Earnings Call Transcript - UFI Q2 2024

Operator, Operator

Good morning, and thank you for attending Unifi's Second Quarter Fiscal 2024 Earnings Conference Call. Today's conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Speakers for today's call include Al Carey, Executive Chairman; Eddie Ingle, Chief Executive Officer; A.J. Eaker, Chief Financial Officer. During this call, management will be referencing a webcast presentation that can be found in the Investor Relations section of unifi.com. Please familiarize yourself with Page 3 of that slide deck for cautionary statements and non-GAAP measures. I will now turn the call over to Al Carey. Al?

Albert Carey, Executive Chairman

Thank you. Good morning, everyone, and thanks for joining our call this morning. I’d like to start by discussing some actions we are taking to enhance the long-term performance of the company and reach our potential. I won’t cover the Q2 results, as Eddie and A.J. will discuss those shortly. I will mention that the quarter is in line with what we communicated during our last earnings call. We continue to see softness in the apparel category and high inventory levels in that supply chain. However, there are signs of a gradual sales pickup, which we expect to continue through the rest of fiscal 2024. The industry has experienced solid end-of-year apparel sales, and inventories are returning to pre-COVID levels. The last 12 to 18 months have been challenging as we've faced macro issues impacting the apparel category and our volumes. However, we believe in making the most of the crisis, and that's what we intend to do. We have identified weaknesses in our business over the past year and believe we can turn these into growth opportunities through the right actions, which are already in progress. We conducted an in-depth review of our organizational structure, processes, and related costs, allowing us to cut significant expenses and enhance operational efficiencies in North America. Our goal is to reinvest a portion of these savings from our profitability improvement plan to enhance the profitability of our North American operations, invest in product innovation for REPREVE, and reduce our reliance on the apparel category by expanding into other end-use markets. Eddie and A.J. will provide more details on these priorities, and we are making good progress. We began this initiative in Q2 around November and December, and have already implemented substantial actions regarding headcount. Most of the measures in our productivity and profitability improvement plan should be completed by the end of Q3, with a few actions potentially extending into Q4. We anticipate the effects will primarily show in the upcoming fiscal year, but some impact may be felt in Q4. Additionally, we will promote several young leaders within the organization to key roles due to these changes. They were instrumental, along with Eddie, in developing these plans and will now oversee their execution, which gives us great confidence in our direction. I will now turn it over to Eddie Ingle, our CEO, who will provide further details on this.

