Cautionary Note Regarding Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements made by or on behalf of the Company. We may from time
to time make written or oral statements that are "forward-looking," including
statements contained in this report and other filings with the SEC, in our press
releases, and in other reports to our shareholders. All statements, other than
statements of historical fact, which address activities, events or developments
that we expect or anticipate will or may occur in the future are forward-looking
statements. The words "plan", "estimate", "project", "forecast", "anticipate",
"expect", "intend", "seek", "believe", "may", "should" and similar expressions,
and discussions of strategy or intentions, are intended to identify
forward-looking statements.
Forward-looking statements are neither historical facts nor assurances of future
performance. Instead, they are based on our current expectations and are
necessarily dependent upon assumptions, estimates and data that we believe are
reasonable and accurate but may be incorrect, incomplete or imprecise.
Forward-looking statements are subject to a number of business risks and
inherent uncertainties, any of which could cause actual results to differ
materially from those set forth in or implied by the forward-looking statements.
Therefore, you should not rely on any of these forward-looking statements.
Important factors that could cause our actual results and financial condition to
differ materially from those indicated in forward-looking statements include,
among others, the following:
• the volatility and uncertainty of cotton and other raw material prices and
availability;
• the general U.S. and international economic conditions;
• the COVID-19 pandemic impact on our operations, financial condition,
liquidity, and capital investments:
• the competitive conditions in the apparel industry;
• restrictions on our ability to borrow capital or service our indebtedness;
• deterioration in the financial condition of our customers and suppliers and
changes in the operations and strategies of our customers and suppliers;
• our ability to predict or react to changing consumer preferences or trends;
• our ability to successfully open and operate new retail stores in a timely and
cost-effective manner;
• changes in economic, political or social stability at our offshore locations;
• significant interruptions or disruptions within our manufacturing,
distribution or other operations;
• our ability to attract and retain key management;
• significant changes in our effective tax rate;
• interest rate fluctuations increasing our obligations under our variable rate
indebtedness;
• the ability to raise additional capital;
• the ability to grow, achieve synergies and realize the expected profitability
of acquisitions;
• the volatility and uncertainty of energy, fuel and related costs;
• material disruptions in our information systems related to our business
operations;
• compromises of our data security;
• significant litigation in either domestic or international jurisdictions;
• recalls, claims and negative publicity associated with product liability
issues;
• the ability to protect our trademarks and other intellectual property;
• the impairment of acquired intangible assets;
• changes in international trade regulations;
• our ability to comply with trade regulations;
• changes in employment laws or regulations or our relationship with employees;
• foreign currency exchange rate fluctuations;
• negative publicity resulting from violations of manufacturing standards or
labor laws or unethical business practices by our suppliers and independent
contractors;
• the illiquidity of our shares; and
• price volatility in our shares and the general volatility of the stock market.
A detailed discussion of significant risk factors that have the potential to
cause actual results to differ materially from our expectations is set forth in
Item 1A of this report entitled "Risk Factors" in this Form 10-Q and in Part 1
under the subheading "Risk Factors" in our Annual Report on Form 10-K for our
fiscal year ended September 28, 2019, filed with the SEC. Any forward-looking
statements in this Quarterly Report on Form 10-Q do not purport to be
predictions of future events or circumstances and may not be realized. Further,
any forward-looking statements are made only as of the date of this Quarterly
Report on Form 10-Q, and we do not undertake to publicly update or revise the
forward-looking statements, except as required by the federal securities laws.
Business Outlook
Our fiscal 2020 second quarter was trending towards a projected 9% increase in
sales for our fiscal 2020 March quarter until the COVID-19 pandemic halted
retail in the U.S. in mid-March. With this March impact, our sales declined 6%
for the 2020 quarter compared to prior year. Despite these headwinds, we are
pleased to have delivered strong gross margin performance that more than offset
our lower sales performance during the quarter.
