Delta Apparel, Inc.

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 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 Form 10-K. This document contains and identifies important factors that could cause actual results to differ materially than those contained in the projections or forward-looking statements.

Please note that any forward-looking statements are made only as of today, and the company does not commit to update or revise these statements even if it becomes apparent that any projected results will not be realized.

I will now turn the call over to Delta's Vice President and Chief Financial Officer, Deb Merrill, who will provide the details of the company's fiscal second quarter.

Thank you. And thank you, all, to everyone joining us on the call this afternoon.

Delta Apparel's fiscal 2014 second quarter net sales were $114.5 million compared to $120.1 million for the comparable 2013 period. The 5% sales decline was due primarily to unseasonably cold and snowy weather throughout the country and a weak retail environment.

Net sales for our basic segment were $64.1 million in the second quarter, a 5% decrease from $67.4 million in the prior year period. Private label sales were lower than the prior year quarter by 17%, as some customers reduced shipments because of slowness at retail and changes in product strategy.

Catalog shipments increased 7% in units but were offset by the promotional activity in the marketplace that drove average selling prices down about 5%. Sales in our branded business were hurt by the overall slowness at retail, with sales coming in at $50.3 million, down 4% from the prior year March quarter.

While the decline in sales was disappointing, there are some positives I'd like to point out. First, strong growth continued at Salt Life and Art Gun, with Salt Life sales up 28% and Art Gun up 34% for the quarter.

Although sales were still down at Soffe, we seem to be gaining traction. The new Soffe branded product offerings launched for spring appear to be resonating well with juniors, as evidenced by solid sell-through information received from retailers.

Junkfood continues to grow its branded presence in boutiques and specialty retailers who love the garment styling and creative graphics that Junkfood offers. The Game apparel and headwear lines are also winning new programs, as college bookstores begin placing orders for the new school year.

On a consolidated basis, we reduced SG&A as a percentage of sales to 18.6% compared to 19.7% in the prior year period. Over the last several quarters, we have taken steps to better leverage our back-office functions and reduce overhead expenses in our business.

You can see the impact of these measures in the 110 basis point improvement in SG&A in our second quarter. Partially offsetting these SG&A reductions were higher legal costs associated with ongoing litigation and regulatory matters, which ran about 30 basis points during the first half of the year.

As we mentioned in our previous conference call, we anticipate higher-than-normal legal costs as these matters are worked through.

Operating profit for our 2014 March quarter was $834,000, down from $2.6 million in the prior year quarter. We were pleased that operating margins in the branded segment improved 160 basis points from the prior March quarter, but this improvement was more than offset by depressed margins in the basic segment from lower selling prices on basic undecorated tees, coupled with higher raw material costs.

This resulted in a net loss for the 2014 second quarter of $763,000 or $0.10 per diluted share compared with net income for the prior year quarter of $1.6 million or $0.19 per diluted share.

Capital spending was $1.6 million during the quarter and $5.6 million year-to-date. Our CapEx is primarily related to our manufacturing expansion, as well as ongoing enhancements to our information technology infrastructure.

Depreciation and amortization, including noncash comp, was $2.6 million for the quarter and $5.1 million for the first 6 months. We expect CapEx to be in the $12 million to $13 million range during fiscal 2014 and D&A to be about $10 million.

Total debt at March, which is typically our seasonally highest debt, was $143.8 million. As we progress through the back half of the fiscal year, we intend to use our cash flows to pay down debt.

We expect debt to decrease approximately $15 million by September. As a reminder, we have a $9 million payment on the seller financing from the Salt Life acquisition that's due on September 31, which is the reason for the higher short-term debt on the balance sheet.

During the quarter, we repurchased 12,000 shares of Delta Apparel stock for $180,000 at an average price of $14.82 per share. There still remains authorization of $5.7 million for our share repurchase program.

We believe periodic repurchases are a sound investment opportunity when our stock is trading at a price that is below what we believe is its intrinsic value, and we will continue to evaluate share repurchases as we progress through fiscal 2014.

Last quarter, we deferred updating guidance until we had a better idea of how the year was shaping up. We now have enough information to provide updated guidance based on the conditions we see as of today.