Edmund Ingle, Chief Executive Officer

Thanks, Al, and good morning, everyone. As Al mentioned, I'm going to talk about the second-quarter fiscal results, which were in line with our expectations but were negatively impacted by the ongoing inventory destocking challenges we continue to see in the apparel industry and its supply chains. However, we remain optimistic that we will begin to see demand normalization in calendar year 2024. As Al mentioned, we are continuing to take proactive actions to control costs and improve the efficiency of our operations in order to strengthen the company's position and improve results. The initial impact of these actions is beginning to show in the underlying performance of the business as we delivered meaningful improvement in gross profit performance in the second quarter. If you turn to Slide 3 for an overview of the period, we recorded $136.9 million in net sales during the second quarter, essentially flat compared to $136.2 million in the second quarter of fiscal 2023. Higher sales volumes were largely offset by lower average prices due primarily to lower raw material costs. Our underlying performance has stabilized as the global apparel inventory destocking should be nearing its end, allowing us to make more strategic decisions in how we position the business for optimal needs of our customers. In the Americas segment, we saw modest improvements in volume, though sales levels remain below our historical averages. This can be mainly attributed to continued weakness in apparel demand. In the Americas, we expect to continue to take share in calendar 2024 and benefit from the exits of one of our primary competitors in the region, which we've mentioned in prior calls. In Brazil, we continue to see improved performance; however, our strong sales volumes and increased gross profit were partially offset by continued unfavorable pricing dynamics from competitive imports. In Asia, while we continue to face challenges with apparel demand, our results were positively impacted by a rich and diverse sales mix. As for operations, we continue to evaluate our expense structure and have been proactive in identifying opportunities to generate efficiencies and improve performance across the business. We have spent the last year taking proactive, strategic actions aimed at reducing ongoing costs and optimizing operations to enhance profitability. In recognition of the current environment, we further bolstered those initiatives through the new profitability improvement plan we announced last night. This plan is expected to provide over $20 million in cumulative profitability benefits moving forward, which will put us in a stronger position to leverage the anticipated recovery in apparel demand in calendar 2024. The first part of this plan focused on realigning our resources, reducing our headcount, and resetting costs primarily in the U.S. This has allowed us to significantly lower our variable operating expenses across both production and administrative functions. These actions will be completed in this quarter ending March 2024, and as a result, we anticipate a reduction in expenses by approximately $2.5 million per quarter on a run-rate basis beginning in fiscal 2025. While the execution of this plan came with very difficult decisions, we are confident that these changes will lead to a substantial improvement in profitability and operating profile of the business going forward. We believe Unifi has a robust foundation for future growth and innovation. The second part of our plan is aimed at expanding our gross margins due to the transformation of our sales process. The approach we've taken includes streamlining processes, enhancing inventory management, and realigning resources to boost efficiencies. Once completed, we expect to see a $6 million annual improvement in our gross profits, which will phase in throughout the rest of the calendar year. We plan to strategically invest these cost savings, as Al had mentioned, to increase profits into the areas of our business that promise additional revenue and margin-enhancing opportunities. This reinvestment will not just bolster our traditional apparel market penetration, but will also enable us to explore and capitalize on new market segments. Innovation remains at the core of our strategy, and leveraging our innovation capabilities in new markets is essential to unlocking our growth potential. We will continue to allocate resources and make investments to develop new and innovative products that expand our brand in new categories, particularly in the areas of our established REPREVE platform and our emerging beyond apparel initiatives, both of which we believe have significant growth opportunities. In tandem with our operating realignment, we have made several strategic appointments across our leadership team to drive further growth and focus on innovation at Unifi. I'm very proud to make these announcements, as leadership development has been a priority for our team, and the promotion of these leaders onto our executive team is well deserved. These series of important decisions to streamline operations and realign our leadership team are central to maximizing our growth and profitability profile going forward. We are fortunate to have A.J.’s financial expertise and sophisticated accounting and business acumen. He brings robust knowledge of our operations and financial processes and has been a critical driver of our strategy over the last few years. These skill sets, coupled with his abilities as the leader of our finance team, distinguished him as the best candidate throughout the search process. Next, Meredith Boyd has been appointed as the Executive Vice President and Chief Product Officer. Meredith joined Unifi in 2007 and has held progressively senior roles throughout our organization, including our manufacturing operations, brand sales, and business development where she had direct customer and industry interactions, and in product development, where she was integral to our innovation initiatives. For the last three years, Meredith has served as our Senior Vice President of Sustainability, Technology, and Innovation. Her contributions in that capacity have been pivotal to our international growth and the expansion of the REPREVE brand and value-added product technologies. We will leverage Meredith's proven success and international impact by having her lead all innovation, plant technology, marketing, and business development. We expect this organizational change to be critical to promoting our global growth initiatives. Brian Moore will take on the role of Executive Vice President and President of Manufacturing, Inc. Brian started his career at Unifi back in 1993 and moved to Asia for Unifi in the early 2000s. For about 15 years, Brian gained additional experience in the private equity world before returning to Unifi at the beginning of 2020. Most recently, he has served as the Senior Vice President of Direct Sales and Operations. Brian's extensive experience and successful leadership in sales and operations are invaluable to our Americas footprint. Greg Sigmon, our General Counsel and Corporate Secretary, has also been promoted to Executive Vice President and will continue to assume more strategic leadership responsibilities, including the management of our government affairs and sustainability functions. This refreshed leadership team is central to our growth strategy, and each has exemplified a commitment to innovation and market leadership over their tenure with the company. On behalf of the board, I'd like to congratulate each leader. Turning to Slide 4 to discuss REPREVE and marketing. During the second quarter, REPREVE represented 33% of sales, marking a sequential quarter and year-over-year increase as a percentage of net sales. Sales of REPREVE have been adversely affected by the current economic challenges in China and a general downturn in apparel production. We expect a rebound in REPREVE sales once China sees improvement in economic conditions and apparel demand. We remain fully confident in the demand for sustainable fibers and the REPREVE brand's position as a leader in the industry. Now, on the marketing front, our focus remains on elevating our flagship brand, REPREVE. We're thrilled to announce that this week, REPREVE will once again have a presence at the WM Phoenix Open. The brand teamed up with WM and Peter Millar to convert water bottles, like those collected at last year's events, into a special edition Peter Millar 2024 WM Phoenix Open apparel collection that will debut at the upcoming events, and we are honored to be part of such an exciting collaboration at a nationally covered event. I will now pass the call over to A.J. to discuss the financial results.