Second quarter fiscal 2020 reported gross margins improved 290 basis points from
the prior year to 21.3% as we leveraged our vertical manufacturing platform and
benefited from internal process efficiencies implemented over the last several
quarters. The March 2020 gross margins were hurt by approximately $1.9 million,
or 200 basis points, of plant curtailment expenses caused by government-mandated
country closures in El Salvador and Honduras in March 2020. Adjusting for these
plant curtailment expenses, gross margins would have been 23.3% during the March
2020 quarter, an improvement of 490 basis points from the prior year and 260
basis points from the fiscal 2020 December quarter.
The strength of our business model remains anchored in our diversification of
our sales channels and our unique business capabilities, as well as our
geographic diversification across the U.S., Central America, and Mexico. We are
leveraging our clear competitive advantages in this disruptive period to gain
greater business traction with existing customers and attract new customers to
Delta Apparel. Unlike many apparel companies, we are not disproportionately
exposed to any specific customer or sales channel, such as brick and mortar,
department stores, mass merchants or wholesale distributors. Over 17% of our
sales are generated through various ecommerce channels, including our branded
consumer websites and our DTG2Go business. Sales on our Salt Life website
increased nearly 20% in the March 2020 quarter compared to prior year. In
April, we have experienced further acceleration of Salt Life ecommerce sales
with sales more than doubling over the same period in the prior year. Sales on
our Soffe consumer website in April have also more than doubled over prior year,
and we are experiencing strong sales of Soffe product on ecommerce sites of our
retail partners.
We have a unique business model with proprietary technology in DTG2Go whose
advantages are more transparent to the marketplace in this time of supply chain
disruption combined with consumer restrictions on traditional shopping habits.
The DTG2Go business experienced headwinds in early March related to the COVID-19
pandemic, but orders increased the last week of March and have accelerated
further in April, with increased demand from existing customers and the rapid
onboarding of several new customers. In April 2020, the average daily orders
received is more than double that of March 2020 and approximates the average
daily orders received during the December 2019 holiday period. Greater than 90%
of DTG2Go sales come through ecommerce sales channels, which have shown positive
sales trends during the COVID-19 pandemic. With the recent supply chain
disruptions in the marketplace, customers appear to be appreciating DTG2Go's
strong competitive advantages with our large geographic network of production
facilities, half of which are integrated with our Delta distribution facilities.
Although the order backlog at DTG2Go is currently significant, we remain
temporarily limited in our production output as adjustments were made to work
schedules and in our facilities to comply with social distancing guidelines and
curfews implemented by certain local governments. We expect the current
positive trends at DTG2Go will continue into the future, as we believe that as
the retail market evaluates their go-forward strategy, there will be an
increased adoption rate for the on-demand supply chain model.
We are also seeing strength within our military business, which historically has
represented about 5% of our overall revenue. We service all branches of the
military, and are seeing solid orders during this pandemic, with opportunities
for growth.
Overall we estimate that approximately 25% of our revenue has not been hurt by
the COVID-19 pandemic, and in many situations has experienced an acceleration of
growth. The remaining business, however, has been significantly impacted in the
near-term, and it is unclear at this point how quickly and to what extent it
will recover.
We are committed to servicing our customers with same-day shipping, picking to
the piece level, retail ready packaging and EDI support, and operate the
majority of our business based on at-once orders. We maintain an inventory
position, located in our US-based distribution centers, to service the
business. Since mid-March, our manufacturing operations in El Salvador and
Honduras have been curtailed due to government-mandated country-wide shutdowns.
We have, however, been able to continue operations in our U.S. manufacturing
facilities, which principally service the military business, and in our
Mexico-based facilities, which are producing private-label and catalog
products. We are also producing face masks and face coverings in our facilities
in North Carolina and Mexico, and recently received approval for a small group
of employees in Honduras and El Salvador to also produce face masks. This
allows us to keep more workers actively employed and provides an additional
revenue stream for Delta Apparel. We expect to restart production at our
manufacturing facilities in El Salvador and Honduras when conditions in these
countries allow and demand rebuilds to a level that requires additional
production. We will also evaluate the level of social distancing and other
protocols required, which could limit the number of employees allowed in our
facilities when production resumes.