We believe the second half of 2014 will show sales growth in the mid-single digits over the prior year, bringing sales to a range of $480 million to $490 million for the year. This compares to sales of $483 million for the prior 12-month period.

With the lower sales levels, we may not be able to reap all of the expected benefits from our manufacturing expansion in the second half of the year. This, coupled with a higher input cost on undecorated tees that we've not yet been able to recoup through higher selling prices, lowers our expected profitability even further and that's caused by the miss on sales.

As such, we now expect earnings to be in the range of $0.80 to $0.90 per diluted share.

This is obviously not the performance we hope to achieve in fiscal 2014. We do, however, want to be realistic in the updated guidance we provide at this time, in light of the current market conditions.

Keep in mind that we are only midway through our fiscal year and a lot of things can change, hopefully for the positive. We have only recently seen spring weather across the southern region of the country.

Pent-up demand from the harsh weather over the last several months could drive sales and improve the operating results in both our branded and basic segment. Rest assured that we will continue to focus on our cost savings and efficiency program.

As both executives and shareholders, Bob and I are not at all happy with the results of the business to date and are taking necessary actions intended to enhance profitability now without relying solely on market conditions or apparel to strengthen.

I'll turn the call over now to Bob Humphreys, our Chairman and CEO, to provide more details on our business and plans for the future.

Thanks, Deb, and thank you, all, for being on the call with us.

Delta's disappointing second quarter may be summed up by saying that all the marketplace risk that we had warned about in last quarter's earnings call came to pass in the second quarter. Although the demand for undecorated tees appeared to be picking up late in the first quarter, it deteriorated again as we went into the spring selling season.

Soft demand also caused deferred call-outs and slower replacement orders of our branded products. Some of the weakness can certainly be attributed to the unseasonable weather that prevailed across the country, but the continuing sluggish economy and its negative effect on consumer purchasing power also played a big part.

The promotional activity that was occurring in the undecorated t-shirt market hampered our ability to pass along any of the higher cotton and other input cost through price increases. In fact, selling prices in the undecorated marketplace decreased about 3% to 5% net the discounting activity.

The lower-than-expected volumes also decreased the anticipated incremental production we would be able to run through our facilities, reducing our ability to use expanded manufacturing capacity in Honduras to leverage against fixed cost and reduce overall product costs.

Our manufacturing costs in our U.S. textile factory continued to be high due to having older, less efficient equipment in the facility, as well as higher U.S.

labor and overhead costs. In addition, during the March quarter, our costs were negatively impacted due to having to shut the facility down multiple times due to the snow and ice that blanketed the southeast.

These higher costs will impact our back half results as well.

First, it supports our Mexico sewing operations, taking advantage of duty-free sewing through the NAFTA treaty. These goods can then be sold in Canada through our recently opened third-party-operated distribution facility.

Having textile and sewing operations in more than 1 region provides a diversified manufacturing platform that is less exposed to natural disasters and political risk.

Finally, the U.S. textile facility also supports our made in the U.S.A.

programs, which are gaining traction with The Game business through our American Threads collegiate line. That being said, we continue to evaluate the different opportunities we have to lower our overall product costs with more efficient and lower cost manufacturing operations.

Despite the disappointing financial results, there were many positive things in the second quarter that should bode well for the remainder of the year. We have been improving service levels at the private label and activewear marketplace, and this has resulted in our winning additional decorated tee programs.

So far this year, we have shipped nearly $5 million in decorated catalog tees to customers previously purchasing undecorated tees. We intend to build on that success in the upcoming quarters.

We've also seen interests from several potential new private-label customers who have recognized the world-class service levels we can provide to support their growth. Our recently expanded manufacturing and screen printing capabilities give us the capacity to continue growing in these decorated and undecorated programs in our basic segment.

We recently opened a third-party-operated distribution facility in Dallas, Texas to better service a large market for undecorated tees, with shorter shipping times and reduced freight cost. We' have also added new upscale fleece products to our line that we expect will attract new customers and help reduce some of the seasonality in this segment of our business.

On the branded side, Art Gun continues its strong growth with a sales increase of 34% in the March quarter. Art Gun is being recognized by e-commerce retailers who want the flexibility and no-risk inventory model that Art Gun service platform provides.