Andrew Eaker, Chief Financial Officer

Thank you, Eddie. Before I discuss the financial results, I'd like to recognize the promotions and achievements of Brian, Greg, and Meredith. I look forward to working closely with these esteemed leaders and our entire global team as we chart a path for a more profitable and successful Unifi. The results this quarter were better than our Q1, despite including the usual scheduled seasonal shutdowns, and we continue to operate in a weak demand environment. In addition to the operating results that we'll cover on the next several slides, we recorded the following unfavorable impacts: $1.3 million of bad debt provision to recognize financial difficulties for a customer in our U.S. market, $5.1 million in restructuring costs, which includes $2.7 million related to the dissolution of an unprofitable joint venture and $2.4 million of severance costs. Beginning with Slide 5, we have provided a year-over-year comparison on net sales and gross profit for each second quarter. Consolidated net sales were flat as the decline in pricing, which has started to stabilize in the current fiscal year, was primarily impacted by lower raw material costs year-over-year. Volume remained seasonally strong for the Brazil segment, although Chinese imports continue to pressure selling prices. The Asia segment continues to maintain a strong pricing and margin profile from growth in the REPREVE brand and several key customer programs, which is helping to offset the impact on net sales from the volume weakness. From a gross profit perspective on Slide 6, the lower raw material costs and variable cost management efforts yielded overall improved profitability. However, the seasonally lower volume and weak apparel demand environment in the Americas, combined with the selling price pressures in Brazil, continued to unfavorably impact gross profit. Turning to Slide 7 for a sequential sales comparison, we achieved a similar volume level compared to the first quarter despite the impact of domestic holidays. Sales volume in dollars were generally flat, although seasonally impacted by the normal holiday period for the Americas and Brazil segments. Slide 8 displays an increase in gross profit on a sequential quarter basis as variable cost management benefited the Americas and Brazil segments. I'll now make a few comments on our balance sheet and liquidity position from Slide 9 before passing the call back to Eddie for his closing commentary. During the quarter, we continued to focus on working capital management and cost controls, as you've heard from Eddie earlier, and net debt increased by $6.8 million from the previous quarter and $2.8 million from the prior year-end, primarily due to the working capital needs of the business and the continued weak demand environment. Our CapEx spend of $3 million in the second quarter mirrored the outflows in the first quarter as we await the anticipated recovery in apparel industry demand before those levels are lifted. You will recall that we began an 18-month pause on our texturing machinery purchases beginning in March 2023, and in December 2023, we extended this pause for an additional 12 months. We continue to remain confident that our business is well-positioned for realizing profitable growth opportunities when the apparel industry and its supply chains normalize, especially with the recent actions outlined by Al and Eddie earlier. I will now pass the call back to Eddie to take us through the last slides of the presentation and make some final comments.