While we are unable to quantify the impact on our forward results, we have taken
swift and decisive action to navigate through these difficult times to
strengthen our financial position, as we prudently preserve cash to improve our
liquidity. We immediately paused capital projects that were not critical in the
short term to the business, suspended our share repurchase program, and took
actions to reduce our fixed costs. We have temporarily furloughed or
permanently terminated approximately 300 employees in the U.S., and have also
reduced spending across all aspects of the business. As it relates to the CARES
Act, we are taking advantage of payroll tax deferrals and credits that are
afforded to companies our size with the newly enacted legislation. On April 27,
2020, we secured a bridge amendment to our U.S. revolving credit facility, which
provides additional flexibility and increased access to the availability
provided under the agreement. We are also looking at other available debt
financing options that may be prudent.
During these unprecedented times, we are benefiting from our fully-integrated
and diversified business model. We believe we are in a solid financial position
and are confident we will emerge from this pandemic stronger, ready to
profitably grow our business and continue to provide value for all of our
stakeholders.
Results of Operations
Our financial results have been presented on a generally accepted accounting
principles ("GAAP") basis and, in certain limited instances, we have presented
our financial results on a GAAP and non-GAAP ("adjusted") basis, which is
further described in the sections entitled "Non-GAAP Financial Measures."
Net sales for the March quarter were $96.7 million compared to sales of $102.8
million in the prior year March quarter. Prior to the COVID-19 pandemic in the
United States, our second quarter sales were growing but the mid-March shutdowns
in retail channels dramatically halted revenue during the final month of the
quarter. For the first six months of 2020, net sales were $192.6 million
compared to $204.5 million. The first quarter sales were hurt by the shortened
holiday calendar and mid-week Christmas Day, combined with earlier shipping
cut-off for in-hands holiday receipts.
Our retail stores and ecommerce sales, including our direct-to-consumer and
business-to-business ecommerce sites, increased 16% over the prior year
three-month period. The growth was driven by increased sales on our Activewear
and Salt Life ecommerce sites as well as growth at our Salt Life retail stores.
Retail and ecommerce sales represented 9% of total revenues for the three-month
and six-month periods ended March 28, 2020, compared to 7% and 8% for the
three-month and six-month periods ended March 30, 2019, respectively.
Net sales in the Delta Group segment were $84.2 million compared to $89.5
million in the prior year. The strong sales growth in our FunTees business,
including shipments to several new direct-to-retail programs in the current
year, was offset by declines in our Catalog business, which was impacted by the
COVID-19 pandemic. Our DTG2Go business was also impacted by the pandemic in
early March with orders rebounding the last week of March.
The Salt Life Group segment second quarter revenue was $12.5 million compared to
$13.3 million in the prior year period. The segment was impacted by the
temporary closure of retail, including our Salt Life branded retail stores, in
March based on government guidelines for COVID-19. However, our
direct-to-consumer web sales increased by nearly 20% from the prior year.
Gross margins in the second quarter expanded 290 basis points from the prior
quarter to 21.3% despite being reduced by $1.9 million, or 200 basis points,
from plant curtailments caused by government-mandated country closures in El
Salvador and Honduras in March. For the first six months of fiscal year 2020,
gross margins improved by 270 basis points from the prior year to 21.0% from
manufacturing efficiencies as well as lower raw material costs.
The Delta Group segment gross margins grew to 17.8% from 14.0% in the prior year
from the continued process efficiencies and further leveraging of the segment's
integrated vertical manufacturing platform. The segment incurred $1.9 million in
expenses associated with plant curtailments. Adjusting for the $1.9 million, or
230 basis points, in plant curtailment expenses, gross margins would have been
20.1% during the March 2020 quarter, an improvement of 610 basis points from the
prior year and 150 basis points from the fiscal 2020 December quarter. Gross
margins expanded 320 basis points from prior year to 18.2% for the first six
months of fiscal year 2020.
