Delta Apparel : Earnings Call Transcript FY 2022

Delta Apparel, Inc.

Fiscal 2022 Fourth Quarter & Full Year Earnings Conference Call

Operator:

Thank you, and good afternoon to everyone participating in Delta Apparel's Fiscal 2022 Fourth Quarter and Full Year Earnings Conference Call. Joining us from management are Bob Humphreys, Chairman and Chief Executive Officer, and Simone Walsh, Chief Financial Officer. Before we begin, I'd like to remind everyone that during the course of this conference call, projections or other forward-looking statements may be made by Delta Apparel's executives. Such projections and statements suggest prediction and involve risk 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'll now turn the call over to Mr. Humphreys.

Robert Humphreys

Good afternoon and thank you for your interest in Delta Apparel.

We are extremely pleased with our performance in fiscal year 2022. As you saw in our press release this afternoon, we delivered full-year sales of $484.9 million and an operating margin of 6.6%, resulting in $2.80 of earnings per diluted share. Our ability to navigate the dynamic economic conditions and consumer environment throughout the year and achieve both double-digit sales growth of 11% and solid bottom-line results for our shareholders is a testament to the resiliency and reach of our diversified go-to-market strategies and, of course, our people. I am incredibly proud of our entire organization's ability to quickly adapt to change throughout the year yet remain focused on the execution of our business goals and strategic initiatives.

All five of our primary market channels, Delta Direct, Global Brands, Retail Direct, DTG2Go, and Salt Life, delivered year-over-year sales growth in fiscal year 2022. The growth was driven by higher units sold in most product categories as well as price increases across product lines. Within our Delta Group segment, demand between its various market channels shifted as the U.S. economy continued to evolve in the post-pandemic environment, with strong early overall demand for our products moderating as the year progressed. We continue to see strong demand in our DTG2Go channel and in our Delta Direct channel's regional screen print and ad specialty businesses. Moreover, the strategic investments we've made in our vertical manufacturing platform immediately adjacent to the U.S. market and our distribution network across the U.S. market continue to generate increased demand in our Global Brands and Retail Direct channels. Brand and retailer interest in the near-shore and domestic sourcing and fulfillment strategies our platform offers is accelerating due not only to U.S. market proximity and speed, but also to better risk management associated with evolving U.S. trade relations; social, environmental, and sustainability priorities; inflationary pressures; and supply chain disruptions. These favorable dynamics, coupled with new investment in screenprint production and other value-adding ancillary services as well as higher selling prices from our pass through of rising input costs, manifested in solid sales growth in our Delta Group segment.

We were heavily impacted by strong inflationary pressures throughout our fiscal year like the rest of our industry, but we were able to move quickly to capitalize on the flexibility of our vertically integrated platform and re-calibrate our production to manage inventory levels and mitigate higher input costs. Our team did a great job of responding

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to the fluid environment and navigating the challenges brought on by the volatility in raw material pricing. The price of cotton, one of our key inputs, increased by almost 50% in a five-month period and reached a high of over $1.50 in our third quarter. We started reducing our forward cotton purchase commitments as futures prices escalated beyond a level that we believed would be accepted at retail, and when we saw declines in overall demand for basic tees in the fourth quarter, we began reducing manufacturing output to level off our finished goods inventory. These inflationary input costs, of course, increase the value of our inventory and put pressure on our gross margin as inventory is sold. We saw this margin impact in the second half of fiscal 2022 and expect it to continue in the first half of fiscal 2023. We currently expect to operate some of our production facilities below full capacity until inventories become better aligned with market demand in fiscal year 2023.

We've seen our retail partners encounter similar challenges in managing their inventory levels to the fluctuations in consumer demand. The overall economic uncertainty going into the holiday season caused by the inflationary environment has dampened replenishment orders for activewear from our mass retail partners, but we continue to stay close to our partners and will be prepared to support demand as we progress through the first half of fiscal 2023.

Our DTG2Go business continues to grow and solidify its leadership position in make-on-demand digital printing and fulfillment through its "digital first" strategy, achieving year-over-year increases in both units sold and sales revenue. We ended the fiscal year with eight digital print locations, six of which also operate as blank garment distribution centers, and the latest technology to support DTG2Go's digital first strategy is now in four locations.

