Unifi Inc Q4 FY2022 Earnings Call

Good morning. My name is Briana, and I will be your conference operator today. I would like to welcome everyone to Unifi's Fourth Quarter Fiscal 2022 Conference Call. All lines have been muted to avoid any background noise. After the speakers' remarks, there will be a question-and-answer session. I will now turn the call over to your host, A.J. Eaker, Vice President of Finance. You may begin your call.

Thank you, Briana, and good morning, everyone. On the call today is Al Carey, Executive Chairman; Eddie Ingle, Chief Executive Officer; and Craig Creator, Chief Financial Officer. During this call, management will be referencing a webcast presentation that can be found in the Investor Relations section of our website, unifi.com. Please turn to Page 2 of the slide deck for our cautionary statements. 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. Lastly, I direct your attention to Slide 3 and remind our audience that we changed our segment reporting to align with recent organizational changes. In the fourth quarter of fiscal 2022, Unifi performed its annual segment evaluation and determined that three geographic segments best represent the composition of the business and the management approach under U.S. generally accepted accounting principles. Accordingly, Unifi is now reporting the Americas, Brazil and Asia segments. You may find quarterly and annual historical financial information using the updated segment methodology on Slides 11 and 12. I will now turn the call over to Al Carey.

Well, thank you, A.J., and thanks to everybody who's joining the call this morning. I'm going to take just a couple of minutes to tell you how we're viewing our business at the start of our new fiscal year. And then I'll turn it over to Eddie and Craig; we're going to take you through the details of our performance for Q4 and how the full fiscal year of 2022 ended. So, I'll start with the Q4. We had very good revenue growth for the fourth quarter. We achieved $218 million in revenue, which is a little better than what we expected. That's 18% growth above a year ago, but that's despite Asia being down by 17% due to the COVID lockdowns that took most of the quarter. That means the rest of our business was up 30%. The Q4 performance allowed us to push the total fiscal year sales above $800 million. And that's the best sales performance this company has had in many, many years, and Craig will talk about that a little bit later on. Q4 performance had two highlights. One is REPREVE continues to be a success with our customers, and also our ability to cover cost increases with pricing. So that's the top line. On the bottom line, we had EBITDA of $12.2 million for Q4, which is right in line with what we were talking about in our forecast. We would have liked to have been better, but we were required to cover the downsides that came at us in the quarter, which was the China COVID lockdown, which is no small thing. And then the spike from raw material pricing that happened in the middle of June, which didn't give us much time to react. So essentially, we had a very strong revenue growth, top line and a respectable bottom line. And if you took those two surprises that we had that were beyond our control, if we took those out of the profit picture, we actually would have had a very strong profit performance. So let me move to Q1. All of us have heard comments from the retail community about the high levels of inventory that are out there and have built up. And so we surveyed some of our customers. We had about 15 of them; we covered mills, brands and also retailers. And there are a couple of common threads that we heard from those people. One quote kind of captures it all. One customer of ours said, six weeks ago, I was asking you to ship me whatever you could get; now I've got too much inventory, and I have to move it. And that's kind of the theme that went through all of the 15 that we spoke to. They've seen some slowdown in apparel sales as their consumers are dealing with inflation on gasoline and food and other necessities. This little bit of a downturn started in about Memorial Day, and it's unclear how much the decline will be seen in apparel volume or how long it will last. But we have seen a decline in volume in North America as a result of this dilemma that's going on. It will make it difficult to give a precise forecast on volume for the first quarter or the second quarter because I think our retailers and customers don't have a good forecast. There's still a lot of uncertainty. But we definitely see it in the first quarter, and probably we'll be updating our guidance more frequently as a result of this marketplace issue that's going on. One other fast-moving development is that with all of this going on, we're seeing very definitely cost reductions on our raw materials that began in August. Now this could be good news and it could offer an opportunity to recover some lost profits from the lower volume, and we have a number of initiatives that we're working on to capitalize on the opportunity, and Eddie will provide you with some perspective on this when we speak about this later in the presentation and in the Q&A. Let me just make one comment on the longer term. While our team is focused on getting beyond this long tail of COVID that causes a few challenges, the top focus we've had in this company is to be focused on the execution of the strategy we presented at the February Investor Day. That is the most important thing. The short-term issues I described a minute ago are not going to slow down our delivery of our goals in 2025. In fact, I think we're making very good progress on some of the key initiatives that make up that strategy. First of all, REPREVE momentum continues with our customers. You'll see a lower mix because of China in the quarter, but we are in a very good spot with REPREVE. EvoCooler technology is now getting some scale, and I think you'll be able to see it's performing above our expectations. I think in the second half of the year, productivity will show up as a result of that new technology. And we've made improvements in labor. We've spent the money to do it. We're not done yet, but I'm encouraged with the progress we're making on labor. Also, Brazil and Asia's future outlook remains bright, and then we've got this raw material cost decrease that's coming at us. So those are some of the positives. We're optimistic about the future. I don't see the short-term challenges having an effect on the long-term view. This long tail of the pandemic certainly has caused some challenges, but they're very definitely going to diminish as the year goes on. So with that, let me turn it to Craig and Eddie to take you through more of the details. And right now, I'll turn it over to Eddie.