The Salt Life Group segment gross margins were 44.8% in the second quarter
compared to 48.0% in the prior year quarter as recently-enacted tariffs
increased product costs. Gross margins for the first six months of fiscal year
2020 were 46.2% when compared to the prior year 48.4%.
Selling, general, and administrative expenses ("SG&A") were $17.9 million, or
18.5%, of sales compared to $17.1 million, or 16.6% of sales, in the prior year.
The increase resulted from investments in our distribution expansion and fixed
costs not fully leveraged against revenues. SG&A for the first six months of
fiscal year 2020 were $36.1 million, or 18.7% of sales, compared to $33.8
million, or 16.5% of sales, in the prior year.
Other income in both years primarily includes profits related to our Honduran
equity method investment and valuation changes in our contingent consideration
liabilities.
Operating income in the second quarter was $3.6 million compared to $2.7 million
in the prior year. For the first six months, operating income was $6.2 million
compared to $2.7 million in the prior year.
The Delta Group segment operating income increased in the current fiscal year
quarter by $1.7 million to $5.1 million, or 6.0% of net sales, compared to $3.4
million, or 3.8% of net sales in the prior year. The increase is attributable to
the strong gross margin expansion, partially offset by lower sales and higher
distribution expenses. For the first six months of fiscal year 2020, Delta
Group segment income was $12.3 million compared to $6.1 million in the prior
year.
The Salt Life Group segment operating income was $1.5 million, or 12.5% of sales
compared to prior year $2.7 million, or 21.4% of sales. For the first six months
of fiscal year 2020, Salt Life Group segment income was $0.8 million compared to
$3.0 million in the prior year. Operating income declined from lower sales
coupled with higher product costs from the newly-enacted tariffs on imported
goods. In addition, the prior year benefited from higher favorable adjustments
to the fair value of contingent earn-out liability.
Net interest expense for the second quarter was $1.8 million compared to $2.0
million in the prior year. For the first six months of fiscal year 2020,
interest expense was $3.6 million compared to $3.8 million in the prior
year. The lower interest expense is due to favorable interest rates in the
current fiscal year.
Our effective tax rate for the six-month period ended March 28, 2020, was 20.3%.
This compares to an effective tax rate of 74.6% for the same period in the prior
year, and 5.5% for the fiscal year ended September 28, 2019. See Note L-Income
Taxes for more information.
We achieved net earnings for the second fiscal quarter of $1.3 million, or $0.19
per diluted share, an increase of 46% compared to the prior year $0.9 million,
or $0.13 per diluted share. When adjusted for the $1.9 million pre-tax, or $0.20
per diluted share, of plant curtailment expenses, our net earnings would have
been $0.39 per diluted share in the 2020 fiscal second quarter. Net income for
the first six months was $2.2 million, or $0.32 per diluted share, compared to
the prior year $0.2 million net loss, or $0.03, per diluted share.
Accounts receivable were $58.7 million at March 28, 2020, compared to $59.3
million as of September 28, 2019. Days sales outstanding ("DSO") as of March 28,
2020, were 55 days compared to 48 days at September 28, 2019. We experienced
slower collections on accounts receivable in March 2020 from customers extending
terms due to the COVID-19 pandemic.
Net inventory was $197.3 million as of March 28, 2020, an increase of $18.2
million from September 28, 2019. The increase is from our seasonal build of
inventory as well as the stronger mix of fashion basics, fleece and performance
products in inventory to support the then-anticipated growth in these
categories. Inventory levels at March 28, 2020 were higher than planned from the
lower March 2020 sales, and we anticipate will remain higher due to lower
anticipated sales in the second half of fiscal 2020, partially offset by the
temporary closures of certain manufacturing operations and initiatives to manage
inventory levels through the COVID-19 pandemic.
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Capital spending was $4.1 million and $6.7 million for the three-months and six
month periods ending March 28, 2020, respectively. The spending primarily
related to investments in our distribution expansion as well as investments in
our retail stores. Depreciation and amortization expense, including non-cash
compensation, was $7.6 million for the first six months of fiscal year 2020.
