DELTA APPAREL, INC - Quarter Report: 2019 December (Form 10-Q)

 

Table of Contents

 

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10-Q

 

☑	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended December 28, 2019

OR

 

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     

 

Commission File Number 1-15583

 

DELTA APPAREL, INC.

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(Exact name of registrant as specified in its charter)

 

GEORGIA		58-2508794
(State or Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification No.)
322 South Main Street
Greenville, SC		29601
(Address of principal executive offices)		(Zip Code)

 

(864) 232-5200

 

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(Registrant’s telephone number, including area code)

 

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(Former name, former address and former fiscal year, if changed since last report.)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes ☑ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of  “large accelerated filer,” “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer ☐

Accelerated filer ☑

Non-accelerated filer ☐

Smaller reporting company ☑

Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class		Trading Symbol		Name of each exchange on which registered
Common Stock, par value $0.01		DLA		NYSE American

 

As of January 22, 2020, there were outstanding 6,988,823 shares of the registrant’s common stock, par value of $0.01 per share, which is the only class of outstanding common or voting stock of the registrant.

 

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		December 28,				September 28,
		2019				2019
Assets
Cash and cash equivalents		$	433			$	605
Accounts receivable, less allowances of $596 and $327, respectively			54,819				59,337
Other receivables			658				1,550
Inventories, net			197,315				179,107
Prepaid expenses and other current assets			3,698				2,999
Total current assets			256,923				243,598
Property, plant and equipment, net of accumulated depreciation of $84,285 and $81,807, respectively			61,255				61,404
Goodwill			37,897				37,897
Intangible assets, net			21,155				21,607
Deferred income taxes			1,514				1,514
Operating lease assets			41,996				—
Equity method investment			10,689				10,388
Other assets			2,584				1,580
Total assets		$	434,013			$	377,988
Liabilities and Equity
Current liabilities:
Accounts payable		$	57,291			$	52,320
Accrued expenses			16,798				20,791
Current portion of contingent consideration			2,700				2,790
Current portion of finance leases			6,822				6,434
Current portion of operating leases			8,497				—
Current portion of long-term debt			7,337				6,540
Total current liabilities			99,445				88,875
Long-term income taxes payable			3,875				3,977
Long-term contingent consideration			5,970				6,304
Long-term finance leases, less current maturities			12,734				12,836
Long-term operating leases, less current maturities			34,430				—
Long-term debt, less current maturities			120,468				109,296
Deferred income taxes			1,561				1,519
Other non-current liabilities			1,119				1,293
Total liabilities		$	279,602			$	224,100
Shareholders’ equity:
Preferred stock—$0.01 par value, 2,000,000 shares authorized, none issued and outstanding			—				—
Common stock —$0.01 par value, 15,000,000 shares authorized, 9,646,972 shares issued, and 6,988,823 and 6,921,417 shares outstanding as of December 28, 2019, and September 28, 2019, respectively			96				96
Additional paid-in capital			58,825				59,855
Retained earnings			137,860				136,937
Accumulated other comprehensive loss			(838	)			(969	)
Treasury stock —2,658,149 and 2,725,555 shares as of December 28, 2019, and September 28, 2019, respectively			(41,119	)			(41,750	)
Equity attributable to Delta Apparel, Inc.			154,824				154,169
Equity attributable to non-controlling interest			(413	)			(281	)
Total equity			154,411				153,888
Total liabilities and equity		$	434,013			$	377,988

 

		Three Months Ended
		December 28,				December 29,
		2019				2018
Net sales		$	95,889			$	101,675
Cost of goods sold			75,996				83,105
Gross profit			19,893				18,570
Selling, general and administrative expenses			18,073				16,784
Other (income) expense, net			(817	)			1,745
Operating income			2,637				41
Interest expense, net			1,802				1,765
Earnings (loss) before provision for (benefit from) income taxes			835				(1,724	)
Provision for (benefit from) income taxes			44				(499	)
Consolidated net income (loss)			791				(1,225	)
Less: Net loss attributable to non-controlling interest			(132	)			(76	)
Net earnings (loss) attributable to shareholders		$	923			$	(1,149	)
Basic earnings (loss) per share		$	0.13			$	(0.17	)
Diluted earnings (loss) per share		$	0.13			$	(0.17	)
Weighted average number of shares outstanding			6,950				6,924
Dilutive effect of stock awards			122				—
Weighted average number of shares assuming dilution			7,072				6,924

 

		Three Months Ended
		December 28,				December 29,
		2019				2018
Net earnings (loss) attributable to shareholders		$	923			$	(1,149	)
Other comprehensive income (loss) related to unrealized gain (loss) on derivatives, net of income tax			131				(373	)
Consolidated comprehensive income (loss)		$	1,054			$	(1,522	)

 