Edmund Ingle, Chief Executive Officer

Thank you, A.J. I'd like to turn your attention to Slide 10 before turning the call over to our Q&A session. Despite the ongoing challenges in the apparel industry, we have taken, and we'll continue to take, the necessary strategic actions to adapt to the current environment and also position Unifi for long-term success. Our focus remains steadfast on driving efficiency, enhancing profitability, and seizing the growth opportunities on the horizon, particularly in our innovative REPREVE and beyond apparel initiatives. We believe we are positioned to expand our global market share, which has already taken place in the Americas, and we expect to gain a meaningful volume and capture a significant portion of this opportunity as we move through the first half of calendar 2024. The strategic alignment of our resources and new appointments to the leadership team, combined with the anticipated recovery in the apparel industry on the horizon, will put us in a position of strength and growth going forward. As we continue to implement cost-saving measures and invest in areas with high growth potential, we are confident in our ability to deliver value to our stakeholders. Now, turning to Slide 11, our forecast for the third quarter of fiscal 2024 is as follows: net sales between $149 million and $154 million, adjusted EBITDA between minus $2 million and $1 million, capital expenditures between $4 million and $5 million, and the effective tax rate is expected to demonstrate continued volatility. As we look ahead, we remain cautiously optimistic that our markets are positioned to rebound in calendar 2024, and we expect to deliver quarterly revenue and earnings improvement on a sequential basis. We are very confident in our position as a partner of choice to brands and customers across the globe, and we believe we have the right short and long-term strategy to drive value for our stakeholders. With that, we will now open the line for questions. Thank you.

Operator, Operator

Thank you. Our first question comes from Anthony Lebiedzinski from Sidoti. Please go ahead.

Anthony Lebiedzinski, Analyst

Good morning, and thank you for your questions. First, congratulations to A.J. and others on their well-deserved promotions. My first question is aimed at understanding the volume and pricing dynamics better. I know you mentioned that lower material costs have had an impact. Could you provide more specifics on what occurred in the second quarter? What should we expect in terms of volume and pricing in your third-quarter guidance? Additionally, how should we consider these two factors from a long-term perspective?

Edmund Ingle, Chief Executive Officer

Yeah. I'll take that, Anthony. Thanks for the call and thanks for joining us today. Q2 was obviously impacted by the seasonality of the Christmas holiday in both the Americas and in Brazil. I'm pleased to say, in Brazil, we are seeing very strong volumes, but the pricing, as we mentioned on the call, is significantly impacted by the Chinese environment as they seek to find opportunities to sell textured polyester outside of China. So, we're not expecting to see pricing improve significantly in Q3 in Brazil, but we do expect it to improve somewhat, and the volumes will continue to get stronger as we move through the quarter and get away from any seasonal impact. In Asia, as we move through the quarter, we did see an improvement in our mix, which improved the average price in that region. The volumes are coming back slowly, as we mentioned on the call, and it's driven primarily by brands reaching the end of this destocking process, which we're very excited about. In the U.S., we have a dynamic pricing structure. We've been reacting to the needs of the customers as the raw materials have come down. I am very excited about what will happen in Q3 because all of the inventories of that competitor that went out should be eliminated by the end of Q2, and our volumes should improve. Pricing will still be under pressure, but raw materials have been stable, so our margins as we move through the quarter are expected to certainly improve slightly. More importantly, our volume is going to improve as we move through the quarter.

Anthony Lebiedzinski, Analyst

Thank you for those details, Eddie. So, I guess as far as your announcement about your cost improvement plan. You guys have talked about moving beyond apparel for a while. So, as you look to invest in margin accretive growth opportunities, I guess, maybe what's new here in this plan that wasn't in the prior plan as far as moving beyond apparel? Maybe you could talk about some low-hanging fruit opportunities and which vertical markets you think will take longer to penetrate?

Edmund Ingle, Chief Executive Officer

Yeah. We have been talking about beyond apparel and, even going back to our Investor Day, two years ago. What I can say is, while we're not at liberty to disclose exact details, we are very much focused on two segments here in the U.S.: the automotive segment and home, particularly in mattresses. We are seeing opportunities there that we expect to grow in the coming quarters. Part of the changes that we made in leadership was to create an organization that was very focused on innovation and growth in the beyond apparel areas. As these new leaders settle into their roles, you'll be hearing more about the results of that. But certainly, the innovation, coupled with REPREVE, in these new markets are going to be the targets and are the targets. The challenge we have is getting our costs right, which we have done now, and taking those additional dollars and funding these growth opportunities. So, the organizational changes, along with additional funds available for these growth opportunities, are going to be the fuel for these initiatives.

