Unifi Inc (UFI) Q2 2021 Earnings Call Transcript

Good morning, ladies and gentlemen. And welcome to the Second Quarter 2021 Unifi, Inc. Earnings Conference Call. At this time, all participant lines are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host Mr. A.J. Eaker, Vice President of Finance. Sir, the floor is yours.

Thank you, and good morning, everyone. On the call today is Al Carey, Executive Chairman; Eddie Ingle, Chief Executive 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 by clicking the 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 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 EPS, adjusted working capital and net debt may be discussed on this call. I will now turn the call over to Al Carey.

Thank you, A.J., and thanks for everyone joining the call this morning. I will be brief in my remarks and I will provide you with the broad themes of what we have seen in the first half of fiscal 2021. Q2 was a very positive quarter for us, as we saw a nice recovery from the COVID impact. We still have plenty of work to do, but this quarter was a strong step forward. While our revenue was slightly below the prior year, it was better than our internal expectations, and both November and December revenues were above the prior year. Our adjusted EBITDA performance was very strong; it was double compared to a year ago. We had some tailwinds and upsides in a few areas, particularly from our Brazil segment. But even after you normalize those items, we still performed significantly better than the prior year. Our balance sheet continues to show improvement, inventory levels, cash, and net debt are all in a good position. As you look into the second half of 2021, we are optimistic. However, we aren’t entirely certain about the most recent spike in COVID cases and how it might impact retail consumption or our people in the plants. We believe the good news on the vaccines should create some optimism for future quarter performance. I wanted to comment on two broad positives outside of the financials. First, we have the right leadership team in place from top to bottom. Our team brings a significant amount of company and industry knowledge. They have shown resilience during this COVID time. We work well together and are beginning to see the value of leadership continuity in our performance. The second positive trend appears to be an acceleration of momentum on environmentally sustainable products from our customers and consumers who feel that they want to do something positive for our environment coming out of this pandemic, which shows up in our mix for REPREVE. Our sales mix for REPREVE has maintained an upward trend and has moved now to a record level of 37% in Q2 from 35% in the last quarter and in the high 20s a year ago. Additionally, the request for our REPREVE hang tags has significantly increased. In the last six months, we shipped 45 million hang tags compared to 33 million a year ago, which is up a third. We believe many of our customers are now taking action on sustainability commitments that they made for 2025. These environmental goals are to be accomplished by our customers and the date is getting closer. Overall, environmental sustainability is a megatrend that is only going to increase, whether discussing brands, public policy, or society. In summary, Q2 was a very solid quarter with nice momentum. Now, before I turn it over to Eddie, I am pleased to announce the addition of Emma Battle to our Board of Directors. Emma has extensive marketing background, general management, and strategy experience. She has had experience with companies like PepsiCo, Hanesbrands, Red Hat, and today, she’s the Founder and CEO of MarketVigor, a marketing company. Emma brings a skill set that’s very complementary to our Board, and we are delighted to have her on the Unifi team. So, with that, let me turn it over to Eddie Ingle, our CEO.