Thanks, Al, and good morning, everyone. Our fourth quarter performance was consistent relative to our expectations, and we are pleased with the results we delivered despite the lasting presence of a volatile and challenging operating environment. So, looking back on the fiscal year, I'm very proud of everyone on the Unifi team for what we've accomplished and the obstacles that we've overcome, and I want to thank them publicly for their hard work and perseverance this year. There has been no shortage of adversity or new challenges to conquer in the last year. And I can say with confidence that Unifi is a stronger company today because of our people. So moving directly to the presentation on Slide 4, let's discuss at a high level our overall performance during the period. In the quarter, we recorded $218 million in net sales, which was up 18% compared to Q4 of last year. This brings our total net sales for fiscal 2022 to $816 million, an increase of 22% from a year ago. In the quarter, the U.S. inflationary pressures we experienced throughout the fiscal year, specifically with the raw materials, persisted and they will impact us as we enter into fiscal 2023. In the U.S. and Central America, we witnessed unprecedented short-term cost increases in virgin polyester raw materials in the month of June to the tune of roughly 20% above March levels. Now, when there are such significant input cost changes, there is, as we've discussed in the past, a normal lag until we catch up with customer pricing, and this negatively impacted our results during the month of June 2022 and will affect us in the first quarter of fiscal year 2023. In addition, we saw U.S. bale bottle prices in April and May reach historic levels. And as a reminder, the price we pay for bale bottles and the yield associated with the recycling process are the most important cost inputs to our PE products. But we have implemented further price adjustments in July and August to mitigate the impact of these cost pressures on our margin profile and are seeing some relief in raw materials, as Al mentioned. We anticipate an opportunity to return to more normal margin levels in the U.S. in the December 2022 quarter. Turning to Slide 5 to discuss REPREVE. We continue to see positive momentum for new products, customer adoptions, and co-branding. In fact, 24 million prehang tags were sent out to our customer brands during the fourth quarter alone. As can be expected, revenue from our pre products were negatively impacted by the China lockdowns in the fourth quarter, and this was significant given the fact that over 80% of the sales from our Asia segment are pre, the highest percentage of any of our segments. For fiscal 2022, we pre-fiber accounted for 36% of our sales. On the marketing front, in May, we celebrated the fifth annual Champions of Sustainability Awards, which recognize our brand, textile, and retail partners that have demonstrated a true commitment to supporting a more sustainable world. The awards were presented to 39 brand and retail partners that have transformed 10 million or more recycled plastic bottles and 53 textile partners that have transformed 50 million or more recycled plastic bottles through the use of REPREVE performance fibers. Additionally, Nike and Target both reached a major milestone this year, each having transformed more than 2 billion recycled plastic bottles, while PoloTech, Walmart, and Tecomektal Group have transformed more than 1 billion bottles. Next, our mobile tour efforts focused on key retailers with visits of both Abercrombie & Fitch and Walmart. Our two-day activation at Walmart's headquarters in Bentonville, Arkansas took place during their annual open call event in June, during which we presented the billion bottle award to Walmart's Senior Vice President over general merchandise apparel. Now building on the success of our APRESPAC12 partnership, we have signed a three-year partnership with both season, an entity that advocates for the 44 bowl games that serve as the pro season for college football. We will be a founding sustainability partner and expect positive brand exposure given their prominence of calendar-end university sporting events. We kicked off the partnership at our annual conference in April where we hosted a panel around circularity. Among other things, this comprehensive partnership includes a working group consisting of executive directors from six bowl games to promote sustainability initiatives. REPREVE mobile tour activation at a bowl game of our choice from the working group to include public service announcements and venue signage and a bold-bound social media campaign, including Bob and REPREVE shirts given to each bowl university. So more to come on that initiative once we get past our first bowl season, which is in the middle of our fiscal year 2023. We also continue to focus on strengthening brand partnerships across our digital and social media channels. During the quarter, we executed social media partnerships with Beyond Yoga, Choka, Iglo, Lovesac, Manduca, Sanuk Pito, the Sac, and Volcom. We will continue to support our brand partners that enable us to amplify the REPREVE story. So turning back now to a review of the consolidated business. Before Craig goes into more details on our financials, our adjusted EBITDA for the fiscal year was $55 million. This was within the range of our forecast from April, but it was obviously impacted by the macroeconomic factors we have discussed earlier. As inflationary conditions ease and our pricing catches up with raw materials, we do expect to be able to expand our overall margins. Until that time, our team will continue to proactively align our pricing with market conditions. To sum it up, you can see our growing brand and customer momentum and our global approach. It's clearly helping us drive and sustain business momentum. We believe we are well positioned to drive long-term value. With that, I will now pass the call over to our CFO, Craig.

