Unifi Inc Q4 FY2020 Earnings Call

Thank you all for joining us for the Q4 2020 Unifi, Inc. Earnings Conference Call. I will now turn the call over to A.J. Eaker, Vice President of Finance. Please proceed.

Thank you, operator, and good morning, everyone. On the call today is Al Carey, Executive Chairman; Eddie Ingle, Chief Executive Officer; Tom Caudle, President and Chief Operating Officer; and Craig 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 fourth 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/or 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 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 net income, adjusted EPS, adjusted working capital and net debt may be discussed on this call. Lastly, please be advised that in consideration of COVID-19 safety measures, the speakers today are utilizing multiple telephone lines. Efficiency for this call may be impacted. I will now turn the call over to Al Carey.

Well, good morning, everyone, and thanks for joining us. I'm going to use Slide 3 in the presentation as a bit of a backdrop for my comments. So I'll start by telling you a little bit about the first three quarters of fiscal 2020 we feel were progressing extremely well prior to the economic shutdowns from COVID-19, which happened at the beginning of our fourth quarter. We made very good progress on the four big priorities that we identified last summer. Those were terrific growth in our Asian business, which is that asset-light model. We began to pick up market share and sales in North America due to the anti-dumping regulations that we spoke about quite a bit and finally began to materialize. REPREVE continued to have momentum from our customers since they were very focused on their ESG goals, and we continued our cost reduction measures successfully. So that's the status going into Q4 and at that time was the beginning of the crisis, the pandemic. The apparel and automotive customers either shut down or significantly curtailed operations at that time, and we saw a corresponding significant drop-off in sales, negatively impacting our operating income as well. So with all that going on, our team decided, let's control what we can control. Our management team took on the task of protecting our liquidity and prioritizing cash generation. I think they did a very good job with both of those. The sale of our share of the Parkdale joint venture allowed us to pay down a significant part of our debt. We generated cash during a quarter of significantly low demand, and we reduced our operating cost and took down inventory levels. I believe all these moves are going to set us up for becoming a stronger company once COVID ends. While sales were hit hard, we have seen sequential improvement every single month since March. April was the low point, May improved from April, June better than May, and July was the best. Even the first two weeks of August have seen another improvement. It's difficult to accurately forecast how fast things are going to come back for the top line because of the uncertainties of the pandemic. But we're very confident that we'll be able to get the top line and profit momentum back to the levels we had through the first three quarters of 2020. The last thing I'll say is I feel very good about the strong team that we've developed at Unifi since last summer. Some of you may remember, we went through quite a bit of change. In September, Craig Creaturo joined us, and he's doing an excellent job in a short period. Eddie Ingle joined us on June 15 as our new CEO. His return to Unifi has been applauded by all our people. It’s not like we have a new CEO. He has a 30-year background at Unifi, which is really coming in handy already. With all this going on, Tom Caudle is retiring; he is on the phone with us today. He will be answering some questions, but he's retiring after an exemplary 40-year career at Unifi. We get a chance to hang on to Tom for some time to take advantage of his experience and wisdom for the next year. I believe we're very well positioned for the future. And I'll turn it over now to our new CEO, Eddie Ingle, to take you through some of the materials.

