Unifi Inc Q1 FY2020 Earnings Call

Ladies and gentlemen, thank you for joining us for the First Quarter 2020 Unifi, Inc. Earnings Conference Call. All participant lines are currently in listen-only mode. After the presentation, we will have a question-and-answer session. Please note that today's conference is being recorded. I will now turn the call over to A.J. Eaker, Vice President of Finance and Investor Relations. Please proceed.

Thank you, operator, and good morning everyone. On the call today is our Al Carey, Executive Chairman; Tom Caudle, President and Chief Operating Officer; and Craig A. Creaturo, Executive Vice President and Chief Financial Officer. During this call, management will be referencing a webcast presentation that can be found at unifi.com, and by clicking the First Quarter Conference Call link. Management advises you that certain statements included in today’s call will be forward-looking statements within the meaning of the Federal Securities laws. Management cautions that these statements are based on current expectations, estimates, and projections about the markets in which Unifi operates. These statements are not guarantees of future performance and involve certain risks that are difficult to predict. Actual outcomes and results may differ materially from what is expressed, forecasted or implied by these statements. You are directed to the disclosures filed with the SEC on Unifi’s Forms 10-Q and 10-K regarding various factors that may impact these results. Also, please be advised that certain non-GAAP financial measures such as adjusted EBITDA, adjusted working capital, and net debt may be discussed on this call, and non-GAAP reconciliations can be found in the schedules to the webcast presentation. I will now turn the call over to Al Carey.

Thanks, A.J., and good morning, everyone. I want to thank you for joining us today. Our first quarter results delivered on our expectations and are a positive sign that we’re focusing on the right things to move our business forward and to begin to capture the underlying sales and profit opportunities. The significant year-over-year improvements we achieved continue to validate that we’re focusing on our core competencies, we’re revitalizing the Americas and better aligning our cost structure, and we’re pleased to see that Unifi is making progress to fulfill its vision as one of the world’s leading innovators in recycled and synthetic yarns. We believe the recent trade developments, including antidumping and countervailing duties, are set to reshape our industry and provide meaningful opportunities over the next few quarters. The timing of the final determinations of dumping subsidization and injury is unchanged and is expected to be by the end of calendar 2019. So we’ll provide you with updates when appropriate. Lastly, we’re excited to welcome Craig Creaturo, our new Executive Vice President and Chief Financial Officer. His skill set and experience complement the team’s operational and strategic focus. With the addition of Craig, we feel that we have a very well-rounded group of senior leaders that will best position our company for future growth. Now I’ll turn the call over to Tom for a high-level discussion of the company’s performance during the first quarter. Tom?