More and more customers see the clear benefits of our digital make-on-demand model versus the traditional, inventory-heavymake-to-forecast model, particularly when coupled with our unique ability to vertically supply blank Delta garments on-demand. Our seamless blank supply reduces not only our customers' garment costs, but also risks associated with adding another third-party layer to their supply chains. For us, this model eliminates nonvalue- added costs, creates a more efficient operation, and lowers working capital needs.

While we experienced additional costs and some production delays in fiscal year 2022 as we brought new print equipment online and worked through challenges from the tight U.S. labor environment, which depressed our margins, we see both sales and margin growth potential at DTG2Go going forward as selling prices continue to grow. We also expect to increase output through productivity gains, additional staffing, and extended operating schedules to meet demand in this high-growth channel for our Company.

We saw great success with our lifestyle brand, Salt Life, in fiscal year 2022, with over 20% sales growth from the prior year. We are pleased with the continued demand for the Salt Life brand across all three legs of our omni- channel go-to-market strategy. Our Salt Life branded retail doors continue to serve as valuable brand awareness tools and drivers of accretive revenue. We ended the year with 21 branded retail doors spread along the U.S. coastline and reached a milestone of eight new doors opened during the year. Our new location in Rehoboth Beach, Delaware is exceeding expectations and we are excited to open another six to eight Salt Life owned and operated stores in fiscal 2023, including an additional store in Long Branch, New Jersey to give Salt Life even more visibility in the northeast.

Salt Life's eCommerce business was challenged by supply chain shortages in the first half of the year but was able to work through them to drive organic growth in this important market segment during the fourth quarter. In addition, our wholesale customers continued to promote Salt Life and devote more floor space and valuable "shop-in-shop" opportunities to drive incremental sales and increased brand awareness.

Our other efforts to elevate the Salt Life brand's profile and appeal and to drive increased consumer engagement are also paying off. The Salt Life YouTube channel reached 7.1 million views in fiscal 2022, a 37% increase compared to FY21, largely driven by the success of YouTube "Shorts". These short segment videos are designed to appeal to a broader audience, and we target producing 2 to 3 shows per week. Beyond YouTube, Salt Life's social channel net audience grew nearly 85% in fiscal 2022, spanning Facebook, Instagram, Twitter, LinkedIn and Pinterest. We also continue to interact with our customers through Salt Life's online content portal, The Daily Salt, which includes published articles featuring reviews of the best gear in the industry, how-to articles, team member travel articles,

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and other content. Additionally, we continue to produce our Salt Life podcast, Above and Below, hosted by professional surfer and Salt Life team member, Kieran Anderson.

Overall, fiscal 2022 was another excellent year for both our Delta Group and Salt Life Group segments and a year of robust overall organic growth for our Company. We have built a strong foundation across our business segments and our full-year performance highlights the range of our five distinct go-to-market strategies, the widespread demand for the unique products and services we offer, the flexibility and efficiencies of our vertically integrated operations and first-mover advantages in digital printing and fulfillment, and the emotional connection our lifestyle brand, Salt Life, has with a broad range of consumers.

Let me now turn the call over to Simone Walsh who will review our fourth-quarter and full-year business highlights and financial results. I will then join back when we open the call up to questions. Simone

Simone Walsh

Thank you, Bob. For both our Delta Group and Salt Life Group, fiscal 2022 was another strong year and we are entering fiscal 2023 with positive momentum across many areas of our business. We delivered strong top-line growth of 11% year over year, including 9.8% growth in the Delta Group and over 20% growth in the Salt Life Group over the prior year.

Within the Delta Group, our three key sales channels in Activewear - Delta Direct, Retail Direct, and Global Brands - all experienced year-over-year sales growth. While Delta Direct was challenged in the second half of fiscal 2022 as a result of scaled-back orders, particularly from mass channel activewear at large retailers, we were pleased with our ability to maintain year-over-year sales growth in that channel and to achieve double-digit sales growth in both the Retail Direct and Brand Direct sales channels on increased units and higher selling prices. As a reminder, in our Retail Direct and Global Brands sales channels, we serve as a supply chain partner to global brands including the development of custom branded garments, the provision of ancillary value-addingretail-ready services, and shipping logistics. These sales channels also serve retailers by providing our portfolio of Delta, Delta Platinum and Soffe products directly to retail locations and their e-commerce fulfillment centers.