																		Accumulated
										Additional								Other												Non-
		Common Stock								Paid-In				Retained				Comprehensive				Treasury Stock								Controlling
		Shares				Amount				Capital				Earnings				Income (Loss)				Shares				Amount				Interest				Total
Balance at September 29, 2018			9,646,972			$	96			$	61,979			$	128,695			$	136				2,737,526			$	(40,881	)		$	93			$	150,118
Net loss			—				—				—				(1,149	)			—				—				—				—				(1,149	)
Other comprehensive loss			—				—				—				—				(373	)			—				—				—				(373	)
Net loss attributable to non-controlling interest			—				—				—				—				—				—				—				(76	)			(76	)
Vested stock awards			—				—				(3,983	)			—				—				(153,472	)			1,867				—				(2,116	)
Stock based compensation			—				—				662				—				—				—				—				—				662
Purchase of common stock			—				—				—				—				—				92,148				(1,711	)			—				(1,711	)
Balance at December 29, 2018			9,646,972			$	96			$	58,658			$	127,546			$	(237	)			2,676,202			$	(40,725	)		$	17			$	145,355

																		Accumulated
										Additional								Other												Non-
		Common Stock								Paid-In				Retained				Comprehensive				Treasury Stock								Controlling
		Shares				Amount				Capital				Earnings				Income (Loss)				Shares				Amount				Interest				Total
Balance at September 28, 2019			9,646,972			$	96			$	59,855			$	136,937			$	(969	)			2,725,555			$	(41,750	)		$	(281	)		$	153,888
Net earnings			—				—				—				923				—				—				—				—				923
Other comprehensive income			—				—				—				—				131				—				—				—				131
Net loss attributable to non-controlling interest			—				—				—				—				—				—				—				(132	)			(132	)
Vested stock awards			—				—				(1,615	)			—				—				(67,406	)			631				—				(984	)
Stock based compensation			—				—				585				—				—				—				—				—				585
Balance at December 28, 2019			9,646,972			$	96			$	58,825			$	137,860			$	(838	)			2,658,149			$	(41,119	)		$	(413	)		$	154,411

 

		Three Months Ended
		December 28,				December 29,
		2019				2018
Operating activities:
Consolidated net earnings (loss)		$	791			$	(1,225	)
Adjustments to reconcile net earnings (loss) to net cash used in operating activities:
Depreciation and amortization			3,161				2,919
Amortization of deferred financing fees			73				78
Benefit from deferred income taxes			—				(278	)
Non-cash stock compensation			601				662
Other, net			(725	)			(679	)
Gain on disposal of equipment			(37	)			—
Changes in operating assets and liabilities, net of effect of acquisition:
Accounts receivable, net			5,410				(8,794	)
Inventories, net			(18,208	)			(11,543	)
Prepaid expenses and other assets			70				(504	)
Other non-current assets			(1,004	)			(17	)
Accounts payable			7,985				13,615
Accrued expenses			(3,920	)			2,055
Change in net operating lease liabilities			931				—
Income taxes			16				(377	)
Other liabilities			(1	)			122
Net cash used in operating activities			(4,857	)			(3,966	)
Investing activities:
Purchases of property and equipment, net			(3,747	)			(989	)
Cash paid for business			(828	)			(2,000	)
Net cash used in investing activities			(4,575	)			(2,989	)
Financing activities:
Proceeds from long-term debt			117,763				114,934
Repayment of long-term debt			(105,211	)			(102,896	)
Repayment of capital financing			(1,259	)			(1,158	)
Payment of deferred financing fees			(1,079	)			—
Repurchase of common stock			—				(1,714	)
Payment of withholding taxes on stock awards			(954	)			(2,113	)
Net cash provided by financing activities			9,260				7,053
Net (decrease) increase in cash and cash equivalents			(172	)			98
Cash and cash equivalents at beginning of period			605				460
Cash and cash equivalents at end of period		$	433			$	558

 

Note A—Basis of Presentation and Description of Business

 

We prepared the accompanying interim Condensed Consolidated Financial Statements in accordance with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles ("U.S. GAAP") for complete financial statements. We believe these Condensed Consolidated Financial Statements include all normal recurring adjustments considered necessary for a fair presentation. Operating results for the three-month period ended December 28, 2019, are not necessarily indicative of the results that may be expected for our fiscal year ending October 3, 2020. Although our various product lines are sold on a year-round basis, the demand for specific products or styles reflects some seasonality, with sales in our June quarter generally being the highest and sales in our December quarter generally being the lowest. For more information regarding our results of operations and financial position, refer to the Consolidated Financial Statements and footnotes included in our Annual Report on Form 10-K for our fiscal year ended September 28, 2019, filed with the United States Securities and Exchange Commission (“SEC”).

 

Delta Apparel, Inc. (collectively with DTG2Go, LLC, Salt Life, LLC, M.J. Soffe, LLC, and other subsidiaries, "Delta Apparel," "we," "us," "our," or the "Company") is a vertically-integrated, international apparel company. With approximately 8,500 employees worldwide, we design, manufacture, source, and market a diverse portfolio of core activewear and lifestyle apparel products under our primary brands of Salt Life®, COAST®, Soffe®, and Delta. We are a market leader in the direct-to-garment digital print and fulfillment industry, bringing DTG2Go technology and innovation to the supply chain of our customers. We specialize in selling casual and athletic products through a variety of distribution channels and tiers, including outdoor and sporting goods retailers, independent and specialty stores, better department stores and mid-tier retailers, mass merchants and e-retailers, the U.S. military, and through our business-to-business ecommerce sites. Our products are also made available direct-to-consumer on our websites and in our branded retail stores. This diversified distribution allows us to capitalize on our strengths to provide our activewear and lifestyle apparel products to a broad and evolving customer base whose shopping preferences may span multiple retail channels.

