recorded in the December or March quarter, when do they begin?

Bob Humphreys: Yes. So, we record them each quarter as they come in.

Jamie Willin : Okay. And they are starting now. They have begun.

Bob Humphreys: Yes, they have been ongoing, but the new ones will be starting this fiscal year.

Operator: Thank you. There are no further questions at this time. I would like to turn the call back over to management for closing remarks.

Bob Humphreys: Well, thank you for your time and attention today and we will look forward to speak in just a few months and report on our first quarter results.

Operator: This concludes today's conference. You may now disconnect your lines at this time. Thank you for your participation.