Thank you, Eddie, and good morning, everyone. The quarter we just completed was consistent with our expectations and was a good ending to a fiscal year that had its share of challenges. Our regional footprint, combined with our focus on sustainable products, has helped us manage through the external factors that Al and Eddie described. Demand for our products remains strong, and our management team remains focused on our long-term goals. Looking at the quarter from a high level, we maintained underlying business momentum as we implemented responsive selling price adjustments and made positive step changes against our recent global challenges. Before we discuss the segment results, I would like to expand on the effective tax rate and EPS. As Eddie mentioned, the pressure on our U.S. operations distorts our worldwide effective tax rate as the foreign locations we operate in, specifically Brazil and China, are not low tax jurisdictions. However, recent developments from the Brazil Supreme Court cleared the path for us to recapture some excess income taxes paid in prior years. You will recall that we benefited from a Brazil Supreme Court decision regarding certain non-income taxes in the year ago period, but the most recent developments relate to income taxes paid in Brazil. Accordingly, the prior period non-income tax changes were reflected as an adjustment to EBITDA and EPS, while these income tax benefits from the current quarter are reflected as an adjustment to EPS. Let's turn to Slide 6 of the webcast presentation. Here, we will begin a review of our reportable segment performance, business developments and our management approach in fiscal 2022, transitioning Unifi to a purely geographic segmentation in which we are focused on recycled and synthetic textile products following our regional models in the Americas, Brazil and Asia. In the Americas, we continue to benefit from the legacy businesses that we previously referred to as polyester and nylon, and both will continue to be valuable to Unifi as we service the diverse needs of our customers. For the Americas segment, a 28.7% increase in revenues demonstrates the robust pricing efforts we have highlighted throughout the fiscal year. In Brazil, the just completed quarter demonstrates a normalized level of strong revenue performance, exceeding the prior year by nearly 50%. We are proud of what our Brazil team continues to accomplish and note that much of this volume improvement stems from the pandemic lockdowns that occurred in the region during the prior year quarter. In Asia, sales volumes were challenged by the previously communicated and ongoing pandemic lockdowns in China. However, the continued interest in sustainable yarns and our ability to support the local customer demand allowed for robust underlying revenue performance given those circumstances. Turning to Slide 7 for the quarterly gross profit overview. The Americas segment's expected decline in gross profit and weaker gross margin percentage were attributed to the import cost headwinds that were mentioned during our last conference call. In addition, because the most recent inflationary impact to our input costs occurred late in the just completed quarter, we were not able to make proportionate pricing adjustments to our customers. In spite of these challenges, it should be noted that on a sequential quarter basis, gross profit and gross margin as a percentage of sales for the Americas segment improved nicely by $2.9 million and 150 basis points, respectively. In Brazil, the gross profit and margin rate included some expected normalization in addition to temporarily unfavorable cost and pricing dynamics in the region. In Q1, fiscal 2023, we expect Brazil's gross margin to surpass the percentage they achieved during the most recent quarter as the short-term headwinds start to alleviate. The Asia segment maintained a strong gross margin profile with a high proportion of REPREVE products, albeit at a lower sales level due to the pandemic-related lockdowns. Without the lockdown in the Asia segment would have continued their strong performance of revenue growth. In spite of the results for the fourth quarter of fiscal year 2022 being lower than expected, the Asia segment exceeded $200 million in annual revenue for the first time in their history, an increase of 12%. Moving on to Slide 8, which provides an update on our balance sheet and capital allocation priorities. We ended the fourth quarter with $41.3 million borrowed against our ABL revolver, which had an availability of $51 million as of July 1, 2022. Under our balanced approach to capital allocation, we expect to continue to invest in the business to drive innovation and organic growth, maintain a strong balance sheet and remain opportunistic with share repurchases and/or M&A prospects. As noted on this slide, and as we have described in recent press releases, we spent $9.2 million during fiscal 2022 to repurchase 16,500 shares under the previously announced share repurchase program with over 500,000 shares repurchased in the just completed quarter. Following that activity, $38.9 million remains available for repurchases under the current program.

