Earnings Call Transcript - UFI Q3 2021

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Unifi Third Quarter Fiscal Year 2021 Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, A.J. Eaker, Vice President of Finance. Please go ahead, sir.

A.J. Eaker, Vice President of Finance

Thank you, Christel, and good morning, everyone. On the call today is Al Carey, Executive Chairman; Eddie Ingle, Chief Executive Officer; and Craig Creaturo, Chief Financial Officer. During this call, management will be referencing a webcast presentation that can be found at unifi.com and 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.

Al Carey, Executive Chairman

Thank you, A.J., and good morning, everyone. Thanks for joining us today on our call. I want to get the call started with a few comments about our overall performance for Unifi's third quarter. I will turn the presentation over to Eddie Ingle and Craig Creaturo, who will provide you with the details. All in all, we had a solid third quarter, stronger than we anticipated, and we continued to see a steady recovery from the pandemic. Our Brazil and Asia business had very strong sales and gross profit performance. Whether you look at it versus Q3 of last year or versus the previous quarter, North American sales saw year-over-year growth in March, so we now have all three regions showing solid growth trajectories. Our EBITDA performance was very positive in Q3. Our balance sheet continues to be strong, as does net debt, and our overall financial performance really puts us in a position to invest in growth as we move into the future. If you look at Q4, while there's still some uncertainty in the Brazil market and even the U.S. market regarding COVID, we see a path to sequentially improving our sales for Q4 and finishing the fiscal year in a way that sets us up for a strong 2022. There's a very definite momentum for sustainable products from consumers and our customers. This bodes well for REPREVE's future. We've seen the REPREVE hang tags with our co-branding partners increase by 80%. Year-to-date, that number is 50%, indicating that trends are continuing to strengthen. For the fiscal year, we expect to end the year at 90 million hang tags on products across the marketplace, so the awareness of our brand is climbing positively. Finally, I am very proud of the team and grateful for their resiliency over these last 12 months. Now, I will turn it over to Eddie Ingle, our CEO of Unifi.

Eddie Ingle, Chief Executive Officer

Thanks, Al, and good morning, everyone. As Al mentioned, our third quarter fiscal 2021 results surpassed our initial expectations and are a testament to our strong global presence and the resilience of both our employees and our business model. This quarter would not have been possible without the many contributions from our employees. I want to once again thank all of our team members for their dedication to the business and especially to our customers. Their compliance with the safety measures we put in place over a year ago has allowed us to maintain low COVID case numbers while continuing to operate our business effectively and navigate a recovery. The business demonstrated another quarter of significant strength. I'm very happy to report we exceeded pre-pandemic revenue levels. Q3 revenues were up 10% sequentially and 5% on a year-over-year basis, with solid performance across all segments and geographies. We generated a 530 basis point improvement in gross margin year-over-year due to strong results in our Brazil and Asia segments. Brazil had the strongest segment performance during the third quarter, and momentum in that region continued well past Q2 as improved selling prices and product availability during Brazil's economic recovery led to strong margin performance. Our Asia segment also demonstrated strength during Q3 as volumes continued to trend up year-over-year, experiencing a meaningful return to growth. Our team in Asia has continued to successfully manage cost and improve product mix, allowing for gross margin expansion. Regarding U.S. raw material costs and supply chain, the March 2021 quarter was the most volatile period we've seen in quite a few years. Many businesses in Texas experienced harsh weather conditions in February, but we were fortunate that our supply chain remained operational, albeit with surcharges on selected input materials and freight. Our raw material costs exhibited a meaningful step up during the March 2021 quarter. We have been working closely with our customers to ensure that the appropriate selling price adjustments are implemented. We do expect some margin pressure in Q4 from the inherent lag during such a process. However, we remain confident in our underlying business momentum and our responsiveness to address these cost headwinds. Again, our financial position remains strong and easily supported the two bolt-on acquisitions we completed in fiscal 2021. I am proud of the progress we've made with improving our balance sheet globally. Our REPREVE-branded Fiber comprised 33% of net sales in Q3 versus 29% in the year-ago quarter. We have several exciting brand highlights to touch on today, starting with our traditional co-branding partnerships, which have continued to accelerate. Our customer, Marina's carpets, launched a line of carpeting made from REPREVE. We believe telling these stories will enhance REPREVE equity and brand awareness in the broader consumer market. This quarter, we hit a milestone of 25 billion bottles recycled into REPREVE. Now, turning to our operating segment performance during the third quarter, I will provide some high-level commentary on each segment before Craig takes you through more specific details. The Asia segment delivered another strong quarter as business conditions continued to improve. With Brazil beating market forecasts, our unique market position has continued to allow us to take market share previously held by competitive importers. We expect to hold on to our market share gains within the region, but note that the COVID-19 lockdowns will impact volumes in the June 2021 quarter. Lastly, the Nylon segment performance met our expectations for the quarter, reflecting a balanced sales level.