Thanks, Al, and hello, everybody. I'm very excited to be rejoining Unifi at such a pivotal and unusual time for the company. In the short time that I've been in the office, I've already settled back into an organization that, obviously, I know so well and have quickly reconnected with the leaders and my friends and colleagues. It's almost like coming back home. I'm very grateful for the supportive handover of the reins by Tom and his continued support for me as CEO of the company. Over the last couple of months, I've been asked by many people why I returned. I returned to Unifi because of my steadfast belief in its people, its innovative mindset, and the core value that everything we do here at Unifi is for the good of tomorrow. Prior to leaving Unifi, I was heavily involved in introducing and growing our signature performance fiber, REPREVE. Today, I believe sustainability is the cornerstone of Unifi's future growth, and our innovative culture makes us the partner of choice for leading global brands around the world who are seeking to meet their sustainability goals. At Unifi, we take pride in our efforts to eliminate waste and wasted resources, and we'll continue to invest in expanding the reach of our innovative sustainable solutions. While this pandemic has created much uncertainty, I'm confident in one of Unifi's core strengths: the ability to adapt. Over the 30 years I've spent with the company, I've seen our people adjust to changing markets and very difficult circumstances, and in every instance, they rise to the occasion. Time and time again, our people have proven their resiliency and have adjusted to evolving market dynamics. History shows that after every crisis, we come out stronger because our people are flexible, nimble, and learned how to adapt. You can see from our Q4 results, which Craig will describe in detail next, that the COVID-19 pandemic resulted in a 52% drop in sales. However, we see this as a temporary situation, and there are many reasons why. First, consumers are rapidly adapting to the new normal and, in certain end markets, are ignoring the pandemic and utilizing their cash reserves to buy big-ticket items. For example, U.S. car sales, which were down 35% in April and 5% in May, saw sales in June 2020 beat June 2019 sales. During this period, automobile inventories grew and quickly dropped to normal levels as a result of plant closures. We hope these are signs of stabilization in the industry, and we will continue to monitor these developments with our customers. Additionally, we are seeing renewed interest in some of our new innovative yarns made with REPREVE, as each automobile company tries to differentiate themselves in the market. This is driven largely by innovation and the disruption caused by the electric vehicle markets. Surprisingly, this translates into new demand for sustainable offerings with performance benefits. Through this crisis, Unifi has been able to deliver on the most arduous performance requests incorporated into our REPREVE yarns, and I'm pleased to note that in July we've experienced an increase in our pounds sold into the automotive market. The second point I'd like to make is that consumers are finding new ways to buy products, especially in sports apparel and comfort wear, with most retailers and brands reporting record online sales. We've seen from the financial results of leading sports and apparel brands that they too had a difficult June quarter; however, there is sentiment around a rapid recovery of that sales volume. At the beginning of July, we restarted our operations in El Salvador and once again began servicing the reopened branded apparel Central American markets from that facility. Additionally, we saw demand from both China and Brazil beginning to claw their way back towards pre-COVID levels. We assume this is driven by brands beginning to fill the supply chains as the consumer returns to business. The third point I want to discuss is in the area of personal protective equipment or PPE. In the U.S., there's a drive to build a stockpile of PPE, some of which is driven by the U.S. government, but much of it is also by the private sector. While the first round of government programs are coming to an end, additional bids are being offered to the market as we speak. We expect our customers to win many of these programs, which should, in turn, benefit Unifi. From April to July, it is estimated that 10% to 15% of our North and Central America revenues came from some form of public or private PPE programs, up from an estimated 2% to 3% pre-COVID. The fourth commercial focus of ours is the Nylon business. The Nylon business was impacted more severely than our Polyester business; however, we did see some bright spots in the PPE market as many protective reusable masks sold in the market have been made using Nylon. We quickly supplied that new market. We also experienced some benefits in the medical markets. Our textured Nylon and covered Nylon yarns serve several of those applications. It comes as no surprise that our ladies hosiery business slowed down considerably during the quarter due to reduced social gatherings, canceled weddings, and diminished opportunities to wear ladies hosiery. This was offset in part by an increase in our sock market. In July, we've seen a slight increase in some of the apparel and footwear markets the Nylon business serves. Looking back several years, many would say the Nylon and apparel markets have been starved of innovation. However, there's a growing interest in our REPREVE Nylon offering, both in the U.S. and in Asia. This indicates that consumers and brands remember the softness and strength of Nylon yarns, making them ideal next-to-skin products. The last point I want to cover is around the consumer experience. For the period from April through June, when our customers were most fearful of their business, their employees, and their customers, we stood by them. Our team delivered a customer experience that was second to none. I'm proud of our people for not being distracted and allowing our different environments to impact how we treated our customers. For that, I'd like to publicly thank them. Like most companies, our visibility beyond the near term, the next 1 to 2 months, remains restricted. We focus on controlling what is within our ability. As Al pointed out, we have reduced costs where possible, ensuring we have ample liquidity as well as a strong balance sheet to weather these uncertainties. Visibility of volumes for our Q2 and Q4 period is narrow. However, based on the recent uptick in volumes we're seeing and published reports from some brands, along with the belief that a vaccine could be available in the next 6 to 9 months, we see no reason why our run rate for revenue and profitability should not return to normal pre-COVID levels by the end of our fiscal 2021. We expect a steady uphill climb as we move through fiscal year, but we have the right balance sheet to protect us, should demand slip for any reason during this terrible event. I'll now turn the call over to Craig. Thank you.