Thank you, Craig. And before we turn the call over to our Q&A session, let's turn to Slide 9 of the presentation to discuss our outlook and expectations for fiscal 2023. As we alluded to, throughout the call, we are very pleased with our revenue performance in the year. And more importantly, this quarter showed our resiliency against market downturns and also the recognition REPREVE has been getting. Even with REPREVE volumes and revenues growing globally and the continued global focus on sustainability, we have some significant inflationary and macroeconomic headwinds to overcome in fiscal 2023, which we believe we are ready to address. That being said, we expect fiscal year 2023 to be more of a gradual ramp each quarter compared to our historical norms until we put some of these challenges behind us. Nevertheless, we remain confident in our ability to achieve the fiscal 2025 goals we laid out in our recent Investor Day back in February and have issued our guidance for fiscal 2023. In fiscal 2023, we expect net sales to reach $855 million to $885 million, representing an increase of 5% or more from fiscal 2022 revenues. We also expect to achieve adjusted EBITDA between $48 million and $57 million, with the second half reflecting more normal business metrics in terms of gross margins and raw material inputs. Our CapEx outlook should fall in the range of $35 million to $40 million. Our sales and profitability expectations include some softness in Americas demand over the first half of fiscal 2023, with a stronger performance expected when we enter the next calendar year, which will be our second half of our fiscal 2023. This forecasted softness is caused by the pullback in demand mentioned earlier by all the large brands and retailers as a result of publicly declared excess inventories, some of which are in their apparel segments. The demand in Brazil is expected to remain strong throughout the remainder of calendar 2022 while Asia will continue to grapple with the effects of the headwind of the lockdowns during the rest of this calendar year 2022. Slide 10 closes out our presentation and reviews the big picture goals we gave in our Investor Day several months ago. We remain confident in our ability to hit our targets and are well-placed on a path to achieve over $1.1 billion in revenue by 2025. REPREVE is expected to comprise half of our sales mix and will ultimately enhance our margins and profitability profile. We will maintain our strong balance sheet to act opportunistically on growth initiatives as we remain well-positioned and focused on being the sustainability partner of choice to brands and retailers across the globe. We will now open the line for questions. Thank you.

Your first question comes from Daniel Moore with CJS Securities.

Maybe start with the guidance, top line. Just talk about the implied price and volume expectations embedded in the mid-single-digit revenue growth guide for fiscal '23. And on the margin front, can you give us a sense of your expectations of gross margin by segment embedded in the guidance, if not to the exact basis point than just at least directionally how we should think about each of the three segments in terms of margin performance and cadence? And I've got a follow-up or two.

Thanks, Dan. I'll take the first question around revenue and volumes. As we talked throughout the call, we have had challenges in our Asia segment. That supply chain is still coming out of the COVID lockdowns that they had in April and May and June. We're seeing some improvement, but we know that it's going to take a while for the business to pick up from a volume perspective and a revenue perspective, particularly in China. We do have a fair amount of our business outside of China, and that is still returning at normal levels. In the U.S., the slowdown that we are experiencing today in both volumes and revenues is around the inventory pullback by the retailers and brands. We do have good expectations on revenues because our pricing has, as we mentioned, gone up in our July month and in our August month that we just started, but volumes will be under pressure. In Brazil, volumes and revenues are at expectations, and we don't see right now any issues at all in that space. And I think I'll turn it over to Craig to talk about that margin question because I think it's particularly interesting as it relates to Brazil.