 

We design and internally manufacture the majority of our products. More than 90% of the apparel units that we sell are sewn in our owned or leased facilities. This allows us to offer a high degree of consistency and quality, leverage scale efficiencies, and react quickly to changes in trends within the marketplace. We have manufacturing operations located in the United States, El Salvador, Honduras, and Mexico, and we use domestic and foreign contractors as additional sources of production. Our distribution facilities are strategically located throughout the United States to better serve our customers with same-day shipping on our catalog products and weekly replenishments to retailers.

 

We were incorporated in Georgia in 1999, and our headquarters is located in Greenville, South Carolina. We operate on a 52-53 week fiscal year ending on the Saturday closest to September 30. Our common stock trades on the NYSE American under the symbol “DLA."  Our 2020 fiscal year is a 53-week year and will end on October 3, 2020. Our 2019 fiscal year was a 52-week year and ended on September 28, 2019.

 

We make available copies of materials we file with, or furnish to, the SEC free of charge at https://ir.deltaapparelinc.com. The information found on our website is not part of this, or any other, report that we file with or furnish to the SEC. In addition, we will provide upon request, at no cost, paper or electronic copies of our reports and other filings made with the SEC. Requests should be directed to: Investor Relations Department, Delta Apparel, Inc., 322 South Main Street, Greenville, South Carolina 29601. Requests can also be made by telephone to 864-232-5200, or via email at investor.relations@deltaapparel.com.

 

 

Note B—Accounting Policies

 

Our accounting policies are consistent with those described in our Significant Accounting Policies in our Annual Report on Form 10-K for the fiscal year ended September 28, 2019, filed with the SEC. See Note C for consideration of recently issued accounting standards.

 

 

 

Note C—New Accounting Standards

 

Recently Adopted Standards

 

In August 2017, the Financial Accounting Standards Board, ("FASB"), issued Accounting Standards Update, ("ASU"), No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, ("ASU 2017-12"). The amendments in ASU 2017-12 apply to any entity that elects to apply hedge accounting in accordance with U.S. GAAP. ASU 2017-12 permits more flexibility in hedging interest rate risk for both variable rate and fixed rate financial instruments, and the ability to hedge risk components for nonfinancial hedges. In addition, this ASU requires an entity to present the earnings effect of hedging the instrument in the same income statement line in which the earnings effect of the hedge item is reported. In addition, companies no longer need to separately measure and report hedge ineffectiveness and can use an amortization approach or continue with mark-to-market accounting. We adopted ASU 2017-12 as of September 29, 2019. The provisions of ASU 2017-12 did not have a material effect on our financial condition, results of operations, cash flows or disclosures.

 

In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and other (Topic 350), Simplifying the Test for Goodwill Impairment, ("ASU 2017-04"). To simplify the subsequent measurement of goodwill, ASU 2017-04 eliminates Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the amendments in ASU 2017-04, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. ASU 2017-04 also eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. Therefore, the same impairment assessment applies to all reporting units. An entity is required to disclose the amount of goodwill allocated to each reporting unit with a zero or negative carrying amount of net assets. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. We early adopted ASU 2017-04 as of September 29, 2019. The provisions of ASU 2017-04 did not have a material effect on our financial condition, results of operations, cash flows or disclosures.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016-02”), which requires lessees to include most leases on the balance sheet as lease liabilities with an associated right-of-use ("ROU") asset. Since the issuance of ASU 2016-02, the FASB released several amendments to improve and clarify the implementation guidance, as well as to change the allowable adoption methods. These standards have been collectively codified within ASC 842, Leases (“ASC 842”). We adopted ASC 842 using the modified retrospective method and applied the standard to all leases existing as of September 29, 2019. Information for prior years presented has not been restated and continues to reflect the authoritative accounting standards in effect for those periods. We elected the package of transition practical expedients that allows us to carryforward our historical assessments of whether existing contracts contain leases, determinations of lease classification, and treatments of initial direct costs. As of September 29, 2019, we recognized total operating lease liabilities of $44.6 million in our Consolidated Balance Sheets, of which $36.1 million was recorded within Long-term operating leases, less current maturities and $8.5 million was recorded within Current portion of operating leases. We additionally derecognized $0.8 million of previously recorded net deferred rent balances and recorded operating lease ROU assets of $43.8 million related to our operating leases, which are reflected within Operating lease assets in our Consolidated Balance Sheets. The adoption of the new leasing standard had no significant impact on covenants or other provisions of our secured credit facility.