Total debt, including capital lease financing, as of the end of the fiscal 2020
second quarter was $167.9 million compared to $135.1 million at fiscal 2019
year-end due to seasonal higher working capital, share repurchases, and
investments in distribution facilities.
Non-GAAP Financial Measures
We provide all information required in accordance with U.S. GAAP, but we believe
that evaluating our ongoing operating results may be difficult if limited to
reviewing only U.S. GAAP financial measures. In an effort to provide investors
with additional information regarding the Company's results, we also provide
non-GAAP information that management believes is useful to investors. We discuss
gross margins and net earnings per share, adjusted for discrete items, as
performance measures because management uses these measures in evaluating the
Company's underlying performance on a consistent basis across periods. We also
believe these measures are frequently used by securities analysts, investors and
other interested parties in the evaluation of the Company's ongoing performance.
These non-GAAP measures have limitations as analytical tools, and securities
analysts, investors and other interested parties should not consider any of
these non-GAAP measures in isolation or as a substitute for analysis of our
results as reported under U.S. GAAP. These non-GAAP measures may not be
comparable to similarly titled measures used by other companies.
Liquidity and Capital Resources
Operating Cash Flows
Operating activities used $10.2 million and $8.3 million in cash in the first
six months of fiscal year 2020 and 2019, respectively. The additional use of
cash in the current year is primarily due to additional inventory levels driven
by broader product offerings within Activewear, partially offset by improved
operating income and higher collections from customers.
Investing Cash Flows
Cash outflows for capital expenditures were $3.9 million during the first six
months of fiscal year 2020 compared to $2.1 million in the same period last
year. Capital expenditures in both periods primarily related to investments in
our distribution expansion and investments in our retail stores, in addition to
machinery and equipment. There was an additional $3.1 million in expenditures
financed under capital lease arrangements and $1.5 million in unpaid
expenditures as of March 28, 2020.
On October 8, 2018, our DTG2Go, LLC subsidiary purchased substantially all of
the assets of Silk Screen Ink, Ltd. d/b/a SSI Digital Print Services ("SSI"), a
premium provider of direct-to-garment digital printed products. The SSI
acquisition purchase price consisted of $2.0 million in cash, a promissory note
for $7.0 million and $3.0 million in capital lease funding secured by the
acquired fixed assets. The cash portion of the purchase price included: (i) a
payment at closing of $2.0 million, and (ii) a post-closing net working capital
adjustment of $0.7 million. In the first six months of fiscal year 2020, we
repaid approximately $1.7 million under the promissory note and capital lease
funding.
We now anticipate our fiscal year 2020 capital expenditures, including those
financed under capital leases, to be approximately $13 million to $15 million,
compared to our previous estimates of $25 million to $28 million for the year.
In March 2020, we took action to significantly reduce or delay capital projects
that were not critical to the business in the near-term, which resulted in a
nearly 65% reduction in capital spending for the second half of fiscal year
2020. We have also temporarily delayed the expansion of our Clinton, Tennessee
distribution center. The remaining capital expenditures for fiscal year 2020
will be focused on completing capital projects that were in process during March
2020, such as distribution and direct-to-consumer initiatives.
Financing Activities
During the six months ended March 28, 2020, cash provided by financing
activities was $24.7 million compared to $15.4 million provided by financing
activities for the six months ended March 29, 2019. The cash provided by our
financing activities during the first six months of fiscal years 2020 and 2019
was used to fund our operating activities and capital expenditures as well as
the SSI acquisition in fiscal year 2019.
Future Liquidity and Capital Resources
See Note F - Debt to the Condensed Consolidated Financial Statements for
discussion of our various financing arrangements, including the terms of our
revolving U.S. credit facility. See Note Q-Subsequent Events to the Condensed
Consolidated Financial Statements for a discussion of the Fifth Amendment to the
Fifth Amended and Restated Credit Agreement entered into on April 27, 2020 (the
"Fifth Amendment").