Anthony Lebiedzinski, Analyst

Okay. Sounds good. Could you clarify whether the cost reset and headcount reductions mainly affected the corporate office, the facilities, or if it was an even split or targeted cuts?

Andrew Eaker, Chief Financial Officer

Hey, Anthony. It's A.J. Thanks for the comments earlier on the question. The reductions that we took in terms of the cost reset are very central to the U.S. We certainly have some of those impacts to corporate duties and the corporate office, as well as some of our manufacturing facilities, and the vast majority of those relate to salaried positions.

Anthony Lebiedzinski, Analyst

Thank you, A.J. Now, shifting focus to Asia, this is a significant REPREVE market with the highest penetration. There has been considerable discussion about China's post-COVID recovery being slower than anticipated. Can you provide insights into what you're observing in China so far? What are your expectations moving forward?

Edmund Ingle, Chief Executive Officer

Yes. As we said in several calls before, Anthony - I know in discussions with you - we see Asia as a feeder to Western Europe and to U.S. brands. The challenge we've had with the Asia environment is that it has caused the Chinese market to seek other markets for their textured polyester, which has particularly impacted our Brazilian operation. But, as retailers have reached their normal inventory levels, we're beginning to see the business come back. This situation is somewhat separate from the economic environment that's still occurring in China. As the Chinese economy recovers and their capacity utilization increases, they will very quickly modify their pricing methodology, which should improve what happens in Brazil and some of the business that we have in China. So, we're still at wait and see for China. A lot of people are looking at it, but we are hearing, as you are, things that the Chinese government are doing to try to kickstart the economy, and that should benefit us, as well as the destocking that has nearly finalized in the industry.

Anthony Lebiedzinski, Analyst

Got you. Okay. And it sounds like you guys are seeing some green shoots in terms of inventory restocking or not yet? I mean, obviously, we've been in this prolonged period of destocking. So, are you seeing actual signs of restocking or are we there yet, or hope to be there in the next quarter?

Edmund Ingle, Chief Executive Officer

We are noticing some positive indicators, but I should mention that whether due to interest rates or the desire of brands and retailers to differentiate themselves, there are now more smaller and frequent orders than we typically observed in the past. Brands and retailers are being cautious about avoiding excess inventory, which is influencing their selling strategies. Overall, we've seen improvements in business, especially in Asia, as the quarter progresses. With the Chinese Lunar New Year coming in February, we anticipate continued growth as we enter March and the rest of our fiscal year. We remain cautiously optimistic about brands and retailers returning to normal, although they are still somewhat hesitant regarding their inventory levels and how they will respond to consumer demand. We are prepared to adapt to their strategies, whether they choose to ramp up or proceed with caution. We are ready to embrace the growth we are witnessing.

Anthony Lebiedzinski, Analyst

Sounds good. Okay. And just a quick follow-up on that. So, as you're seeing these smaller and more frequent orders, how are you dealing with pricing for those orders? Is it just ensuring that you get the margin that you deserve?

Edmund Ingle, Chief Executive Officer

Yes. As part of this sales transformation, we are continuing to match our pricing to the value we're providing. We are changing our pricing structure, as the market responds to their demands. Since that's not the case, we are reacting, and our pricing is much more targeted based on the value that we're bringing to that product. As we move through the next two quarters, we will see the benefit from a profitability and margin perspective.

Albert Carey, Executive Chairman

One of the things that…

Anthony Lebiedzinski, Analyst

Sounds good. I’ll…

Albert Carey, Executive Chairman

This is Al. I just want to throw on one more comment. In this efficiency move, we've taken out close to 20% of the line items, and most of those are line items that were very low volume, low run times, and low margin. This effectively gets us a positive margin mix that's contributing there, too. Some of these items have been around forever, and finally, A.J. and his team went after it.

Anthony Lebiedzinski, Analyst

Well, thank you for that additional detail and thanks very much, and best of luck going forward.

Albert Carey, Executive Chairman

Thank you, Anthony.

Edmund Ingle, Chief Executive Officer

Thank you, Anthony.

Operator, Operator

Thank you, ladies and gentlemen. As we have no further questions at this time, we will conclude today's conference call. We thank you for participating, and you may now disconnect.