 

 

Standards Not Yet Adopted

 

In August 2018, the FASB issued ASU No. 2018-15, Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract (“ASU 2018-15”), which will require customers to apply internal-use software guidance to determine the implementation costs that are able to be capitalized. Capitalized implementation costs will be required to be amortized over the term of the arrangement, beginning when the cloud computing arrangement is ready for its intended use. ASU 2018-15 is effective for financial statements issued for fiscal years beginning after December 15, 2019, and interim periods within those annual periods. ASU 2018-15 will therefore be effective for us as of October 4, 2020 including the interim periods within our fiscal year 2021 annual period. The standard allows changes to be applied either retrospectively or prospectively. We are evaluating the effect that ASU 2018-15 will have on our financial statements and related disclosures.

 

 

 

 Note D—Revenue Recognition

 

We only recognize revenue to the extent that it is probable that we will not recognize a significant reversal of revenue when the uncertainties related to the variability are ultimately resolved. In determining our estimates for discounts, allowances, chargebacks, and returns, we consider historical and current trends, agreements with our customers and retailer performance. We record these discounts, returns and allowances as a reduction to net sales in our Condensed Consolidated Statements of Operations and as a refund liability in our accrued expenses in our Condensed Consolidated Balance Sheets, with the estimated value of inventory expected to be returned in prepaid and other current assets in our Condensed Consolidated Balance Sheets. As of December 28, 2019, and September 28, 2019, there was $1.1 million and $1.0 million, respectively, in refund liabilities for customer returns, allowances, markdowns and discounts within accrued expenses.

 

Our revenue streams consist of wholesale, direct-to-consumer ecommerce and retail stores which are included in our Condensed Consolidated Statements of Operations. The table below identifies the amount and percentage of net sales by distribution channel (in thousands):

 

 

The table below provides net sales by reportable segment (in thousands) and the percentage of net sales by distribution channel for each reportable segment:

 

 

 

 

 

Note E—Inventories

 

Inventories, net of reserves of $9.7 million and $10.0 million, as of December 28, 2019, and September 28, 2019, respectively, consisted of the following (in thousands):

 

 

Raw materials include finished yarn and direct materials for the Delta Group, undecorated garments for the DTG2Go business and direct embellishment materials for the Salt Life Group.

 

 

Note F—Debt

 

Credit Facility

 

On May 10, 2016, we entered into a Fifth Amended and Restated Credit Agreement (the “Amended Credit Agreement”) with Wells Fargo Bank, National Association (“Wells Fargo”), as Administrative Agent, the Sole Lead Arranger and the Sole Book Runner, and the financial institutions named therein as Lenders, which are Wells Fargo, PNC Bank, National Association and Regions Bank. Our subsidiaries M.J. Soffe, LLC, Culver City Clothing Company (f/k/a Junkfood Clothing Company), Salt Life, LLC, and DTG2Go, LLC (f/k/a Art Gun, LLC) (collectively, the "Borrowers"), are co-borrowers under the Amended Credit Agreement. The Borrowers entered into amendments to The Amended Credit Agreement with Wells Fargo and the other lenders on November 27, 2017, March 9, 2018, and October 8, 2018.

 

On November 19, 2019, the Borrowers entered into a Consent and Fourth Amendment to the Fifth Amended and Restated Credit Agreement with Wells Fargo and the other lenders set forth therein (the "Fourth Amendment"). The Fourth Amendment, among other things, (i) increased the borrowing capacity under the Amended Credit Agreement from $145.0 million to $170.0 million (subject to borrowing base limitations), (ii) extended the maturity date from May 21, 2021 to November 19, 2024, (iii) reduced pricing on the revolver and first-in last-out "FILO" borrowing components by 25 basis points, and (iv) added 25% of the fair value of eligible intellectual property to the borrowing base calculation. In addition, the Fourth Amendment amended the definition of Fixed Charge Coverage Ratio to exclude up to $10.0 million of capital expenditures incurred by the Borrowers in connection with the expansion of their distribution facility located within the Town of Clinton, Anderson County, Tennessee.

 

The Amended Credit Agreement allows us to borrow up to $170.0 million (subject to borrowing base limitations), including a maximum of $25.0 million in letters of credit. Provided that no event of default exists, we have the option to increase the maximum credit to $200.0 million (subject to borrowing base limitations), conditioned upon the Administrative Agent's ability to secure additional commitments and customary closing conditions. 

 

 

As of December 28, 2019, there was $115.0 million outstanding under our U.S. revolving credit facility at an average interest rate of 3.9% and additional borrowing availability of $38.3 million. This credit facility includes a financial covenant requiring that if the amount of availability falls below the threshold amounts set forth in the Amended Credit Agreement, our Fixed Charge Coverage Ratio (“FCCR”) (as defined in the Amended Credit Agreement) 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 December 28, 2019, 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. At December 28, 2019, and September 28, 2019, there was $16.6 million and $16.1 million, respectively, of retained earnings free of restrictions to make cash dividends or stock repurchases.

 

The Amended Credit Agreement contains a subjective acceleration clause and a “springing” lockbox arrangement (as defined in FASB Codification No. 470, Debt ("ASC 470")) whereby remittances from customers will be forwarded to our general bank account and will not reduce the outstanding debt until and unless a specified event or an event of default occurs. Pursuant to ASC 470, we classify borrowings under the Amended Credit Agreement as long-term debt.