Craig Creaturo, Chief Financial Officer

Thank you, Eddie, and good morning, everyone. I am pleased with our third quarter fiscal 2021 results and our ability to navigate the complexities of this recovery with a regional and responsive business model. Operating income and adjusted EBITDA were up significantly from Q3 of fiscal 2020. The increase is primarily attributable to the gross profit outperformance in Brazil, further aided by robust results from Asia. Consolidated net sales increased to $178.9 million, up 4.6% from $171.0 million in Q3 of fiscal 2020. The Asia segment exhibited a return to pre-pandemic momentum with continued underlying demand from REPREVE driving segment revenue growth of 25.5%. The Brazil segment maintained its position of market strength, adjusting prices to accommodate movements in global pricing dynamics and competition, driving 22.1% revenue growth. The Nylon segment was essentially flat compared to the prior year due to a shift in sales mix. Gross profit exhibited a 66% increase and a 530 basis point increase in gross margin from Q3 fiscal 2020 to Q3 fiscal 2021. Our commitment to financial health has allowed us to leverage our strong balance sheet during 12 months challenged by the global pandemic. We will continue to allocate CapEx to new technology in the Americas. Under our balanced approach to capital allocation, we will continue to invest in the business to drive innovation and organic growth, maintain a strong balance sheet and remain opportunistic with share repurchases and M&A opportunities.

Eddie Ingle, Chief Executive Officer

Thank you, Craig. I will conclude with slide 10 of the presentation and provide some context around our expectations for the fourth quarter of fiscal 2021. The third quarter's strong performance supports the expectation we laid out earlier in the fiscal year that we will see incremental progress in net sales trends throughout fiscal 2021. We anticipate sales volumes to increase and June 2021 quarter net sales to improve sequentially on the March 2021 quarter by approximately 1% to 3%. Adjusted EBITDA for the fourth quarter of fiscal 2021 is expected to be in the range of $12 million to $14 million, including our current expectations for pandemic uncertainty and raw material cost increases. We will now open up the line for questions. Thank you.

Operator, Operator

Your first question comes from the line of Chris McGinnis with Sidoti & Company.

Chris McGinnis, Analyst

It was a nice quarter. If we could start off just on the raw material. A lot's changed since, I think, the last time we've seen Unifi in a pretty volatile period of raw material. Can you just talk maybe a little bit about the strength and the relationship with the customer base? I think the big thing is REPREVE growing to a bigger percentage of sales. Does that change the positioning to get price increases through quicker? Can you just talk a little about your thoughts around the increases and how easy you can pass it along?

Eddie Ingle, Chief Executive Officer

Yes, Chris, thanks for the question. We have experienced significant raw material increases that we weren't anticipating. Fortunately, we weren't impacted from a supply chain point of view. But we do traditionally lag increases and give our customers time to adjust. What we're doing is no different from all of our competitors. I do believe that during this Q4, most of the raw material increases that we have to pass on to our customers will have been implemented. The environment is such that everybody knows raw material prices are going up. There is inflation and it's a natural take from our customers, albeit they don't like it and we don't like passing it on, but we are managing to get through that. On the REPREVE side, we've had increased demand in the region, particularly in the U.S. and Central America, and people understand that because of the strength of our brands and the tightness in the market for recycled products. We're able to get the full price increase during this quarter. Thank you.

Chris McGinnis, Analyst

Great, thanks for that. And I guess just to stay on REPREVE, it sounds very successful, obviously, and seems to be ramping up. Can you just talk about the changes of the conversations you're having? Is it just the environment being pushed by the consumer? Where are you seeing the biggest requests as you start to see this increase in demand come in from the sustainable side?

Eddie Ingle, Chief Executive Officer

Well, as you said, it is driven by the consumer. What the brands that service the consumers are recognizing is that the consumer wants this. We're in the right position to deliver that globally, both here and in Asia. Big brands and retailers are declaring sustainability targets. A lot of that is due to the inputs, as polyester can be recycled at a high rate. With our REPREVE brand, which offers transparency and traceability, we are a natural go-to company to supply their sustainability needs.

Al Carey, Executive Chairman

Chris, this is Al. I just wanted to add to Eddie's answer. Sometime around August and September, as we moved through COVID, the momentum for environmental sustainability significantly increased. The discussions around this began to rise as key leaders in these retailers and brands, many of whom are millennials, are taking over big roles in their companies. As a result, they're getting close to the 2025 commitmentssome of these companies have in terms of the amount of recycled material they need for their products.