Thank you, Al, and good morning, everyone. As Al said, the first quarter came in as expected, exhibiting significant improvement in sales volume and underlying profitability, despite one less week of sales for domestic operations. We look forward to carrying this momentum into the remainder of the fiscal year. Other positives during the quarter included a continuation of strong performance from the PVA portfolio, specifically REPREVE branded products, our cost containment initiatives, and a more favorable raw material cost environment in the U.S. While we believe the current business environment in the Americas is still challenging and evolving, we foresee improvement and hope to build incremental momentum as the year unfolds. Continuing the trend from last quarter, our PVA sales now account for 54% of consolidated sales. This significant growth is a testament to our innovative product offering on both our REPREVE and PROFIBER platforms. Notably, our operating income saw an improvement as a leaner cost structure allowed our top line growth to better flow through to the bottom line. This helped to fuel stronger operating cash flows, which afforded us the ability to best manage our capital priorities. I’m also pleased to see a significant improvement in our tax rate, as expected with improved domestic performance. As we navigate this fiscal year and beyond, we will continue to invest in optimal areas of our business to ensure our competitive position is maintained. Moving on to our commercial and branding initiatives, Kate Hudson’s sustainable flagship brand, Happy x Nature, was released in New York in company retail stores as well as online. Kate Hudson has been promoting the line on social media and on national talk shows, highlighting that REPREVE is made from recycled plastic bottles. Second, we worked closely with the PAC-12, Nike, and Stanford University to develop a 30-second commercial airing nationally on PAC-12 network, website, and social media channels. The commercial highlights how REPREVE, Nike, and Stanford partner to facilitate the circular economy, recycling plastic bottles into yarn, and REPREVE producing recycled performance apparel, with Nike retailing the recycled merchandise at Stanford bookstore. Lastly, we had another great showing at the Intertextile event in Shanghai, exhibiting several exciting variations of REPREVE, and we’ve remained busy with over 200 customer meetings during the event. Turning to a walkthrough of our segment performance over the first quarter, I’d like to remind everyone of the update we made last quarter to our operating segments as a result of the growth of our international operations. The reporting segments are Polyester, Nylon, Brazil, and Asia. PVA sales, notably in Asia, continue to be our bright spot as our portfolio of REPREVE branded products resonates with the world’s leading companies. First, Asia benefited from a doubling of volume and a near doubling of revenue dollars, driven by a broad portfolio of growth with significant sales of both chip and staple fiber. However, Brazil's economic and competitive environment led to softness in sales and profitability this quarter. Polyester saw lower sales driven by softness in certain markets such as Industrial and Automotive. Looking to the rest of the fiscal year, we still believe the historic levels of imports experienced in prior quarters will subside with the playing field normalizing after the final trade determinations. Nylon experienced a challenging quarter and revenues were negatively affected from the program that was lost in the fourth quarter of fiscal 2019. Our sales teams are working on backfilling that lost volume to return the segment to more normalized levels, and we hope new innovations like our REPREVE nylon will help solidify the segment's future. Overall, we are pleased that the first quarter benefited from a more positive raw material environment in the U.S. and hope to see a neutral or possibly positive trend throughout the fiscal year. Looking outside of our core operations, our equity affiliates saw lower operating profitability during the quarter. However, we were very encouraged that Parkdale provided Unifi a distribution of $10.4 million. As we stated in the past, Parkdale goes as an investment that has benefited us historically, as evidenced by the cash distribution this quarter. This cash was applied to our debt, providing a meaningful reduction in the net debt levels to the end of the quarter. We remained steadfast in our strategic decision of partnering with Parkdale. Before we move on to the financial review, I’d also like to welcome Craig to the team here at Unifi. We were thorough and patient during our search for a new CFO, and we are pleased to bring Craig on board. We’re very excited to work with him and leverage his 15-plus years of experience as an executive leader for finance and accounting teams and businesses with complex manufacturing and global operations. We see Craig as a great addition to the strong culture and team here at Unifi. I will now pass the call to Craig.

Thank you, Tom, and good morning, everyone. As Tom noted, revenue and profitability results met our expectations as strong cash flow performance generated significant momentum to begin the fiscal year. I’ll review the key drivers of our performance in my discussion today and I would like to begin with a short overview of the quarter. Overall for Q1 fiscal 2020, our cost reduction efforts flowed through as a comparable benefit to SG&A. While the pressure on gross profit and the performance shortfall from Parkdale resulted in pre-tax income of $4.4 million, $200,000 less than the first quarter of fiscal 2019, a significant improvement in our effective tax rate, decreasing from 61% to 16%, allowed for a doubling of net income and EPS from Q1 fiscal 2019 to Q1 fiscal 2020. Moving to Slide 3 of the webcast presentation, you can see sales and gross profit highlights by segment. As a reminder, our segment gross profit includes the effect of certain technology-related expenses charged by the Polyester segment to the Asia segment. Such amounts are recorded as a benefit to cost of sales for the Polyester segment and a charge to cost of sales for the Asia segment, thereby impacting gross profit for each segment. Fiscal 2019 segment results have been revised to reflect comparability for this change, as presented on this Slide 3 and the full fiscal year 2019 segment results by quarter are shown on Slide 11. Consolidated net sales decreased 0.9% with significant volume growth in Asia that nearly overcame one less week of sales for domestic operations. For Polyester segment sales, which declined 11.4%, the volume decline of 9.6% exhibits one less week of sales, plus lower demand from customers in the Industrial and Automotive market segments. Nylon sales decreased 27.7% as a result of one less week of sales, combined with a larger customer transitioning certain programs overseas. In Brazil, sales volumes were 3.7% lower, despite competitive and economic pressures, while declining raw material costs drove down pricing. Sales results for the Asia segment continued their strong performance as volumes increased 116.7%, despite uncertainty and global trade and international competition. Sales of REPREVE products led the way in Asia, as we continue to attract quality brand programs and maintain a leading position in the recycled market. The PVA portfolio remains a growth engine as our Asia strategy continues to be validated. Moving on to gross profit, at the bottom half of Slide 3, consolidated gross profit decreased from $20.0 million to $17.4 million with the associated margin declining from 11.0% to 9.7%. Overall, the decline is primarily attributable to competitive pricing pressures that were most pronounced in Brazil and Asia, along with a higher proportion of sales in Asia. The decrease was partially offset by a more favorable raw material cost environment in the U.S. Looking at this from a segment perspective, Polyester primarily benefited from a more favorable raw material cost environment, increasing gross margin by 100 basis points from 7.8% to 8.8%. Nylon primarily experienced weaker fixed cost absorption due to lower revenues, as its margin rate declined from 7.7% to 5.8%. Brazil faced competitive and economic pressures along with higher raw material costs and inventory during a declining cost environment, generating a gross margin decline from 23.8% to 17.2%. Lastly, Asia’s sales mix included significant chip and staple fiber sales which currently carry a lower margin profile, as these products are used to see new programs and initiate further customer development. As a result, Asia's gross margin declined from 13.9% to 9.3%. On Slide 4, we present an overview of gross margin, showcasing the changes that stem from each of our four reportable segments: Polyester, Nylon, Brazil, and Asia. We can see that the Polyester segment performance benefited from raw material costs relief, helping to lift consolidated gross margin, while the competitive and sales mix pressures in Brazil and Asia challenged the overall gross margin profile. These segment dynamics combined generated a decline in overall gross margin of 130 basis points, resulting in weaker gross profit versus the prior year first quarter. Moving on to Slide 5, we present equity affiliates. Pre-tax earnings decreased approximately $1.1 million from Q1 2019 to Q1 2020. Parkdale’s results primarily reflected lower operating leverage during a period of elevated costs. Equity affiliates’ distributions in the quarter totaled $10.4 million, all provided by Parkdale, as Tom mentioned earlier. Slide 6 covers balance sheet and liquidity highlights. At September 29, 2019, working capital was approximately $194 million and adjusted working capital was approximately $174 million. Adjusted working capital as a percentage of sales was 24% within our range of expectations and was an improvement from both June 30, 2019 and September 30, 2018. We ended the period with $122 million in debt, while net debt was approximately $88 million, a 17% reduction from June 30, 2019. Revolver availability increased to $62.8 million, and total liquidity increased to $96.9 million. At September 29, 2019, our weighted average interest rate was 3.5%. Before opening up for questions, Slide 7 details our guidance that was contained in today’s earnings release, which reaffirms our original guidance published in August 2019. With that, we will now open up the line for questions.