Sure. So Dan, I'll just add on to the revenue comments. For us, as we have laid out our segments, projections for FY '23, definitely the Americas will have its toughest period in the early part of the year, especially this first quarter. And as we noted in the call, we saw quite a sudden increase in costs at the very tail end of our June quarter. We are now seeing the exact opposite of that, which is a sudden reversal of a lot of those input costs. So we will be taking some hits writing down inventory, doing those types of things during that first quarter and probably maybe even into the second quarter. And that will also parallel with where the demand will be softest. But after that, we do feel like we will get back to more normalized levels of profitability for the Americas. For Brazil, as Eddie said, we do feel like they had a good conclusion to the end of the fiscal year as far as from a revenue perspective, and that's continuing here as we start this year. So we expect them to be pretty steady and get out of the gate very well here in the beginning of FY '23. For Asia, our current forecast is very consistent with what we noted back in April, and that is that the COVID lockdown will probably impact the Asia operations in the first half of our fiscal year '23, so through the end of this calendar year. But after that, we expect that to alleviate and continue to grow. Now, one thing to note is the Asian impact is really just impacting the sales impact; the margin impact, the margin profile of the business has remained very positive, very consistent with the historical levels even in spite of the lower sales that we're seeing because of the COVID lockdown.

That's very helpful. And maybe just talk directionally. It's still early, obviously, but on the rate of change on input pricing. As virgin input costs tied to oil prices, should they continue to come back down? You talked about your ability to hold the line on pricing. And if we could see potentially maybe a bigger margin benefit in H2 than what's embedded in the guide? And just talk about bale bottles as sort of supply dynamics more generally. That would be great.

Yes. So on the virgin side, what happened in June was someone quoted some of the petrochemical injuries that were at historic levels of pricing for one of the major inputs into polyester, and it was unforeseen. It was a very rapid spike just in that one month of June. We are seeing a reduction in the pricing, and we have raised the cost of those inputs, and we have raised our pricing in July and August just to catch up with what we saw in June. We do see the ability to expand the margins, get back to normal margins in our Q2 and beyond. But as Craig had mentioned, we have this inventory that we'll have to work through, but we are going to be very focused on managing our price points as we move through this. On the bale bottle side, again, in April and May, bale bottles reached very high levels. They have since returned back to more normal levels, and we are being opportunistic in buying some bottles at the lower price. But again, we do have the inventories that we have to work through. And so if we get to Q2, our margin should be improved significantly over Q1. All that higher price inventory will push through. And again, any REPREVE products we sell, we are going to be managing our price points very carefully in the U.S. specifically. In Brazil, what you saw in Q4 is sort of what we're seeing here in the U.S. from a margin perspective. We are back to sort of more normal margins in Brazil as the lower-priced raw materials for them are being used in the system.

Makes sense that. No, it does. And then you’ve touched on the tax rate, but the guide implied is on a different level than what we’ve seen. So just kind of maybe a little bit more commentary or color on what's driving that 55% to 65% tax rate. And just trying to understand it and what is your effective tax rate in Asia, Brazil? I realize there’s a mix involved, but that’s still above what I would have expected.

Yes. It does come down, Dan, to what we're now projecting to be more of the profitability for FY '23 coming from Asia and from Brazil. Asia's headline tax serves 25%, and Brazil, closer to 35%. But unfortunately, we're not able to use some of the tax attributes in the U.S. because of our lower profitability. So really, it's a reflection of what we're expecting as we were just kind of helping to kind of frame the conversation more so in the first half of the year. We do expect that Americas profitability to be lower, and that is going to impact our overall effective tax rate to the negative side. That's why the rate is being pushed up.

Okay. I've got a follow-up or two, but I'll jump back in the queue.

Yes. I'm just wondering, over the cycle of price variation of your input costs, can you just talk about in price spikes, you lose a little bit of gross margin if prices come down, you gain a little bit of gross margin. Is the net effect over the cycle that it really has no impact on your profitability? Or is it dependent on the frequency of the change? A little bit of help on how to think about this as the world evolves going forward.