Chris McGinnis, Analyst

Sure. And I appreciate that. Thank you very much.

Operator, Operator

Your next question comes from the line of Daniel Moore with CJS Securities.

Daniel Moore, Analyst

Yes, thank you. Good morning. Just really quickly, Tom, if you are on the call, and if this does mark your last call in official capacity at Unifi, just thank you for all the help over the years, particularly your candor and straightforward approach. It's been really excellent to work with you and refreshing, so thank you. Just want to maybe touch on North America first. Poly flipped to positive growth in March, I think I heard. Do you expect that to continue into Q2 and beyond, particularly given kind of easier pandemic-related comps? And any further color or update on the trade dispute progress would be helpful.

Eddie Ingle, Chief Executive Officer

Thanks, Dan. I’m sure Tom will appreciate that comment. Regarding North America, we are continuing to see growth in demand. We do see this continuing in Q4 and beyond. This is related to the antidumping initiatives we initiated back in December. We expect a preliminary ruling sometime in late May or early June, which we think will further accelerate growth in North America, particularly in the U.S.

Daniel Moore, Analyst

Very helpful. And maybe just dig into Brazil a little bit. It’s kind of been boom-to-bust, and now back to boom. Is the COVID crisis limiting competition? How is that affecting margin gains? What's a realistic sustainable gross margin level on a long-term basis?

Eddie Ingle, Chief Executive Officer

Yes, there are two questions. The retail environment did face constraints in late March and then into April. However, we are seeing the environment open up, giving us confidence that volumes will return to normal. Margins were exceptionalPreviously we did have a boom, and we do believe margins will return to our normal range but with volumes up, we will see total gross profit that we are pleased with.

Daniel Moore, Analyst

Okay. And just last housekeeping; what's driving the tax rate in Q4? And what's an expectation for a more normalized rate as we think about fiscal '22?

Craig Creaturo, Chief Financial Officer

For Q4, a mix of U.S. and international earnings is a factor in the higher rate. We're also not able to use as many foreign tax credits now, which is contributing to a higher rate. Going forward, we expect it to normalize, with profitability in the U.S. making it favorable to Unifi's position.

Daniel Moore, Analyst

All right, congrats. Momentum looks forward, more surely.

Operator, Operator

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

Marco Rodriguez, Analyst

Good morning, everybody. Thank you for taking my question. I was wondering if you could follow back up on Brazil here. I mean, the last quarter, and this quarter, obviously, you had very good performance. On the last call, we were talking about the performance, and there was some expectation of a competitive response this quarter. That doesn't seem to have played out as you anticipated. Can you provide some color in terms of what's going on with competitive dynamics in Brazil that has allowed you guys to perform well again?

Eddie Ingle, Chief Executive Officer

Marco, thanks for the question. Yes, it was a remarkable quarter. The biggest competitor we have in that market are imports. With the volatility of the currency and uncertainty of the pandemic, we saw an opportunity to gain market share against imports and a local competitor. We expect to maintain our market share and anticipate volumes will return to normal in our new fiscal year starting in July.

Marco Rodriguez, Analyst

Understood. And then on REPREVE, I was wondering if you could share any insights learned over the past year that are changing or helping drive additional marketing efforts. What are the biggest drivers for REPREVE growth going forward?

Eddie Ingle, Chief Executive Officer

What we've learned is that life goes on during the pandemic. We were able to build relationships with companies like WM and Disney, for example, which we discussed in the last call. While we were unable to physically promote, we leverage social media, recognizing that younger generations understand and demand sustainability. We expect growth in automotive, apparel, and particularly in home furnishings as we see traction in that area. The transition to sustainable products will take time, but we are very optimistic.

Gus Richard, Analyst

Just on the supply side of REPREVE, do you have constraints in your supply chain if demand continues to grow? What do you need to do to ensure you can fulfill that demand?

Eddie Ingle, Chief Executive Officer

Yes, in the U.S., recycling rates are lower than desired. While in Asia, particularly in China it's much higher. In the U.S., we are a bit concerned but believe that as demand increases, the collection rates will grow. We don’t currently need to expand our manufacturing capacity to meet the demand for REPREVE.

A.J. Eaker, Vice President of Finance

Thanks, everyone for participating today. Our next earnings release for the fourth fiscal quarter ending June 27 is tentatively scheduled for Wednesday, August 4 after the close of the market, with a conference call to follow the next morning, Thursday, August 5, at 8:30 A.M. Eastern Time. Thanks again for joining today's call.

Operator, Operator

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