Thank you, Eddie, and good morning, everyone. Like the rest of the team, I am excited to have Eddie at Unifi and look forward to growing the business together. As Eddie noted and as we forecasted in our call on May 1, 2020, the COVID-19 pandemic has had a significant impact on demand around the globe and for the textile industry, especially apparel. In this stifled demand environment, our U.S. operations are challenged by lower fixed cost absorption, but our model in Asia proved strong through its agility. Al and Eddie provided a great overview of fiscal 2020, and I would like to add just a few thoughts. Our efforts in fiscal 2020 focused on improvements over fiscal 2019, which included a lower SG&A run rate, a better raw material cost environment, and the first signs of success from our recent trade actions. Fiscal 2020 was shaping up to be a great year from an income statement perspective until demand and economic activity dropped quickly due to the COVID-19 pandemic. Despite the pandemic headwinds, we generated significant operating cash flows in both the fourth quarter and the full year of fiscal 2020. We then drove down net debt even further with our divestiture of the Parkdale America business. Although we described this transaction in our last earnings conference call, it closed during the fourth quarter and is reflected in this quarter's financial results. Let's walk through that transaction briefly on Slide 5. We received $60 million in cash, which improved our net debt by the same amount in Q4, and we applied approximately half of the proceeds directly to debt paydown. This transaction allowed us to eliminate all borrowings on our ABL revolver. With this transaction completed, we can focus our full efforts on expanding our leadership position in recycled and synthetic polyester and nylon fibers, while providing additional flexibility and liquidity for long-term opportunities and short-term needs during this pandemic. While our joint venture relationship with Parkdale Incorporated has ceased after 22 years, we continue to have other business interactions with Parkdale Incorporated. On Slide 6, I will provide an update on our liquidity position. Compared to the end of fiscal 2019, our liquidity position has improved substantially, as noted by the following: the ABL revolver balance was reduced to zero; total debt principal fell below $100 million; cash and cash equivalents rose to $75 million; revolver availability was $56 million; and we have not requested any changes or concessions to our debt covenants or repayment terms. This results in a net debt position below $25 million, a level unseen in many years, and liquidity in excess of $100 million. After strong operating cash flow generation and the Parkdale divestiture on June 28, 2020, approximately 54% of our $75 million of cash were held by our domestic operations. This improved from 0% at the end of fiscal 2019. This provides us reserves for weathering the rest of the economic uncertainty surrounding the pandemic. I will now turn to Slide 7 of the presentation and review the net sales performance for the fourth quarter. Consolidated net sales declined from $179.5 million in Q4 fiscal 2019 to $86.1 million for Q4 of fiscal 2020, a 52.1% decrease, almost entirely a result of stifled demand for textile products related to the pandemic. The polyester segment experienced a revenue decline of 46.2%, primarily attributable to lower volume, including a price and sales mix decline of 16%. The average selling price decline primarily follows the year-over-year decline in polyester raw material costs. The Asia segment experienced a revenue decline of 49.7%, of which 50.8% was attributable to lower sales volume. However, it had strong pull-through on settlement programs during the fourth quarter, driving a sales mix benefit despite lower polyester raw material costs. The Brazil segment experienced a stark decline in economic activity during the June 2020 quarter, along with heavy foreign exchange pressures, generating an overall revenue decline of 72.8%. Lastly, the nylon segment experienced a 56.6% revenue decline. We note that both the nylon segment and the polyester segment benefited from fabric face mask and gown production from many customers. However, this PPE demand was not enough to offset the decline in overall global apparel. On Slide 8, we will discuss gross profit performance. Consolidated gross loss of $9.5 million in the fourth quarter of fiscal 2020 was due to a significant decline in demand, which led to weak fixed cost absorption for our capital-intensive operations in the U.S. and Brazil. Conversely, the Asia segment demonstrated strength and agility in that region, contributing positive gross profit. Even though we quickly undertook numerous actions during the just completed quarter, including rolling production curtailments in the U.S. and Brazil, as well as temporary and permanent headcount reductions, these actions could not fully overcome the financial impact of volume reductions. The polyester segment was impacted the most from COVID-19 as it is the largest and most asset-intensive segment. When production volume declined to the levels experienced in Q4, some costs could no longer be allocated to inventory. Consequently, the cost of sales increased at a higher per unit rate compared to a normal production period. The polyester segment reported a gross loss of $9.4 million. The Asia segment showed strength in the quarter. Although sales volumes were significantly reduced, the segment experienced a richer sales mix with greater filament pull-through, achieving a gross profit of $2.3 million. For the Brazil segment, margins decreased as demand fell with the local economy, and gross profit was $0.2 million. Lastly, the nylon segment was impacted similarly to the polyester segment, as low sales volumes in Q4 did not allow for adequate fixed cost absorption, resulting in a gross loss of $2.5 million. I will now pass the call back to Eddie to discuss our transition to reporting REPREVE fiber sales on Slide 9, along with our assumptions for fiscal 2021 on Slide 10.