Thanks, Al, and good morning, everyone. As Al mentioned, our second quarter fiscal 2021 results outperformed our initial expectations and reflect our strong global presence and the resilience of our employees and our business model. Before I speak about the quarter, I want to personally thank our employees for their continued hard work and dedication to the business and especially their dedication to our customers. This strong quarter would not have been possible without their many contributions. I am very pleased to report that the health and safety protocols we put in place at the beginning of the pandemic allowed us to maintain normal operations, positioning us well for further recovery. The business performed well during the second quarter and is approaching pre-pandemic revenue levels. Q2 revenues were up 15% from Q1, with meaningful improvement across all segments and geographies. The flexibility of our global business model and its innovative components continue to allow us to adapt and quickly capitalize on new efficiencies and market share opportunities. Key drivers to the 670-basis-point increase in gross margin year-over-year have included our continued focus on cost, outperformance by the Brazilian segments, and the expansion of our REPREVE and other innovative products. Despite a challenging environment, our team’s dedication and hard work contributed to Unifi achieving its best quarterly profits since June 2016 and the best second-quarter profitability in 10 years. The demand for sustainable solutions continues to grow along with interest in our REPREVE fibers, including multiple new customer adoptions and co-branding opportunities, which are increasing REPREVE’s contribution to sales. REPREVE Fiber sales now represent a record 37% of consolidated net sales, compared to 35% in the previous quarter. While these Q2 results will be hard to sustain in the short term, it’s clear that the COVID crisis has enabled our organization to find new efficiencies and drive ongoing productivity across our manufacturing platforms while pursuing market share opportunities as they arise. It’s certainly an exciting time for everyone in the company, and I am looking forward to building on our current performance long-term. Our work towards strengthening our balance sheet has allowed us to execute on growth-focused capital allocation priorities. Shortly after the second fiscal quarter ended, we made the strategic acquisition of Fiber and Yarn Products, Inc.’s Nylon portfolio. We expect a quick and seamless integration process as this business transitions to our Madison, North Carolina operations. We have several exciting brand highlights to discuss today, including our partnership with Disney. For the holiday season, Disney launched t-shirts and face masks in their Orlando Parks stores, prominently displaying REPREVE signage. Another notable success is the towel program at Nordstrom, which was developed through our Turkey supply chain operations. We are humbled and excited by the expansion opportunities we have with leading global brands, enhancing our relationships and building on sustainable practices. I will provide some high-level comments on our operating segment performance during the second quarter before Craig takes you through more specific details. The Polyester segment benefited from a better production and sales mix, along with raw material and pricing stability. Brazil had a record second quarter, driven by our unique market position. We do expect some moderation of our profit growth in the region, given how strong it has been recently. The local Brazilian team continues to work to maintain and expand the solid market share they have captured. Lastly, the Nylon segment’s performance met our expectations for the quarter, showing a balanced sales level. With that, I will turn it over to Craig.

Thank you, Eddie, and good morning, everyone. Like the rest of the team, I am very pleased with our second quarter of fiscal 2021 results and our ability to navigate this recovery with strong cash and liquidity position. I will provide our normal commentary on the completed quarter compared to the same period in the prior year. We are pleased the business has recovered significantly, making the information presented meaningful again. Let’s start with a sales comparison. Polyester segment volumes were just 1.1% lower than the prior year, and raw material costs drove prices down, though partially offset by a richer sales mix generating a 7.3% decrease in net sales. The Asia segment showed lower volumes negatively impacted by 8.1%, generating an overall 6.7% decrease in net sales. Brazil segment outperformed with a 21.7% growth from higher volumes, supported by strong pricing. The Nylon segment exhibited stability, with revenues just 6.3% below the prior year, following sales mix changes. All segments exhibited an increase in gross profit. The Polyester segment benefited from a favorable raw material and pricing environment achieving a gross margin of 14.2%. The Asian segment saw improvements driving gross margin to 14.6%. The Brazil segment again with its outperformance doubled both gross profit dollars and gross profit percentage year-over-year by gaining market share. Unifi's overall gross profit was $25.9 million, reflecting a 670-basis-point increase in gross margin. As we move down the income statement, our SG&A remains consistent with expectations, leading to strong operating income and significant improvements in pretax income, net income, and EPS. Further improvements in our debt and equity positions are demonstrated by diligence around working capital and cash flows. We continue to have zero borrowings on our ABL revolver, with an availability of $56 million. Unifi’s commitment to financial health has allowed us to leverage our strong balance sheet. We will continue to allocate capital towards new texturing technology in the Americas. With our balanced capital allocation, share repurchases and further debt reduction can occur at appropriate times. I will now turn the call back to Eddie.