During its peak periods, Art Gun is experiencing demand that is actually outpacing its capacity. So we are currently evaluating expansion opportunities to ensure that we can service our current and future customers to continue Art Gun's consistently rapid growth.

Soffe, while still on a negative sales comp for the quarter, is showing considerable improvement. It appears our new Soffe line that we launched for spring is being well received by the junior consumer, as evidenced by strong sell-through numbers in retail despite the weather conditions.

Slowness in the sporting good channel grow the decrease in sales in Soffe. But this is a channel that has generally been growing for us, and we believe we'll see this turn in future quarters.

We expect revenue growth at Soffe in the back half of the year, along with a return to profitability.

I'm pleased to say that during the March quarter, our landlord was able to work through several construction and permitting issues that caused delays in the scheduled opening of Junkfood's long-awaited flagship retail store on Abbot Kinney Boulevard in Venice, California. I'm also happy to tell you that other than the delay in retail revenue stream, we incurred no out-of-pocket expense due to these delays, as they were not of our making or within our control.

With these major issues behind us, we anticipate opening the first Junkfood store in May of this year.

Salt Life continues to exceed our expectations with its strong top line growth and its profitability. Salt Life sales increased 28% during the March quarter and sales were up 29% for the first half of this year.

Since the onset of our involvement with Salt Life, we have expanded its geographic base from being primarily in Florida to now being in about 2,300 retail doors, stretching primarily from Texas, up the East Coast, as well as in the Caribbean. We continue to expand the product offerings and lifestyle and performance products to reach across consumer bases in fish, dive, board and beach.

This not only broadens the retail doors for Salt Life products, but should help expand the average sales per door. We saw this in the March quarter when we were able to increase the Salt Life presence in retail doors and increase the average shipping into existing doors by about 20%.

Based on what we are experiencing, we expect that Salt Life products should exceed $30 million in sales in calendar year 2014.

To bolster brand awareness for Salt Life, we have just initiated our first consumer advertising runs in several key publications, including Surfer Magazine, which featured paddleboard professional, Colin McPhillips. We are also sponsoring several paddleboard competitions, principally on the West Coast, to continue our grassroots marketing in that region.

In the course, you can't miss the Salt Life decals that you see on cars all around the country. What better marketing than that?

In addition to the brand awareness campaigns we have initiated, we are extremely excited about our Salt Life restaurant licensee's grand opening of the new Salt Life Food Shack restaurant in St. Augustine Beach this week.

This location is perfect for experiencing the Salt Life across the street from the St. Augustine Beach Pier, with a rooftop deck to watch the sunset on one side and the Atlantic Ocean on the other.

You may have seen this restaurant featured on the hit television show TANKED on Animal Planet a couple of weeks ago. They installed a 1,300-gallon wave-inspired saltwater fish tank that can be enjoyed from both the inside the restaurant, as well as on the bottom outside deck.

With 3 restaurants now open, we expect over 0.5 million consumers annually to experience Salt Life through the Food Shack concept, driving significant consumer awareness of our brand.

There are many opportunities for expansion with Salt Life, and we believe it has the opportunity to continue its current growth path for years to come. We are currently generating very strong operating profits on Salt Life and anticipate these to continue for the foreseeable future.

In summary, while we're not at all pleased with our second quarter financial performance, I believe Delta Apparel's in an excellent position for growth, as the economic conditions improve and consumer buying is renewed. In the meantime, we're keeping our costs in line and introducing new products that consumer wants with the efficiency, service and price points that our customers need.

Now Deb and I will be glad to answer any questions you have. Amber, you can open up the phone lines for questions.

Looking at SG&A, you've done some work, 100-basis point decline year-over-year. How much more is left in your mind to cut out in the SG&A side?

We certainly still have some things that we're looking at doing, so there are some further opportunities. And as we work through those and in balancing what we want to get done at what time, but there still is probably some continued focus areas that we are working on.

And then turning to Salt Life, up 28% year-over-year, Bob just mentioned that you're expecting $30 million on calendar '14 sales. As far as marketing is concerned, I know a lot of it's in viral, the bumper stickers, et cetera, any incentive down the road for a larger marketing push?