Also within the Delta Group, our DTG2Go make-on-demand business experienced both unit and selling price growth year over year, and order flow for our digital first strategy exceeds our current capacity. We are excited to continue to expand our digital first initiative across our markets and plan additional investments in the latest digital print equipment to meet the growing customer demand in this sales channel.

Bob shared a lot regarding Salt Life's engagement with consumers, which drives strong direct-to-consumer sales for Salt Life and also enhances its wholesale business as consumers seek out the brand while shopping at department stores, outdoor retailers, resort shops, specialty stores, and other retail outlets. With the strength of the Salt Life brand and growth we are experiencing in our direct-to-consumer channels, we remain extremely excited about Salt Life's potential in fiscal 2023 and beyond.

Our business is significantly influenced by the price of cotton used in our manufacturing operations. During the fiscal year, the elevated price and volatility negatively impacted the gross margins in our business. We expect our margins to continue to be depressed in the first half of fiscal year 2023 as we sell through the inventory we produced in the latter half of fiscal 2022 which was impacted by both the higher-priced cotton and other elevated input costs. Although we took action to use less of the higher priced cotton by reducing our production, we do expense additional unabsorbed fixed costs from these measures.. The fourth quarter reduction resulted in $1.1 million of unabsorbed expense, which impacted gross margins by approximately 90 basis points for the quarter. In addition, we expect to take additional targeted production shutdowns and continue to operate some of our facilities below full capacity until inventories are better aligned with overall demand. These adjustments are expected to result in approximately $2 million and $775 thousand of additional unabsorbed expense in the first and second quarters of fiscal year 2023, respectively.

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Currently, with the price of cotton declining and stabilizing recently from the volatility and peak price in last year's third quarter, we anticipate we will return to margin expansion in the fourth quarter of fiscal 2023.

Additionally, we note that our inventory on hand has increased from the prior year. This increase is a result of the price of inventory escalating due to rising input and labor costs as a result of inflationary pressures, coupled with an increase in units on hand. We are closely monitoring inventory levels and will continue to monitor our manufacturing output and make adjustments as necessary to align with market conditions. The vast majority of our inventory consists of basic Delta blank garments that we fully expect to sell-through our various channels as demand arises.

Now, I'll go through a more detailed review of our fourth quarter and full-year financial results.

For the fourth quarter, net sales were $115.5 million compared to $114.7 million in the prior year fourth quarter, with Delta Group sales decreasing 1% and Salt Life Group sales up nearly 16% over the prior year fourth quarter

During the fourth quarter, Delta Group net sales declined to $101.5 million compared to $102.6 million in the prior year fourth quarter., Global Brands growth helped to offset with softness in our Retail Direct channel.

The Salt Life Group fourth-quarter revenue grew 16% to $14.0 million compared to $12.1 million in the fourth quarter of 2021. The segment's growth was driven by organic growth across all three of its markets - wholesale, retail and eCommerce.

Gross margins were 18.7% overall for the quarter compared to 23.1% in the prior year fourth quarter. The 440-basis point decline was driven by higher input costs in both our Activewear and DTG2Go businesses as well as unbudgeted production curtailments, offset by an improvement in the Salt Life Group segment.

In the Delta Group, gross margins were 14.1% for the fourth quarter, a decline from the prior fourth quarter's margins of 20.2%. Gross margins were most negatively impacted by higher cost inventory flowing through cost of sales, including elevated cotton, energy, dyes and chemicals, freight and labor costs.

As Bob mentioned, we started reducing production of basic tees in the September quarter, which resulted in $1.1 million of unabsorbed fixed cost, expensed in our fourth quarter. Our plan to reduce production further in the first half of fiscal 2023 until inventories get in better alignment will result in additional unabsorbed fixed costs impacting our gross margin.