Thank you, Craig. I will now turn to provide a brief update on the recent trade developments. In short, after normalization for China and India imports, imports of polyester textured yarn surged from Indonesia, Malaysia, Thailand, and Vietnam. We petitioned for an investigation into this activity, and U.S. agencies have thus far determined there’s a reasonable indication of material injury. We expect these investigations to occur throughout 2021. I will provide context around our expectations for the back half of fiscal 2021. Our business visibility is returning to more normal levels, but we can’t offer the specificity prior to the pandemic. Yet we expect net sales trends to continue improving sequentially in the March quarter due to sustained momentum in REPREVE and other value-added products. Adjusted EBITDA is also expected to improve by low double-digit percentage over the pre-pandemic third quarter of fiscal 2020. This will include strong performance from Brazil, tempered by seasonal domestic shutdown impacts for Polyester and Nylon segments and raw material cost pressures due to recent increases in petroleum prices. Lastly, our annual CapEx spend should range from $22 million to $24 million, excluding acquisitions. To conclude, our strong performance in the second quarter reflects our unique business model. We will continue focusing on sustainable products to drive organic growth and maintain our strong financial position for future M&A opportunities.

Thank you, sir. You have your first question from the line of Daniel Moore from CJS Securities. Please go ahead.

Thank you. Good morning, gentlemen. Thanks for taking the questions. I want to start with the macro perspective. Do you see COVID, perhaps aided by the recent change in administration, as a tipping point for product co-branding opportunities for REPREVE? Can you talk about the rate of change you've seen over the last nine months and heading into 2021?

We do believe the COVID pandemic has affected consumer mindsets and how brands approach communication with their consumers. There’s a megatrend of sustainability, and the general consumer is trying to do what they can for the environment, reflecting an indication of the climate situation we are in. It’s good for us that there’s a movement towards sustainable products, and REPREVE shipments reflect that environment.

When COVID first hit, there was a concern that environmental sustainable products might go backwards. However, around August, we observed a definite change in the trajectory of environmental sustainability among our customers. Big brands and customers are now focusing heavily on sustainability, especially as we approach the 2025 timeframe for their commitments.

That’s helpful. Let's dig into the gross margin. Specifically, for Brazil, could you walk us through the factors impacting that improvement? How much of it is sustainable in the next quarter or two?

Brazil has been preparing for the last 20 years to react to the pandemic. They supported their raw material inventory, which allowed them to supply the market when business returned. We managed price points effectively to meet market demand. While this was a record quarter for gross profitability, we expect it to moderate in the coming quarters. However, we have grown market share in Brazil and expect to maintain it going forward.

Excellent operational performance from the Brazil team helped us gain market share. As we recover, we expect gross margins will trend back toward previous levels but we are proud of how they performed in this quarter.

What about the Polyester segment? Can you rank the factors impacting gross margins from most to least in this quarter?

We took significant costs out of the Polyester business during the pandemic, which allowed us to maintain a lower level of costs. This combined with an improved product mix has allowed us to expand margins compared to previous years.

Regarding acquisitions, do we expect more in the Nylon space and what does the M&A pipeline look like more generally?

The two acquisitions were small but strategically important. We expect to realize growth in revenue and margin from these. We are on the lookout for more opportunities that fit our capabilities, but there are no specific plans at this time.

Good morning. Congratulations on a great quarter. Can you discuss sustainability and how your competitive landscape is evolving given the 2025 goals?

Brands like Adidas aim for 100% recycled content for their apparel by 2025. Our REPREVE brand is traceable and facilitates reliable sourcing globally, giving us an advantageous position. Our asset-light model in Asia allows us to meet increased demand without issuing capacity constraints. We will continue supporting the growth of REPREVE with existing capabilities while planning for future investments.

As things normalize, how do you expect the mix of products to change? Will the positive trends seen during the pandemic continue?

As schools reopen, we expect a boost in apparel sales. Additionally, societal trends have shifted towards more casual attire. We believe this will benefit us moving forward.

Can you discuss your outlook for Q4 and whether we should expect continued improvements?

For Q4, while we expect strong performance, we are unlikely to provide further specifics at this point. However, based on current trends, we anticipate Q4 to be strong.

With no further questions, we would like to thank everyone for participating today. Our next earnings release for the third fiscal quarter ending March 28, 2021, is tentatively scheduled for Wednesday, April 28, 2021, after the close of the market with a conference call to follow the next morning, Thursday, April 29, 2021, at 8:30 a.m. Eastern Time. Thank you all for joining today’s call.

Ladies and gentlemen, this concludes today’s conference. Thank you for your participation and have a wonderful day. You may all disconnect.