And if so, do you have a CAGR in line for growth of this business for the next 2 to 3 years?

We have just started that expanded marketing. Some of the magazine ads that we've talked about and other campaigns that we're doing are an expansion of our current marketing, and that will continue.

So we're just -- the consumers are just now starting to see that expanded marketing plan. And that's what we believe will allow us to continue to grow in the future years at this same growth path.

We're expecting -- this 12-month period, we'll be up about 50% over the prior year. Prior to that, we were up 70%.

And so we think that, that sort of growth path in the next couple of years to where we're tracking right now can be expected.

And you mentioned Soffe was well received in some of the mid-tiers you've been in to date. How would you try to balance out their growth versus -- be it on the product side, compared to health in the mid-tier channel, in general?

I guess, how do you look at those 2 separately, if that makes any sense?

I'm not really sure I understand what your question is...

I guess, looking at your product versus looking at performance in the mid-tier. Do you think that -- is the mid-tier channel, is the health of that still going to dictate Soffe at the end of the day?

Well, I don't think so. I mean, we lost -- a lot of the revenue at Soffe was in the mid-tier channel.

And we are gaining some of that back. And no doubt, it has been fairly challenged.

I think from a positive standpoint for us, in going back around and rebuilding some of the business we had there, that channel is very supportive of the Soffe brand, and I think it fits well into their strategy. So the good news at Soffe is we have a lot of channels of distribution, so there's a lot of different ways that product gets to the end consumer.

So we would see that mid-tier channel as a growth opportunity for the next couple of years as we rebuild some of what we'd lost there.

So just in terms of Art Gun, why was that so strong during the quarter? You said it was related to e-commerce.

And do you think that growth can continue in the back half of the year?

The Art Gun business that is an e-commerce business channel. So that's where it's focused.

And it has been growing at that growth pace or higher year-over-year for the last 2 years. So that's just a growth of new customers and growth within the existing online retail partners that they have.

Okay. And I guess, just is in terms of right now, what you're seeing in the promotional activity, do you think this will continue for the next couple of months?

Well, I think that's the big question that a lot of people have that participate in this space. Typically, in April, the sale of undecorated tees gets robust, and it's certainly picking up seasonally.

But not as robust as we would have expected 3 or 4 months ago. So I think it's still a question mark.

Clearly, as weather gets better around the country and outdoor activities increase and fun runs and all the things that drive T-shirt sales, we'll see where that goes. But it is somewhat weaker than we would expect.

I would point out, in that marketplace in the last couple of years, we've had significant unit volume growth, and we're actually up 7% in unit volume during the March quarter. We expect it to be up higher than that, quite frankly.

So we are gaining market share in that. We have new manufacturing capacity in place to service that business.

And while we haven't gained that share as quick as we would have liked, it will come, and we'll run that manufacturing.

Right, okay. But with the guidance you're giving out, I guess, you guys are still anticipating a pretty strong second half?

Correct.

But down from our previous expectations. We certainly based it [ph] on the situations as we see it right now.

So a couple of questions, actually. Maybe, Bob, just kind of big picture question, when you think about what's happening on the conversion or getting customers to move from undecorated to decorated, what's -- I don't know if you can give us like a percent of that business.

Do you think could actually migrate over to decorated tees? Is there a number that you've got in the back of your mind that you think could be up for grabs, so to speak?

Well, again, if you want to look globally and kind of on a revenue base, not on a unit base, we're probably shipping about 1/3 of our business now in decorated form versus undecorated form. And I think that could grow to probably 50% or so.

If you look at the big-run retail license programs, there's obvious continued margin pressure. And where -- if people have those programs, they can more effectively be printed.

And the retail put up work provided offshore versus domestically. So we see that continuing to grow.

Obviously, the smaller runs for kind of local business will continue to be printed locally by local screen printers.

Okay. And in terms of Soffe, as -- you said that you're getting some pretty good indications on sell-through.

What's happening -- even if you haven't had formal kind of orders put in, reorders or chase, what's kind of the feedback you're getting in terms of, perhaps, increasing orders, maybe not just for fall but also for next spring, if we're looking at the sell-throughs, especially at the mid-tier?