Thanks, Craig. We spend a great deal of time educating everyone on the value of REPREVE and how it aligns with many sustainability goals present today. As stated earlier, I was integral in bringing REPREVE to life with the team more than a decade ago and spent much of my prior time at Unifi establishing the brand, the supply chain and its growth. We are transitioning from reporting the proportion of premium value-added or PVA sales as a percentage of consolidated revenue to reporting the proportion of pre-fiber sales as a percentage of consolidated revenue. Unifi has long been a textile fibers leader, and reporting a pre-fiber sales allows for better tracking against our goal of growing the global share of REPREVE using apparel and other end markets. Slide 9 provides the current and historical view of pre-fiber and PVA sales percentages. Now turning to Slide 10 of the presentation. As we look ahead, it is important to understand that the medium- to long-term underlying fundamentals that drive our business remain in place. Barring no significant government shutdowns driven by a rise or resurgence in pandemic activities, we believe that the near term should exhibit the following. Certainly, we will have pressure on immediate sales and profitability given the slow rate of recovery in our core end markets. Quarterly growth should be in line with most of our end markets. We do anticipate quarter-over-quarter sequential improvement in our results for fiscal 2021 and working capital will naturally increase as the recovery takes hold. Looking beyond the pandemic and more in the long term, we believe sustainability is here to stay, and the current environment will accelerate these trends as a younger generation demands accountability. We expect REPREVE to grow globally as companies work to meet existing and new sustainability goals. We already support the world's leading progressive brands and continue having daily conversations with potential new customers that recognize the immediacy of the situation and the benefits of REPREVE. As Craig mentioned, our recent trade actions are currently in place and should provide benefits to sales volumes and cost absorption in the U.S. for an extended period of time. We believe the sum total of these concepts should fuel a return to growth by the end of fiscal 2021. I'm incredibly proud to be back at Unifi and look forward to leading this company towards achieving its growth potential. We have the right team, the right focus, and the right footprint in place to drive long-term growth and shareholder value. I'm looking forward to taking advantage of the opportunities that lie ahead for all of us. Thank you. Randy, we will now open the lineup for questions.

Your first question comes from the line of Dan Moore with CJS Securities.