The Salt Life Group segment's gross margins improved to 51.8% in the fourth quarter of fiscal 2022 compared to 48.0% in the prior year fourth quarter resulting from a favorable mix of sales, including increased Salt Life branded retail store sales.

Selling, general, and administrative expenses ("SG&A") were $19.8 million in the quarter, increasing 170 basis points to 17.2% of sales. This increase was primarily driven by a higher percentage of our sales coming through the Salt Life retail stores and increased distribution labor costs across all of our business operations.

As a result, operating profits were $2.2 million, or 1.9% of sales, declining from $10.1 million, or 8.8% of sales, in the prior year quarter.

Other income for the fourth quarter of 2022 was $0.5 million. This is substantially made up of valuation changes in our contingent consideration liabilities of $0.6 million associated with the acquisition of DTG2Go. In the prior fiscal fourth quarter other income was $1.3 million, driven primarily by a valuation change in the DTG2Go contingent consideration liability of $1.2 million.

Interest expense was $2.4 million in the fourth quarter of fiscal 2022, up from the prior year fourth fiscal quarter expense of $1.6 million due primarily to higher debt levels.

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Overall, we incurred a net loss for the September 2022 quarter of $0.3 million, or $0.04 per diluted share, as compared to net income of $6.8 million, or $0.96 per diluted share, in the prior year.

Now turning to our full fiscal year results.

For the full 2022 fiscal year, net sales increased 11% to $484.9 million, with almost 10% growth in the Delta Group and approximately 21% growth in the Salt Life Group over the prior year

For the Delta Group, net sales for fiscal 2022 were $424.8 million, up from $387.0 million in the prior year. For Salt Life, net sales were $60.1 million, up $10.3 million from the prior year net sales of $49.7 million in the comparable period.

Gross profit increased 6.8% to $108.8 million, with gross margins contracting 90 basis points to 22.4% of sales driven by a decrease in the Delta Group segment of 190 basis points that was partially offset by an improvement of 370 basis points in the Salt Life Group.

Within the Delta Group, gross margins were 18.3% compared to 20.2% in the prior year with the decline driven by increasing input and labor costs as well as production curtailments.

In the Salt Life segment, gross margins grew to 51.6% of sales from 47.9% in the prior year, driven by sales channel mix and higher selling prices.

SG&A expenses were $79.5 million in fiscal year 2022, or 16.4% of sales, a decline of 20 basis points from the prior year.

Overall, the increased input costs coupled with slightly increased SG&A expenses resulted in $31.8 million in operating profit, or a 6.6% operating margin. In the prior year, operating profit was $32.7 million, or a 7.5% operating margin.

Other income of $2.4 million in 2022 included $0.9 million in profits related to our Honduran equity method investment, as well as $1.9 million in income from the net reduction in contingent consideration liabilities, offset by a loss on the disposal of fixed assets of $0.4 million. In the prior year, other income of $1.6 million included $0.5 million of profits related to our Honduran equity method investment as well as $2.4 million of income from the net reduction in contingent consideration liabilities, partially offset by $1.3 million of expenses related to the two hurricanes that disrupted our Honduran manufacturing facilities in the prior year December quarter.

Interest expense was $7.7 million in fiscal 2022, up from the prior year interest expense of $6.8 million due primarily to higher debt levels.

Our effective tax rate for fiscal 2022 was 17.9%, down from the prior year effective tax rate of 21.9%.

As a result, our net income for fiscal 2022 was $19.7 million. On just under 7.1 million shares, these earnings translated to $2.80 per diluted share, compared to prior year net income of $20.3 million or $2.86 per diluted share.

Net debt, including capital lease financing and cash on hand, was $170.6 million at year end. Cash on hand and availability under our U.S. revolving credit facility totaled $34.6 million.

Total inventory at year-end was $248.5 million, compared to $161.7 million a year ago when the market was generally in a low inventory position. The year-over-year inventory expansion reflects both higher input costs impacting materials, transportation and labor and an increase in units on hand. We continue to work across the Delta Group to balance our manufacturing output with demand and appropriately manage on-hand inventory.

During the fiscal year, we invested approximately $20 million in capital expenditures. This capital spending was mainly focused on digital print equipment to support our DTG2Go business, retail store openings, and information

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