Our first question comes from Chris McGinnis with Sidoti & Company. Your line is now open.

Hi. Good morning. Nice quarter and thanks for taking my questions. Can you just start off with the growth in Asia, can you talk to these new relationships being built or the expansion of existing relationships and maybe a makeup of, is it straight REPREVE or does it maybe have some other offerings along with the REPREVE then maybe higher margin? Thanks.

Chris, this is Tom. As we’ve discussed before, a large portion of Asia’s business is REPREVE. We continue to seek out new supply chain partners and new mill partners, as well as new customers for new applications of REPREVE in the region. The team over there has done a really stellar job during this quarter, expanding our offering of chip, flake, and filament, and we’re very pleased with the results.

All right, thank you. And then maybe just to touch on, did you say that you haven’t seen a positive impact from the kind of the antidumping tariffs at this point? And when would you expect to see some positive changes from that possibly coming to the next year?

We have experienced inquiries, but the impact so far through the first quarter has been minimal. That was kind of the way we built our strategy going forward. We felt like the first half would be weaker and we started to see more impact in the second half.

Okay, thank you. And then just two quick ones, just on the SG&A levels in Q1, is that a sustainable level or can you comment a little bit about if there are any changes going forward for the remainder of the year? Thanks.

Yeah, Chris, this is Craig. Yeah, I think the SG&A levels, we’re happy with where that came in for the quarter, definitely reflecting the actions the company took to get us to that point, to get a cost structure that matches our revenue profile and our business objectives. We are still thinking that we will be around a $51 million run rate for the full fiscal year. We will see some further investments in SG&A as the quarters go on, but that guidance was included in the guidance that we published today.

Okay, and then just a quick one on Parkdale and the size of that distribution that you received as a dividend. Do you think that’s a sustainable level? If I remember right, that’s the first time in a while that you received something that large from Parkdale, if I’m correct?

Yeah, that was a great distribution. You’re correct that it has been a while since we saw something of that magnitude. We have definitely put it to good use. That is definitely a big factor for us reducing both debt and net debt for this quarter. So we’re very thankful for that. You know we have not exhausted the future dividends that could come to us from Parkdale, but we are glad that that one did come in and glad that it came in during the just completed quarter.