 

Promissory Note

 

On October 8, 2018, we acquired substantially all of the assets of Silk Screen Ink, Ltd. d/b/a SSI Digital Print Services. In conjunction with the acquisition, we issued a promissory note in the principal amount of $7.0 million. The promissory note bears interest at 6% with quarterly installments which began January 2, 2019, with the final installment due October 1, 2021. As of December 28, 2019, there was $4.7 million outstanding on the promissory note.

 

Honduran Debt

 

Since March 2011, we have entered into term loans and a revolving credit facility with Banco Ficohsa, a Honduran bank, to finance both the operations and capital expansion of our Honduran facilities. Each of these loans is secured by a first-priority lien on the assets of our Honduran operations and is not guaranteed by our U.S. entities. These loans are denominated in U.S. dollars and the carrying value of the debt approximates its fair value. The revolving credit facility requires minimum payments during each six-month period of the 18-month term; however, the loan agreement permits additional drawdowns to the extent payments are made and certain objective covenants are met. The current revolving Honduran debt, by its nature, is not long-term, as it requires scheduled payments each six months. However, as the loan permits us to re-borrow funds up to the amount repaid, subject to certain covenants, and we intend to re-borrow funds, subject to those covenants, the amounts have been classified as long-term debt.

 

Additional information about these loans and the outstanding balances as of December 28, 2019, is as follows (in thousands):

 

 

 

 

 Note G—Leases

 

We lease property and equipment under operating lease arrangements, most of which relate to distribution centers and manufacturing facilities in the U.S., Honduras, El Salvador, and Mexico. We also lease machinery and equipment under finance lease arrangements in the U.S. We include both the contractual term as well as any renewal option that we are reasonably certain to exercise in the determination of our lease terms. For leases with a term of greater than 12 months, we value lease liabilities and the related assets as the present value of the lease payments over the related term. We apply the short-term lease exception to leases with a term of 12 months or less and exclude such leases from our Condensed Consolidated Balance Sheets. Payments related to these short-term leases are expensed on a straight-line basis over the lease term and reflected as a component of lease cost within our Condensed Consolidated Statements of Comprehensive Income (Loss). Lease payments generally consist of fixed amounts, and variable amounts based on a market rate or an index are not material to our consolidated lease cost. Our operating lease agreements for buildings generally include provisions for the payment of our proportional share of operating costs, property taxes, and other variable payments. These incremental payments are excluded from our calculation of operating lease liabilities and right of use assets. We have elected to use the practical expedient present in ASC 842 to not separate lease and non-lease components for all significant underlying asset classes and instead account for them together as a single lease component in the measurement of our lease liabilities.

 

Generally, the rate implicit in our operating leases is not readily determinable. Therefore, we discount future lease payments using our estimated incremental borrowing rate at lease commencement. We determine this rate based on a credit-adjusted risk-free rate, which approximates a secured rate over the lease term. The weighted average discount rate for operating leases as of December 28, 2019, was 4.2%. We discount our finance lease payments based on the rate implicit and stated in the lease. The weighted average discount rate for finance leases as of December 28, 2019, was 5.2%.

 

The following table presents the future undiscounted payments due on our operating and finance lease liabilities as well as a reconciliation of those payments to our operating and finance lease liabilities, recorded as of December 28, 2019 (in thousands):

 

 

As of December 28, 2019, we have entered into certain operating leases that have not yet commenced and which will result in annual fixed lease payments that range from $1.0 million to $1.3 million for a 10-year period.

 

Our Ceiba Textiles manufacturing facility is leased under an operating lease arrangement with a Honduran company, of which we own 31% of the outstanding capital stock of the lessor at December 28, 2019. During the three-months ended December 28, 2019, and December 29, 2018, we paid approximately $0.4 million in lease payments under this arrangement.

 

As of December 28, 2019, we recorded $42.0 million of operating lease ROU assets, which were reflected within Operating lease assets in our Condensed Consolidated Balance Sheets, and $23.9 million of finance lease ROU assets, which were reflected within Property, plant, and equipment, net in our Condensed Consolidated Balance Sheets.

 

The weighted average remaining lease terms for our operating leases and finance leases were approximately 7 years and 4 years, respectively, as of December 28, 2019.

 

 

The components of total lease cost were as follows for the three months ended December 28, 2019, (in thousands):

 

 

Total rent expense recognized during the three months ended December 29, 2018, prior to the adoption of ASC 842, was $0.3 million.

 

Operating cash outflows for operating lease payments during the three months ended December 28, 2019, was $2.6 million.  Financing cash outflows for finance lease payments during the three months ended December 28, 2019, was $1.5 million.  Operating cash outflows for interest payments for finance leases during the three months ended December 28, 2019, was $0.2 million.

 

ROU assets obtained in exchange for operating lease and finance lease liabilities during the three months ended December 28, 2019, were $0.5 million and $1.8 million, respectively. During the three-month period ended December 29, 2018, ROU assets obtained for finance lease liabilities were $4.6 million.