Thanks, Chris, for your question. Yes, I'd just answer that by saying what we've seen really in our Q4 has been unprecedented, both on the inputs for REPREVE, and I'm talking specifically here in the U.S. and in our virgin petrochemicals. So anything we would have normally done in the past wouldn't have been able to deal with what happens. I will say that we have been much more proactive in modifying our prices on the way up than we have been historically. I do believe we have a focused sales team that do a great job on making sure that they pass through these increases, these input cost increases, both on the Royal side but also on the manufacturing cost side, the inflation costs that we've seen both on packaging and labor. So I would basically close out by saying we will be in a better position to manage our margins in the U.S. as these raw materials come down. We do need to and we will be giving some of this benefit of the raw materials back to the customer, but we'll be very diligent about how we do that and very focused on where we do that. What basically happened in the last quarter and is happening today as we move through this high-priced inventory is very, very unusual.

I think the mix of REPREVE going forward allows us to improve our margins down the road. I also think there are some processes that have been changed in sales that Eddie has brought to the team where they individually can manage the profitability by customer, which is a big change over what we've had in the past. So, for that reason, I also think we see our margins go up in both the longer term.

Got it. That’s very helpful. And then in terms of the lockdowns in China, is the impact just on the sales side? Or are the lockdowns impacting your ability to manufacture products? And sort of what has the trajectory been over the last couple of months as the lockdowns will be used a bit?

Yes. Our ability to manufacture and deliver products to customers has not been affected. The impact has been mainly on sales because the entire system was disrupted; our customers couldn't produce fabrics, which meant their customers couldn't make garments due to regional lockdowns, leading to a backlog in yarn demand. Furthermore, U.S. and Western European brands and retailers are reducing their orders because of their current inventory issues. This situation stems from both the immediate effects of the lockdowns and the resulting inventory reductions causing lower orders. However, as Craig pointed out, our margins remain unaffected because we operate with an asset-light model in Asia.

Got it. And then the last one for me, and this is probably a longer-term question. But California passed a very significant single-use plastic recycled plastic bill at the beginning of July, and it ought to be the sort of the template for other states. I’m wondering, talking to your suppliers of bale bottles. Are there any thoughts on the trajectory of recycling rates and the availability of raw material for REPREVE?

Yes, that's a great question and an important point. California has indeed passed a bill, and New Jersey has also implemented a similar measure focused on extended producer responsibility, which requires companies that introduce products into the market to be accountable for their recycling rates. We view this as a positive development because it will encourage municipalities and communities to boost their collection efforts. In California, there is a mandate to achieve 25% recycled content within a specified timeframe, which will drive demand for recycled materials and highlight the need for improved collection systems. Currently, the U.S. faces low recycling rates, which contributed to the rise in bale bottle prices during the second quarter of this year. Overall, I see this as a favorable long-term initiative that will promote higher collection rates. While this will help reduce our dependence on bottles, the impact will mainly be felt on the West Coast, whereas most of our collection operations are centered on the East Coast.

Got it. I would have thought it would have increased recycling rates would reduce your input cost. Am I getting that right?

Yes. Eventually, that will be good. What happens in the calendar second quarter, there was a new auto wash facility started up. They were trying to build inventory of the raw materials. That law came bill passed, and people were very concerned about how they're going to meet the 25% even though it's fairly far out. It was a very strange phenomenon. But long term, we do expect these bills will increase collections, more bottles to get on the market, the better off we are from a pricing point of view.

Got it. That's it for me.

Thanks, Gus.

Your next question comes from Anthony Lebazynski with Sidoti.

Thank you. So, I know you guys talked about the price increases in July and August. I was wondering if you could perhaps expand on that and give us some more color as to the level of price increases? And then also the second part of that question would be – so aside from price increases, what are the other key initiatives that you’re looking to strengthen and improve profitability in the U.S.?

Thanks for those questions, Anthony, and welcome to curbing Unifi. Over the past 15 to 16 months, we have been raising prices almost every month. What we did in July and August was significant in finally aligning our pricing with raw material costs. I believe our prices are now at the right level, and I’m comfortable with what we’ve established. However, we still need to manage our inventory as we progress through the month. Beyond raw materials, maintaining our main price points will be crucial. We are carefully managing our purchases in the U.S., especially on the manufacturing side due to a slowdown in volumes. We're focused on reducing costs as much as possible and have cut some of our SG&A expenses. Additionally, we are significantly reducing inventory and purchasing minimal materials to take advantage of the downturn in raw material prices while identifying volume opportunities that make sense. We are also managing our price points carefully. Regarding labor hours, these are a significant cost for us in the U.S., and our manufacturing team is very careful about our staffing needs. Interestingly, this situation allows us more time to train our new employees. These are the strategies we're implementing beyond just reducing raw material costs.