Our credit facility, as amended on April 27, 2020, as well as cash flows from
operations, are intended to fund our day-to-day working capital needs, and
along with capital lease financing arrangements, to fund our planned capital
expenditures. However, any material deterioration in our results of operations,
such as could occur with the COVID-19 pandemic, may result in the loss of our
ability to borrow under our U.S. revolving credit facility and to issue letters
of credit to suppliers, or may cause the borrowing availability under that
facility to be insufficient for our needs. Availability under our credit
facility is primarily a function of the levels of our accounts receivable and
inventory. A significant deterioration in our accounts receivable or inventory
levels could restrict our ability to borrow additional funds or service our
indebtedness.
Prior to the Fifth Amendment executed on April 27, 2020, our credit facility
included a financial covenant that if the availability under our credit facility
falls below the amounts specified in our U.S. credit agreement, our fixed charge
coverage ratio (FCCR) for the preceding 12-month period must not be less than
1.1 to 1.0. We were not subject to the FCCR covenant at March 28, 2020, because
our availability was above the minimum required under the Amended Credit
Agreement, but we would have satisfied our financial covenant had we been
subject to it. The Fifth Amendment amends the financial covenant provisions from
the amendment date through October 3, 2020, including effectively lowering the
minimum availability thresholds and removing the requirement that our FCCR for
the preceding 12-month period must not be less than 1.1 to 1.0. Following the
expiration of these Fifth Amendment terms on October 3, 2020, a significant
deterioration in our business could cause our availability to fall below minimum
thresholds, thereby requiring us to maintain the minimum FCCR specified in our
credit agreement.
Purchases By Delta Apparel Of Its Own Shares
During the six months ended March 28, 2020, we purchased 99,971 shares of our
common stock for an aggregate $2.0 million the quarter ended March 28, 2020 (see
Note O-Repurchase of Common Stock). As of March 28, 2020, there was $7.5 million
of repurchase authorization remaining under our Stock Repurchase Program. During
March 2020, we temporarily suspended share repurchases in an effort to preserve
liquidity during the COVID-19 pandemic.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations
are based upon our Condensed Consolidated Financial Statements, which were
prepared in accordance with U.S. GAAP. The preparation of our Condensed
Consolidated Financial Statements requires us to make estimates and judgments
that affect the reported amounts of assets and liabilities and disclosure of
contingent liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting periods. We base our
estimates and judgments on historical experience and various other factors that
we believe to be reasonable under the circumstances, the results of which form
the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions. The most
significant estimates and assumptions relate to revenue recognition, accounts
receivable and related reserves, inventory and related reserves, the carrying
value of goodwill, and the accounting for income taxes.
A detailed discussion of critical accounting policies is contained in the
Significant Accounting Policies included in Note 2 to the Audited Consolidated
Financial Statements included in our Annual Report on Form 10-K for the fiscal
year ended September 28, 2019, and there have been no changes in those policies,
except as disclosed in Note C-New Accounting Standards related to the adoption
of the new revenue recognition standard, since the filing of that Annual Report
on Form 10-K with the SEC.
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Environmental and Regulatory Matters
We are subject to various federal, state and local environmental laws and
regulations concerning, among other things, wastewater discharges, storm water
flows, air emissions and solid waste disposal. Some of our facilities generate
small quantities of hazardous waste that are either recycled or disposed of
off-site.
The environmental regulations applicable to our business are becoming
increasingly stringent and we incur capital and other expenditures annually to
achieve compliance with environmental standards. We currently do not expect that
the amount of expenditures required to comply with environmental laws and
regulations will have a material adverse effect on our operations, financial
condition or liquidity. There can be no assurance, however, that future changes
in federal, state, or local regulations, interpretations of existing regulations
or the discovery of currently unknown problems or conditions will not require
substantial additional expenditures. Similarly, while we believe that we are
currently in material compliance with all applicable environmental requirements,
the extent of our liability, if any, for past failures to comply with laws,
regulations and permits applicable to our operations cannot be determined and
could have a material adverse effect on our operations, financial condition and
liquidity.
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