 

We do not have significant leasing transactions in which we are the lessor.

 

 

 

Note H—Selling, General and Administrative Expense

 

We include in selling, general and administrative ("SG&A") expenses the costs incurred subsequent to the receipt of finished goods at our distribution facilities, such as the cost of stocking, warehousing, picking, packing, and shipping goods for delivery to our customers. Distribution costs included in SG&A expenses totaled $4.9 million and $4.2 million for the three-month periods ended December 28, 2019, and December 29, 2018, respectively. In addition, SG&A expenses include costs related to sales associates, administrative personnel, advertising and marketing expenses and other general and administrative expenses.

 

 

Note I—Stock-Based Compensation

 

On February 4, 2015, our shareholders re-approved the Delta Apparel, Inc. 2010 Stock Plan ("2010 Stock Plan") that was originally approved by our shareholders on November 11, 2010. The re-approval of the 2010 Stock Plan, including the material terms of the performance goals included in the 2010 Stock Plan, enabled us to continue to grant equity incentive compensation awards that are structured in a manner intended to qualify as tax deductible, performance-based compensation under Section 162(m) of the Internal Revenue Code of 1986, as applicable.  Recently enacted tax legislation in 2017 changed several conclusions under Section 162(m), including that there will no longer be a performance-based compensation exemption, and the Chief Financial Officer position is now included in the applicable calculation along with the next three highest-paid officers.  This reform impacted taxes related to fiscal years 2020 and 2019.

 

Since November 2010, no additional awards have been or will be granted under either the Delta Apparel Stock Option Plan ("Option Plan") or the Delta Apparel Incentive Stock Award Plan ("Award Plan"); instead, all stock awards have been granted under the 2010 Stock Plan.

 

Shares are generally issued from treasury stock upon exercise of the options or the vesting of the restricted stock units, performance units or other awards under the 2010 Stock Plan.

 

Compensation expense is recorded on the SG&A expense line item in our Condensed Consolidated Statements of Operations over the vesting periods. During the three-month periods ended December 28, 2019, and December 29, 2018, we recognized $0.9 million and $0.6 million, respectively, in stock-based compensation expense.

 

2010 Stock Plan

 

Under the 2010 Stock Plan, the Compensation Committee of our Board of Directors has the authority to determine the employees and directors to whom awards may be granted and the size and type of each award and manner in which such awards will vest. The awards available under the plan consist of stock options, stock appreciation rights, restricted stock, restricted stock units, performance stock, performance units, and other stock and cash awards. The aggregate number of shares of common stock that may be delivered under the 2010 Stock Plan is 500,000 plus any shares of common stock subject to outstanding awards under the Option Plan or Award Plan that are subsequently forfeited or terminated for any reason before being exercised. The 2010 Stock Plan limits the number of shares that may be covered by awards to any participant in a given calendar year and also limits the aggregate awards of restricted stock, restricted stock units and performance stock granted in a given calendar year. If a participant dies or becomes disabled (as defined in the 2010 Stock Plan) while employed by the Company or serving as a director, all unvested awards become fully vested. The Compensation Committee is authorized to establish the terms and conditions of awards granted under the 2010 Stock Plan, to establish, amend and rescind any rules and regulations relating to the 2010 Stock Plan, and to make any other determinations that it deems necessary.

 

During the three-month period ended December 28, 2019, restricted stock units and performance units, each consisting of 60,000 shares of our common stock, were granted and are eligible to vest upon the filing of our Annual Report on Form 10-K for the fiscal year ended October 2, 2021. One-half of the restricted stock units and one-half of the performance units are payable in common stock with the remainder payable in cash.

 

During the three-month period ended December 28, 2019, restricted stock units and performance units representing 54,750 and 78,106 shares of our common stock, respectively, vested upon the filing of our Annual Report on Form 10-K for the fiscal year ended September 28, 2019, and were issued in accordance with their respective agreements. One-half of the restricted stock units were paid in common stock and one-half were paid in cash. Of the performance units, 59,213 were paid in common stock and 18,893 were paid in cash.

 

During the three-month period ended December 29, 2018, restricted stock units and performance units representing 205,000 and 42,000 shares of our common stock, respectively, vested upon the filing of our Annual Report on Form 10-K for the fiscal year ended September 29, 2018, and were issued in accordance with their respective agreements. All vested awards were paid in common stock.

 

As of December 28, 2019, there was $3.6 million of total unrecognized compensation cost related to unvested awards granted under the 2010 Stock Plan. This cost is expected to be recognized over a period of 1.9 years.

 

 

Note J—Purchase Contracts

 

We have entered into agreements, and have fixed prices, to purchase yarn, finished fabric, and finished apparel and headwear products. At December 28, 2019, minimum payments under these contracts were as follows (in thousands):

 

 

 

 

Note K—Business Segments

 

Our operations are managed and reported in two segments, Delta Group and Salt Life Group, which reflect the manner in which the business is managed and results are reviewed by the Chief Executive Officer, who is our chief operating decision maker. 