Great, thanks for taking my questions. I’ll jump back in queue and good luck in Q2.

Thanks, Chris.

Thanks, Chris.

Thank you. Our next question comes from the line of Daniel Moore with CJS Securities. Your line is now open.

Good morning, gentlemen. Thanks for taking the questions.

Good morning, Dan.

Good morning, Dan.

Wanted to follow up on the first one, in terms of Asia, obviously exceptional growth there. Can you give us a little more color, Tom on what’s changing if anything? Is the verification story really starting to gain traction? Are you perhaps also being a little bit more aggressive on price? Any more color on the growth there would be great.

Well, I think certainly the notoriety of REPREVE continues to be relevant with brands and retailers, as the lower end of the market with chip and staple fiber is outpacing filament growth, although we are growing filament at a much lower rate than staple fiber and chip. We are seeking out new opportunities, and even our REPREVE chip is higher grade than most people need for recycled applications. As I’ve mentioned before on the last call, we’re seeking other mill or supply chain partners, and over time, we expect to see some improvement in our margin even on the lower end.

Hey, Dan, this is Al. One thing I have noticed is many of the companies that we work with, either retail or brand, are now getting closer to those commitments that they’ve made on environmental sustainability. You see some of these big retailers by 2023 or 2025 have commitments on the percentage of their apparel that’s going to be made from recycled materials. There’s no doubt that that’s stepping up and many of them are supplied from Asia. We have a relatively small share of the business over there, so we will be aggressively going after the business. At some point, our innovation will help us make that up in margin.

Very helpful.

And also, there’s another thing to keep in mind. We are asset-light in Asia. Any sale and any volume that we can move at a positive margin is a benefit to our results.

Understood. Taking a step back, overall revenue down slightly, obviously had the one fewer week but, you know, despite 16% volume growth. In terms of pricing, is it possible to rank order or to give color in terms of the impact of mix versus any competitive pressure versus just the pass-through of raw material prices? Is it really just lower raw materials, number one, and then maybe mix? Just a color on that would be great.

Yeah, Dan, this is Craig. I think you’re on the right track there. There were definitely some impacts that we pointed out in our prepared comments. Both Polyester and Nylon were impacted by that one week less sales, and that’s a big impact. If you do the math, I mean, roughly we’re saying it’s about 7% or 8% of a difference because of that one less week. So that was significant for those two units. The other units, as we pointed out, were impacted by competitive pricing pressures, specifically in Brazil. As Tom mentioned, we are being aggressive in Asia, and we have a lot of runway to take share there. I think it’s a little bit of a different story within each segment, but those are the main components you’re looking for.

Just a little more color on that. Look at it in three or four different geographies. That’s the way I feel like we need to look at the businesses in geographies, otherwise, it gets very complicated. Brazil had raw material increases that caused us to have to be competitive, and I think that $2.3 million of our $2.6 million miss on gross profit is all Brazil. Then you look at Central America and Asia, where our business is strong and we have a low share, but we’re gaining share. We’re willing to spend a couple of share points to go get that business. In the U.S., we actually picked up some business from the antidumping, a small amount, but we were offset by a fairly high margin product in North America that is in the Automotive and Industrial category. Our customers are experiencing tough sales in the first part of the year and they’re explaining it by the uncertainty with the China-US trade negotiations. We hope to see improvement in the next couple of months.

Very helpful. And lastly, I know it’s a challenging question, but within the PVA portfolio, you have a lot of moving parts including the mix shift to chip and staple fiber. Is there an inflection point a year or two out when you would expect to see margins for PVA start to improve again, just gross margins within PVA, or is that just difficult to say at this point? Thanks for the color.

Yeah, we believe that the driver for margins in our PVA and REPREVE portfolio is all about innovation. That’s just innovation that we currently have in the pipeline and future innovation. In some instances, these things take 12 months to 18 months to come to fruition and get an actual program up and running to get it to retail.

And our sales forecast for margin for the balance of the year is positive.

Very good. Good progress. Appreciate the color – thank you very much.

Thank you, Dan.

Thank you. Our next question comes from the line of Marco Rodriguez with Stonegate Capital Markets. Your line is now open.

Good morning guys. Thank you for taking my questions.

Hey, Marco. Good morning.

Hey, I was going to follow up here on the Asia line of questioning, specific to the margin and the mix. Just wondered if maybe you can provide a little bit more color in terms of what has been driving the mix shift more towards chip and filament versus your higher margined PVA product?

