Earnings Call Transcript - UFI Q3 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Unifi Third Quarter Conference Call. At this time, all participant lines are in a listen-only mode. After the speaker’s 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 Mr. A.J. Eaker, Vice President of Finance. Thank you. Please go ahead sir.

A.J. Eaker, VP of Finance

Thank you, operator, and good morning everyone. On the call today is Al Carey, Executive Chairman; Tom Caudle, President and Chief Operating Officer; and Craig Creaturo, Executive Vice President and Chief Financial Officer. During this call, management will be referencing a webcast presentation that can be found at unifi.com and by clicking the third quarter conference call link. Management advises you that certain statements included in today's call will be forward-looking statements within the meaning of the federal securities laws. 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 net income, adjusted EPS, and adjusted working capital and net debt may be discussed on this call. Lastly, please be advised that in consideration of COVID-19 safety measures, the speakers today are utilizing multiple telephone lines; efficiency for this call may be impacted. I will now turn the call over to Al Carey.

Al Carey, Executive Chairman

Well, good morning, everybody and thanks for joining our call today. I'm going to open up with a few comments about our performance. And then, I'm going to turn it over to Tom and Craig, who will give you more of the specifics of our performance. And then afterwards, we're going to entertain some questions, and I imagine it will take a bit longer than normal due to this unusual time that we're operating in right now. So on Q3, I'd say that it was a good one for us. And Craig will point this out in the next few minutes as he presents, but we delivered at or above our forecast on most of our important financial metrics and we generated a significant improvement over last year's Q3 performance. But there were two highlights from the quarter that I'd like to mention; one was that we were pleased to see our U.S. polyester textured yarn sales returned to year-over-year growth, and it's been a long time coming. It indicates that these trade anti-dumping actions are finally showing up in the marketplace for us. After December, when those antidumping regulations were finally put in place, we began seeing a positive improvement in our U.S. sales. The other thing we were very excited about was that Asia has performed well for six or nine months for us. But when they started the year in January, they were doing terrific. February came with the COVID-19 virus in China. We didn't anticipate much of a comeback in March, but I would say that it was a remarkable comeback for our team in March. I really think our asset-light model in Asia served us well, and I think it's going to be an advantage moving forward. However, as we hit the last two weeks of the quarter, we saw a drop-off in sales directly attributed to the retail apparel stores being closed and also automotive plants; those are the two segments where we do a disproportionate amount of our business. We're staying close to every single customer, and I can tell you that we're ready to begin shipping when they're ready to take the shipments. However, forecasting volume and how fast it's going to come back will be tricky. If I were to bet, I'd say that production will come back ahead of consumer demand, as is what happened in China. So it's likely to be a little uneven for a while. Our primary attention will focus on managing cash and working capital very carefully. We also have some new actions on cost reductions that will allow us to be more profitable when we come out the other end of this. I'm confident that we'll be in a good place at the end of the quarter, and I also think that we're well positioned going forward after the virus ends. I'd also like to tell you about another key event during the quarter; we were able to conclude a search for the right leader to take the helm at Unifi. That leader is Eddie Ingle. He has 30 years of experience in many key leadership roles at Unifi. Most recently, he was the CEO of Indorama's global recycling business. We're all delighted to have Eddie back at Unifi, and our leadership team and employees are unanimously excited about hearing about Eddie's return. He'll start on July 1st, at the beginning of our new fiscal year. The bittersweet news is that we also announced the planned retirement of our President and COO, Tom Caudle, after what I'd call an exemplary 40-year career at Unifi. The good news is that Tom's not going to leave us until June of next year. He will be leading some key strategic initiatives for our business over the next 12 months, and I described these initiatives as ones that only Tom Caudle could get done. Going forward, here's what we expect from ourselves. I believe Unifi can regain the top-line momentum that we saw in Q3 once this virus gradually diminishes. Our strengths will be that we have a very flexible global supply chain that will serve our customers well. I like the fact we have an asset-light model in Asia and Europe. We have the ability to potentially fully utilize our assets in North America, thanks to the anti-dumping pickup and our innovation. We will become the most prominent producer of environmentally sustainable yarns that have tracing capabilities like no others have. I believe ESG is only going to become more important after COVID-19 subsides, which will bode well for the REPREVE growth going forward. I'm confident in our cash position and our liquidity, which will get us to the other end of this COVID-19 crisis successfully. My expectation is that we're going to be a better overall company going forward. Lastly, about our people, I want to mention that we have had a very small number of incidents among our 3,000 employees who have experienced the virus. None have been seriously ill, and thankfully, none have passed away. Other companies are not as fortunate as we have been. In my 45 years of experience, I've never seen a team more resilient than this one, from top to bottom. Our leadership team has taken a year to get right, and it's a great blend of experienced veterans and also young people with lots of potential. I believe the newest additions, CFO Craig Creaturo and now Eddie Ingle, our new CEO, will lift our expectations even higher. As the Chairman, I feel very good about the leadership team we have in place. With that, let me turn it over to Tom Caudle, our President and COO, and he's going to take you through some specifics of our performance in Q3. Tom, take it away.