It's actually Lee Jagoda for Dan. So just starting, can you walk us through on both the Polyester side and maybe on the Asia side, just the cadence of volume declines and the improvement you saw in April, May, and June and maybe now into July? And then just following up on that. How far below pre-pandemic levels from a volume standpoint are we in July versus, again, prior?

Yes, I'll take that question, Lee. Thank you. As Al said in his script, we did see a significant shortfall in revenue in April; that was our worst month. As we went into May, things improved. June was better, and of course, we have seen improvements in July. Every month since April has presented significant improvements across the board. I can point to the three regions where we sell. Starting in Brazil, we were down 73%, as Craig pointed out. We're seeing that business bounce back to, I wouldn’t say normal levels, but much closer than we expected. Volatility in exchange rates scared off some traders, but we could locally supply the increase in demand when the retail environment opened. In Asia, particularly China, business has returned to normal post-pandemic. That’s why our gross profit is much stronger there than in any other region. While volumes are down, they are also coming back, and July is significantly better than June in that region. When I turn to the U.S., we have two parts of the business: U.S. and Central America. As stated, much of Central America was shut down throughout April, May, and June. We saw a huge revenue increase in July, driven from our plant in Central America. We have been shipping yarn down from the U.S., but with our El Salvador plant reopening, demand is increasing as supply chains needed to be filled for the power brands down there. It’s hard to give you an exact number, but if we assume August is slightly better than July, and September remains stable, we expect this to contribute to reaching EBITDA breakeven or exceeding that level. Thank you. I hope that answers your question.

It's very helpful. Just following up on that. Assuming that August improves compared to July and, for the sake of discussion, if volumes in September remain at the August level, is that enough volume to get you back to EBITDA breakeven or above? Or do you still need to see further improvement to cover more of those fixed costs?

Lee, this is Craig. I think Eddie probably framed it up pretty well. We see what's ahead of us for the next few weeks. The wildcard remains in September. All signs are continuing to point positively. We feel significant strides will be made relative to the quarter just completed, which was affected by lower sales. As we mentioned both in the script and in the release today, we incurred additional costs and couldn't allocate them or inventory. We think those will continue at lower rates through the end of the calendar year. We should see progress. Ultimately, it will rely on the last month of the quarter, where we will see how good of an improvement over Q1 of FY '21 is.

Okay. Fair enough. One more for me, and I'll hop back in here. Just Eddie, from a more strategic high-level perspective. Once the pandemic kind of gets past us and we return to some sense of normalcy, what are the things on your list that you plan to do differently or better than your predecessors to improve the business?

Thanks for that question. Let me answer that by first describing who I am. I am a numbers guy, but I'm not here on this call to talk about the numbers. Craig does a fantastic job at that. Instead, I would like to outline three different points. I have a growth mindset. I wasn’t brought back to maintain the business. You will see over the coming years that while we look to the future, we will seek to grow and take any opportunity we find. Much of these opportunities will be organic, but there may be some M&A down the road. Secondly, innovation is at the heart of Unifi. We are a technical and curious company, and my mindset aligns with that. We’ve seen our business grow not merely through commodities but through technical solutions that we provide to our customers. Lastly, people development is key. Companies say that people make the difference, and at Unifi, it’s certainly true. We will invest in our people over the next few years to help them reach their full potential. These three points—growth, innovation, people development—are all focused on what we call the good of tomorrow. We want to grow our business profitably, create value, and provide value to our customers through the team we have. Thank you.

Your next question comes from the line of Marco Rodriguez with Stonegate Capital.

I was wondering if you could discuss some strategically reduced costs that you've taken out in this last quarter. If you could walk through where those costs came out by segment, that would be helpful.