 

The Delta Group is comprised of our business units primarily focused on core activewear styles, and includes our Delta Activewear (encompassing our Delta Catalog and FunTees businesses), Soffe, and DTG2Go business units. We market, distribute and manufacture unembellished knit apparel under the main brands of Soffe®, Delta Platinum, Delta Pro Weight^®, and Delta Magnum Weight^® for sale to a diversified audience ranging from large licensed screen printers to small independent businesses. Through our FunTees business, we serve our customers as their supply chain partner, from product development to shipment of their branded products, with the majority of products sold with value-added services including embellishment, hangers, hangtags and ticketing, so that they are ready for retail sale to the end customers. We assist our customers in managing their production and inventory needs and provide technology tools to help them manage and grow their business. We sell our products to a diversified audience, including sporting goods retailers, large licensed screen printers, specialty and resort stores, and ad-specialty and promotional products businesses. We also service major branded sportswear companies, trendy regional brands, retailers, and sports-licensed apparel marketers. Our DTG2Go business is a market leader in the direct-to-garment digital print and fulfillment industry, bringing technology and innovation to the supply chain of our many customers. We use highly-automated factory processes and our proprietary software to deliver on-demand, digitally printed apparel direct to consumers on behalf of our customers. Utilizing its seven fulfillment facilities throughout the United States, DTG2Go offers a robust digital supply chain to ship custom graphic products within 24 to 48 hours to consumers in the United States and to over 100 countries worldwide.

 

The Salt Life Group is comprised of our lifestyle brands focused on a broad range of apparel garments, headwear and related accessories to meet consumer preferences and fashion trends, and includes our Salt Life and Coast business units. These products are sold through specialty and boutique shops, traditional department stores, and outdoor retailers, as well as direct-to-consumer through branded ecommerce sites and branded retail stores. Products in this segment are marketed under our lifestyle brands of Salt Life® and COAST®, as well as other labels.

 

Our Chief Operating Decision Maker and management evaluate performance and allocate resources based on profit or loss from operations before interest, income taxes and special charges ("segment operating earnings"). Our segment operating income may not be comparable to similarly titled measures used by other companies. The accounting policies of our reportable segments are the same as those described in Note 2 in our Annual Report on Form 10-K for the fiscal year ended September 28, 2019, filed with the SEC. Intercompany transfers between operating segments are transacted at cost and have been eliminated within the segment amounts shown in the following table (in thousands).

 

 

⁽¹⁾In the quarter ended December 29, 2018, the Delta Group operating income included $2.5 million of expense incurred in connection with the settlement of litigation related to the 2016 bankruptcy filing of a customer.

 

The following table reconciles the segment operating income to the consolidated income before provision for income taxes (in thousands):

 

 

The Delta Group segment assets have increased by $47.0 million since September 28, 2019, to $362.7 million as of December 28, 2019, primarily as a result of the adoption of ASU 2016-02 and increases in working capital due to the seasonality of the business. The Salt Life Group segment assets have increased by $8.2 million since September 28, 2019, to $65.8 million as of December 28, 2019, primarily due to seasonal inventory build.

 

 

Note L—Income Taxes

 

The Tax Cuts and Jobs Act of 2017 (the “New Tax Legislation”) was enacted on December 22, 2017, which significantly revised the U.S. corporate income tax code by, among other things, lowering federal corporate income tax rates, implementing a modified territorial tax system and imposing a repatriation tax ("transition tax") on deemed repatriated cumulative earnings of foreign subsidiaries which will be paid over eight years. In addition, new taxes were imposed related to foreign income, including a tax on global intangible low-taxed income (“GILTI”) as well as a limitation on the deduction for business interest expense (“Section 163(j)"). GILTI is the excess of the shareholder’s net controlled foreign corporations ("CFC") net tested income over the net deemed tangible income.  The Section 163(j) limitation does not allow the amount of deductible interest to exceed the sum of the taxpayer's business interest income, 30% of the taxpayer’s adjusted taxable income, and the taxpayer’s floor plan financing interest expense for the year. We have included in our calculation of our effective tax rate the estimated impact of GILTI and Section 163(j) which were effective for us beginning in fiscal year 2019. We have elected to account for the tax on GILTI as a period cost and, therefore, do not record deferred taxes related to GILTI on our foreign subsidiaries.

 

Our effective income tax rate on operations for the three-month period ended December 28, 2019, was 5.2% compared to a rate of 28.9% in the same period of the prior year and an effective rate of 5.5% for fiscal year 2019.

 

We benefit from having income in foreign jurisdictions that are either exempt from income taxes or have tax rates that are lower than those in the United States. However, changes in the mix of U.S. taxable income compared to profits in tax-free or lower-tax jurisdictions can have a significant impact on our overall effective tax rate.  In addition, the future impact of the New Tax Legislation may differ from historical amounts, possibly materially, due to, among other things, changes in interpretations and assumptions made regarding the New Tax Legislation, guidance that may be issued, and actions we may take as a result of the New Tax Legislation.