Yes. Well, the discussions have been very positive now.

They'll look at our new spring merchandise that we will be showing them very soon. And they're also looking to see what part of our new success that we will put in as basic items and also replenishment.

And so I think those 2 things are still to be worked through, but an encouraging environment so far.

Are you getting expansion into -- because I think you were, perhaps, only in -- not all the -- quite all the junior categories that you had been in before. [indiscernible]

Yes. It really -- it varies a good bit by retailer.

We're probably in more girls areas and different people have different strategies with that versus juniors. But clearly, we're in a lot more doors now with that product than we were in the middle of the summer and fall last year.

Okay. And perhaps, give us an update on when the classing [ph] of the college bookstore business.

How is that -- you indicated that you feel like that business is starting to, I'd say, get ready for the fall season. But has the migration or classing [ph] between the 2 business kind of fully behind us and you really should start to be able to leverage this one sales channel for this year and into 2015?

Yes. So we put that together really about this time last year, worked through the season last year with some old product and old blanks and sold through a lot of that.

Some of them were still in our line. And so now we're in the selling season for this fall.

And I think our backlog position right now is about $2 million ahead of where it was last year in that customer segment. So quite frankly, we are encouraged with the feedback that is really the college bookstore buyers are showing towards these programs and the support they've been giving us.

Okay. And then just one last question.

You mentioned other cost pressures, perhaps just what's happening right now with cotton? And then relatedly, what other cost pressures are you seeing?

Well, cotton has been averaging up, not down for a couple of months now. When I last looked today, it was up for nearby deliveries and was in the high $0.92 range.

There's some additional costs on top of that, that actually get it. So you're getting close to $1 cotton.

We've done more hedging going into this year than we have traditionally done. So we think we're in a reasonable position with nearby cotton.

But other costs are going well -- going up to your point. So in general, dyes and chemicals are increasing, some energy costs are increasing.

So there's certainly some cost pressures, and we need some pricing help in this basic undecorated tee market to get that passed along to our customer.

On the Salt Life brand, you're talking about $30 million of revenues and a very significant growth rate. What's the business model that you look at as to -- what are you going -- what percentage of high gross margin product, what are you going to spend on promotional campaigns to get this thing to stay at and maintain that growth rate?

Yes. Well, just about all of our products are high gross margin.

So obviously, our source performance, products and more fashion products are high gross margin because of their very nature. But in addition to that, because we're vertical on it, our basic tees which -- are still growing for us.

The performance stuff is a lot of new business for us. But anyway, we can make that in our own facilities.

We can actually do the screen printing offshore, for some part of it, we'll be doing more and more offshore. So all of it should have significant gross margins that would be typical of growing lifestyle brands.

So typically, you're going to see those in the mid-40% range. As far as spend on marketing and promotional activities, really very little had been spent prior to our acquisition of that brand.

And we expect that to be in the mid-single digits of revenue, which will be new spend, and we think can really help drive brand awareness across the country, resulting in additional business for us.

Mid-single digit of revenue, what did that -- I didn't quite follow...

So 5% to 7% of sales.

Okay, okay, perfect. And on the basic goods, pricing has -- is staying depressed even as we head into the spring season?

We actually implemented a price increase recently. And of course, the key in this business is often not necessarily list price but what's discounted for volume purchases and what have you.

So we'll have to see how that evolves over the next month or 2.

Okay. How would you contrast your business there to an Alstyle or something in that part of the business?

Well, we've over the last -- let me just kind of look bigger picture and say a couple of years, we've grown considerable market share there, and Alstyle has lost market share for whatever reasons and strategies that they've invoked. So we think we'll continue to gain market share in there, and we need to do that to fill up our manufacturing a little bit better.

And if you look at new crop cotton, so that would be cotton -- started to be delivered in December is about $0.10 to $0.12 a pound less than what's being delivered in the next 3 or 4 months. And so with a little pricing help and get to new cotton, I think it can be a good market for us to be in.

Well, thanks for joining with us today, and we look forward to updating you in a few months about our third fiscal quarter. Thank you.