Got it, okay. And then, so within your EBITDA guidance for '23 it sounds like overall that you're holding SG&A as much as you can, and it's really the pressure is really on the gross margins. Is that a fair assessment?

Yes. Anthony, I think that's a very fair assessment. Yes, definitely, the guidance for the range for EBITDA anticipated several different scenarios for each of the three reportable segments. But you are correct that really most of that, almost all of that is centered around manufacturing and operations and sales prices and not so much about SG&A.

Got it. And then as far as Brazil, the gross margins have been kind of all over the place here last few quarters. What’s a reasonable long-term assumption for gross margins in Brazil?

Yes, you're correct. During the peak of the pandemic about six quarters ago, we experienced impressive gross margins in Brazil. However, we advised everyone not to expect those to remain at 30% to 40% as that has not been their historical performance. Recently, they encountered some increased costs but managed to address these quicker than we expected. We believe they will return to a more typical profitability level, with gross margins in the mid- to upper teens, possibly reaching around 20%. It’s a well-managed business with a strong customer base, and they are beginning to see the benefits from the new Evo texture equipment being integrated into their operations. These factors give us confidence that they will recover well and are already showing signs of recovery this quarter. A more realistic long-term expectation for Brazil would be in the mid- to high teens, and perhaps slightly better than that.

Got it. And best of luck.

Thanks, Anthony.

Your next question comes from Daniel Moore with CJS Securities.

Following up on the margin question and just kind of thinking longer term. You mentioned margins getting back to more normal levels by H2. I assume more normal overall is something in the 10%-plus range, maybe 10% to 12%. Is that sort of the right way to think about it, given all the puts and takes over the last year or two with Brazil, et cetera? And then the bigger question is just how do we think about the bridge implied between what would be kind of more normal late fiscal '23 margins and your 2025 goals of 14% to 15%? What are the key drivers or levers there?

Yes, Dan, you're right. When we refer to normal margins and combine all the factors, we are indeed talking about something above 10%. Our long-term model is targeting higher profitability closer to 15%. As we've mentioned, an increase in REPREVE and an improved margin profile for those products will definitely contribute to reaching that percentage over time. However, in the short term, it is more accurate to expect gross margins in the range of 10% to 12% as we approach the second half of the year.

And Craig, on the move towards 15 and the longer further out years. REPREVE mix and EvoCooler is probably the two biggest impacts?

Yes. I would say those definitely are the biggest impact and also a continued input from Asia as well. We do feel like that will continue to pull up and make good progress there. Again, they have the highest level of pre products, and we expect that to continue to grow. Eddie, do you want to add on to that?

Yes. We have engaged someone to assist us in identifying the best opportunities for Unifi in the beyond apparel sector. We're conducting a thorough analysis in certain segments that will largely focus on food. In our strategy presentation back in February, we stated our goal was to find segments with higher gross margins, which we believe is crucial for achieving our target gross margin levels of around 14% globally.

Perfect. I apologize.

And it's the mix of Asia today versus when we get to 2025 is quite a difference and that carries along quite a bit of REPREVE margin.

Got it, Al. That’s helpful. And Eddie, I think you read my mind. My last question was about updating us on some of those growth initiatives outside of apparel. I realize these are not projects that will yield results in one or two quarters; they are multiyear efforts. But regarding auto packaging and medical footwear, where are you noticing more discussions or excitement about sustainability and long-term partnerships? Any insights you could share would be appreciated.

Yes, as you noted, this is a long-term initiative. We aim to complete this analysis within this quarter, which will enable us to accelerate our efforts in the segments you've identified, along with a few additional ones we've found intriguing. We recognize that some projects will extend over several quarters; for example, it typically takes 18 months to develop a program in the apparel market. However, we are committed to dedicating substantial time and resources to explore these emerging opportunities, which will include more than just the four segments you've brought up. Personally, I find the shift towards electric vehicles particularly exciting. Automotive companies are increasingly focused on sustainability, not only in their drive systems but also in the materials used for textiles in their vehicles. This is likely where we will see the quickest developments.

Thank you.

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