 

 

 

Note M—Derivatives and Fair Value Measurements

 

From time to time, we may use interest rate swaps or other instruments to manage our interest rate exposure and reduce the impact of future interest rate changes. These financial instruments are not used for trading or speculative purposes. We have designated our interest rate swap contracts as cash flow hedges of our future interest payments. As a result, the gains and losses on the swap contracts are reported as a component of other comprehensive income and are reclassified into interest expense as the related interest payments are made. As of December 28, 2019, all of other comprehensive income were attributable to shareholders; none related to the non-controlling interest.  Outstanding instruments as of December 28, 2019, are as follows:

 

 

No interest rate swap agreements were settled during the three-month period ended December 28, 2019, or the three-month period ended December 29, 2018, and therefore, no amounts were reclassified into income during those periods.

 

The following table summarizes the fair value and presentation in the Condensed Consolidated Balance Sheets for derivatives related to our interest swap agreements as of December 28, 2019, and September 28, 2019 (in thousands):

 

 

 

From time to time, we may purchase cotton option contracts to economically hedge the risk related to market fluctuations in the cost of cotton used in our operations. We do not receive hedge accounting treatment for these derivatives. As such, the realized and unrealized gains and losses associated with them are recorded within cost of goods sold on the Condensed Consolidated Statement of Operations. No such cotton contracts were outstanding at December 28, 2019, or September 28, 2019.

 

ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Assets and liabilities measured at fair value are grouped in three levels. The levels prioritize the inputs used to measure the fair value of the assets or liabilities. These levels are:

 

	○	Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities.
	○	Level 2 – Inputs other than quoted prices that are observable for assets and liabilities, either directly or indirectly. These inputs include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are less active.
	○	Level 3 – Unobservable inputs that are supported by little or no market activity for assets or liabilities and includes certain pricing models, discounted cash flow methodologies and similar techniques.

 

The following financial liabilities are measured at fair value on a recurring basis (in thousands):

 

 

The fair value of the interest rate swap agreements was derived from a discounted cash flow analysis based on the terms of the contract and the forward interest rate curves adjusted for our credit risk, which fall in Level 2 of the fair value hierarchy. At December 28, 2019, and September 28, 2019, book value for fixed rate debt approximates fair value based on quoted market prices for the same or similar issues or on the current rates offered to us for debt of the same remaining maturities (a Level 2 fair value measurement).

 

The DTG2Go acquisition purchase price consisted of additional payments contingent on the combined business’s achievement of certain performance targets related to sales and earnings before interest, taxes, depreciation and amortization ("EBITDA") for the period from April 1, 2018, through September 29, 2018, as well as for our fiscal years 2019, 2020, 2021 and 2022. The valuation of the fair value of the contingent consideration is based upon inputs into the Monte Carlo model, including projected results, which then are discounted to a present value to derive the fair value. The fair value of the contingent consideration is sensitive to changes in our projected results. At December 28, 2019, we estimated the fair value of contingent consideration to be $8.5 million, a decrease of $0.4 million from the September 28, 2019 balance of $8.9 million. The decrease in the accrual was related to lower operating results in the first quarter fiscal 2020.

 

In August 2013, we acquired Salt Life, which included contingent consideration as part of the purchase price and which is payable in cash after the end of calendar year 2019 if financial performance targets involving the sale of Salt Life-branded products are met during the 2019 calendar year. At December 28, 2019, and September 28, 2019, we had $0.2 million accrued in contingent consideration related to the acquisition of Salt Life.

 

 

Note N—Legal Proceedings

 

At times we are party to various legal claims, actions and complaints. We believe that, as a result of legal defenses, insurance arrangements, and indemnification provisions with parties believed to be financially capable, such actions should not have a material adverse effect on our operations, financial condition, or liquidity. 

 

 

 

 

Note O—Repurchase of Common Stock

 

As of September 28, 2019, our Board of Directors authorized management to use up to $60.0 million to repurchase stock in open market transactions under our Stock Repurchase Program.

 

Through December 28, 2019, we have purchased 3,498,962 shares of our common stock for an aggregate of $50.5 million since the inception of our Stock Repurchase Program. All purchases were made at the discretion of management and pursuant to the safe harbor provisions of SEC Rule 10b-18. As of December 28, 2019, $9.5 million remained available for future purchases under our Stock Repurchase Program, which does not have an expiration date. There were no repurchases of our common stock for the quarter ended December 28, 2019.

 

 

Note P—Goodwill and Intangible Assets

 

Components of intangible assets consist of the following (in thousands):

 

 

Goodwill represents the acquired goodwill net of the $0.6 million cumulative impairment losses recorded in fiscal year 2011. The goodwill recorded on our financial statements is included in both of our segments, with $18.0 million and $19.9 million included in the Delta Group and Salt Life Group, respectively.

 

Amortization expense for intangible assets was $0.5 million for the three-month periods ended December 28, 2019, and December 29, 2018. Amortization expense is estimated to be approximately $1.7 million for fiscal year 2020, $1.6 million for each of fiscal years 2021 and 2022, $1.5 million for fiscal year 2023, and approximately $1.4 million for fiscal year 2024.

 

 

Note Q—Subsequent Events

 

None