Sure. Good question, Marco. It was a combination of several things. There were some temporary costs that needed to be removed. As we discussed, we were able to implement rolling outages as customer demand dictated at various sites. We did not need to fully shut down any sites in the U.S. We handled this strategically, piece by piece, department by department, and line by line, and I credit both our management and our flexible workforce for achieving this. We did need to make some permanent headcount reductions, as that was necessary for the business level we were at. Additionally, we executed numerous discretionary reductions—obviously, doing what we needed to protect the balance sheet and minimize discretionary spending. Some of those reductions happened naturally due to fewer travel needs, while others required more effort. Finally, we took a more conservative approach to capital spending during the completed quarter, focusing on maintenance and safety items. This ensures we set ourselves up nicely with minimal projected capital spending in FY '21 and we should have a higher portion in the second half rather than the first half. I’ll ask Tom Caudle to add some comments for a better answer, Marco.

Marco, we were careful not to impair our ability to service our customers through these efforts. However, we did remove significant costs across all areas of the company, managing to keep all our U.S. facilities operational to meet customer needs. We take pride in that regard and in being here to service our customers throughout the pandemic situation during our fourth quarter.

Got it. Very helpful. I was also wondering if you could discuss some dynamics between your retail customers. It was obviously a very challenging quarter for everyone involved, especially since many brick-and-mortar locations were closed and consumer spending paused. However, it sounds like things are starting to recover for you. Based on conversations with your clothing retailers, how does the pricing situation look? Are they trying to extract more pricing pressure from you? Or are you willing to work with them because they are your important clients? Any color around pricing dynamics would be appreciated.

Yes, thanks for the question. It is interesting. The retail environment was largely shut down during April and May, starting to reopen in June in many states in the U.S. China opened much earlier, and Brazil began opening up in July. Throughout this time, as I mentioned in my remarks, we evolved our shopping habits, especially looking to online shopping, which created new purchasing opportunities. Regarding pricing, we have actually encountered limited pricing pressure. Everyone has been supportive of each other during this time. I'm sure pricing pressure will arise, but currently, the priority is to ensure customers receive the products they need when required. As Tom mentioned before, we've been here to support them, but pricing pressure has not been an issue presently. Thank you.

Got it. And Eddie, if you could describe your perspective— I understand you’ve only been back for a short time, and I heard your answer on your outlook—but are there things that you might take differently from the sales and marketing perspective to market REPREVE?

Yes, thanks for the question. We have been on the REPREVE journey for over a decade. An important focus that has emerged, especially in the last few months, is the circular economy. We will invest in developing circular solutions for brands so they can reintroduce their products back into the system. We have had a Textile Takeback Program for some time, and I expect that investing further will add defensibility to the REPREVE brand and offer much-needed solutions for our partners. You can expect to hear more about this as we progress. I hope that answers your question.

Yes, that's helpful. Lastly, from a cash flow perspective for fiscal ‘21, can you outline your expectations for operational cash flow and free cash flow?

Yes, Marco, we realize that although we took significant costs out of the business in the second half of FY 2020, we will need to fund the recovery of our customers by increasing investments in working capital, specifically accounts receivable. We expect growth in this area the quicker sales recover. We will maintain our focus on improving inventory levels. We made substantial progress, and we have room to improve as we enter FY ‘21. Overall, we expect it to be a good cash flow period. Looking ahead into FY ‘21, we don't foresee any major bumps needing us to seek additional liquidity or credit. We appreciate our good position; we have no borrowings on the revolver. At least for the next few quarters, we maintain that stance and expect to generate good working capital. We had a solid performance in FY ‘20 with $53 million of operational cash flow and reasonable capital spending. Overall, we should expect to see a favorable trajectory moving forward into FY ‘21.

There are no further questions. At this time, I would like to turn the call back over to management for closing remarks.

Thank you, Randy. With no further questions, we would like to thank everyone for participating today. Our next earnings release for the first quarter fiscal of September—which ends September 27, 2020—is tentatively scheduled for Monday, October 26, 2020, after the market close, with a conference call to follow the next morning, Tuesday, October 27, 2020, at 8:30 Eastern Time. Thank you for joining today's call.

This concludes today's conference call. You may now disconnect.