Marco, this is Tom. One thing to keep in mind is that the staple category is much larger than the filament category. It was one that we were not in two or three years ago, which we’ve developed in Asia. There are just so many opportunities on the staple fiber side and also chip; more and more people want the chip to be able to span REPREVE and sell the product under the REPREVE brand, and those are the primary reasons.

And can you then maybe talk a little bit more in terms of you had some comments that innovation that’s coming down the pipe or that you’ve already started to put into your products on the chip and stable fiber side that should help margins progress higher? Can you talk a little bit about how that sort of impacts and what a 12 to 18-month timeframe from today would look like in terms of stabilization or increasing gross margins for Asia?

Well, I think it goes back to the partner, innovate, and build strategy. We are working on the supply chain outside of China for a better cost position on raw materials. We’re working on innovation with the brands and retailers on things that potentially will come to market here in the next 12 months, 18 months, and just building stronger relationships and expanding on with new customers and working with customers that we haven’t worked with in the past. We think a culmination of all that is going to lead us to better margins and better results in our Asia operation.

I’d add that we’re very close with the new supply chain partner in Asia, which is going to be very positive for our business, supply as well as cost. And I’d also say some of the innovations will be coming into play more in the second half of this year than in the first half.

Understood. And then switching gears here on the expense side. On the SG&A, a couple of comments that you made in terms of some additional investments in the latter part of the year. If you can maybe talk a little bit about what those efforts are and timing-wise? And then also just real quick on the current quarter SG&A. Were there any sort of timing issues or maybe some expenses didn’t get spent in that quarter?

Yeah, I think for the balance of the year, I do think that we will see SG&A continue to move up slightly, again, all within the context of having a full year SG&A that’s around that $51 million. There will be some further investments in certain areas. A couple that comes to mind would be in the marketing areas and some other areas that we have some programs that we feel are very targeted and worthwhile to give us both short-term and long-term benefits. We’ll see some additional spending in that area. There wasn’t really nothing that unusual during the current quarter that needed to be called out separately or that we held back unnecessarily on. So it was a pretty typical quarter from that perspective.

Yeah, we feel confident in that $50-$51 million. We won’t let it get higher than that. I would say that there are a couple of marketing opportunities that we got to look at, but we’re also doing a very good job this last quarter and we’ll continue on inventory management, reducing costs, and watching every penny we spend so that we have resources to spend in the future.

Got it, and last quick question, if I may. You made a comment earlier in your prepared remarks about the U.S. side at least looking for or anticipating improvements as the year sort of unfolds from the domestic market. I know you’ve called out that Auto and Industrials have been weak and impacted your Polyester side. Is the commentary from the Autos and Industrials where you said that you thought that maybe the tariff impacts would kind of abate here in the next couple of quarters the main driver there or are there other things that you’re sort of seeing there that has given you confidence in the U.S. market?

No, I think there are two separate issues. There’s definitely uncertainty in the marketplace because of the tariffs that have affected the Industrials and Automotive, and hopefully they will subside. In the Americas, specifically in Central America, investments are going on today, people are expanding our capacity, we’re regaining market share down there, and we feel very excited about what’s going on in Central America. We believe that once the tariff situation is abated, we will see gradual improvement here in the U.S. as well.

You know, for a little more on that, we’ve visited with customers. I don’t want to mention who they are, but they’re in the Auto and Industrials segment. They often don’t know what’s causing the depressed volume in this first quarter. When you probe a little further, it seems that there is uncertainty in the market; they can’t pinpoint it, but it is in Automotive and Industrial. It doesn’t appear to be any systemic reason for their decline. We think when there’s more certainty in trade, they’ll see their business come back. We’ve found out from a few customers that their sales were up at retail, and their inventories were significantly down. These are retailers, and I know of at least three or four big ones that are having the same success in reducing their inventory and keeping their comps up. That is definitely having some impact on this. We don’t have an exact projection on this. My belief is that we will see it come around, hopefully this quarter; if not this quarter, in the second half of the year.

Got it. That’s great color. Appreciate your time, guys.

Thank you.

Okay. Thank you, Marco.

Thank you. And there are no further questions in the queue at this time.

Okay. Thank you, Sarah. If there are no further questions, we’d like to thank everyone for participating today. Our next earnings release for the second fiscal quarter ending December 29, 2019, is tentatively scheduled for Wednesday, January 29, 2020, with the conference call to follow that same day at 8:00 AM Eastern Time. Thank you for joining today’s call.

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.