Tom Caudle, President and COO

Thank you, Al, and good morning, everyone. Let's start with a quick business update as outlined on page three of the slide presentation. As Al noted, we started the quarter strong, seeing very positive momentum from the strategic actions we've taken over the last few quarters. Even our operations in China, which had been closed for an extended period in the middle of the quarter, came back and made up significant lost trends. However, the economic impacts of the virus across the globe began to hit our volumes in late March. We are all working hard to prioritize the safety of our people, customers, and communities. While our volumes have slowed and some of our assets are underutilized temporarily, many of our facilities continue serving essential markets. Like many companies, our visibility over the near-term is challenged. That doesn't prevent us from thinking proactively and protecting the balance sheet. For example, we made the strategic decision to divest our 34% ownership of Parkdale America and closed the transaction earlier this week. We received $60 million in cash, improving our net debt by $60 million this week, and applied approximately half of the proceeds to debt retirement while maintaining the other half as cash reserves. We have a very positive relationship with Parkdale, and this transaction is a natural evolution of the joint venture. With this, we can focus our full efforts on expanding our leadership position in recycled and synthetic fibers while providing additional flexibility and liquidity for both long-term opportunities and short-term needs during the pandemic. Moving to slide five, let's talk about what we're doing in terms of risk mitigation and safety. Our top priorities are to protect our employees and their families and to support our operations through the significant challenges we face today. We are keenly focused on ensuring the long-term financial health of the business and have taken steps to fortify our cash position and balance sheet. While it's not currently possible to estimate the full impact that COVID-19 could have on our business, our leadership team took decisive action to mitigate risk when COVID-19 initially impacted our operations in Asia, and we continue to take action to stay ahead of the global spread. Throughout the organization, we have restricted travel, maintained diligent sanitation and disinfection practices, and encouraged social distancing. Furthermore, I'm proud of the work our team is doing in the fight against COVID-19, as we have participated in the supply chain for PPE necessary for first responders, healthcare personnel, and military. Craig will walk you through a more thorough review of our balance sheet shortly, but I want to highlight some bright spots in our liquidity. Cash flow generation for the last nine months continued positive trends seen in the first half of the fiscal year, improving to $32 million compared to a negative $1.5 million in the comparable period last year. Additionally, we have reduced capital expenditure levels to bolster our cash position, focusing our CapEx only on safety and maintenance activities at this time, while strategically reducing manufacturing operations to further support critical businesses and manage working capital. Given that the economic outlook is evolving quickly, we will continue to review our plans and adjust as needed, being thoughtful about preserving liquidity. The good news is we support a number of essential businesses today, and raw material levels remain very low, which would further aid our working capital and liquidity as we navigate this temporary period. Now turning to our third quarter results. Prior to the disruption caused by the pandemic, the consolidated business was performing in line with our expectations. The trade actions we took in 2019 began to take effect as higher textured yarn volumes drove stronger utilization and sales trends for our core polyester business. Total sales volume increased 6.5% on a year-over-year basis during the third quarter, primarily driven by Asia despite pandemic impacts lingering for weeks in that region. Lower polyester raw material costs led to lower average selling prices across the Polyester, Asia, and Brazil segment, while the pre-existing Nylon and Brazil foreign exchange headwind dampened overall revenue. In the U.S., we anticipate the recapture of domestic sales and market share with new duties in place, and we were hitting our target run rate prior to the pandemic, driving higher textured yarn production volumes during the March quarter, which helped our margin profile. We still believe that share recapture is attainable, but due to the ongoing pandemic, we can't specify the timing today. Now, I'll walk through our segment performance for the third quarter. Polyester began the March quarter showing great promise with anti-dumping volumes driving strong utilization and sales trends. However, COVID-19 impacts began in mid-March. Our Central American production has been shut down due to shelter-in-place ordinances in March. In the U.S., demand has been stifled by retail closures, and we expect this to continue at various levels throughout our fourth quarter. Turning to our second largest segment, Asia. Despite the significant shutdown in China in response to the COVID-19 outbreak, the Asian segment was able to recover quickly, restoring its continued sales growth with a 28% increase in sales volume led by REPREVE branded products. While our relationships in China are strong and the region remains a powerhouse, we are continuing to expand our supply chain beyond China to remain nimble and service our customers' shifting demand. Moving on to operations in Brazil. We began the quarter demonstrating positive momentum with raw material pressures stabilizing. These trends continued into February, and it was not until March that Brazil began to show signs of disruption from the pandemic. The third quarter was also impacted by a significant weakening of the Brazilian real. We have since seen overall demand drop significantly in the Brazilian market, causing a reduction in production and a further weakening of the Brazilian currency. The nylon segment continues to remain pressured from recent customer shifts, but we remain supportive of our nylon business, and those assets remain important to our ongoing strategy, innovation efforts, and global expansion. Looking ahead, we are confident that our recent mitigation efforts and focus on preserving cash will be effective in weathering the current storm. We will continue to monitor demand levels, economic indicators, and conversations with our customers while prioritizing health, safety, and risk mitigation measures. I will now pass the call to Craig.

Craig Creaturo, CFO

Thank you, Tom, and good morning everyone. As Tom noted, our underlying financial results were significantly improved over the prior third quarter, and we continued solid momentum leading up to the pandemic. I'll provide more detail on the Q3 performance and then some context around our liquidity position to expand on Tom's remarks regarding the steps we are taking to adjust to the changes in our business environment. On slide 6, we show an overview of operating income. Q3 fiscal 2019 operating income was $0.8 million, and Q3 fiscal 2020 operating income was $3.1 million. The $2.3 million increase was driven by strong performance from our Polyester, Brazil, and Asia segments, combined with less severance charges and foreign currency transaction losses in Q3 fiscal 2020 compared to Q3 fiscal 2019. Below the operating income line, we recorded a $45.2 million impairment charge in connection with selling our investment in the Parkdale America joint venture, arriving at a net loss of $41.1 million and a loss per share of $2.23. Excluding the non-cash impairment charge, adjusted net income and adjusted EPS reached $4.1 million and $0.22 respectively. Therefore, on an adjusted basis, overall income performance was $5.6 million or $0.30 per share better than the prior year. Parkdale America's recent nine months' performance was $0.8 million lower than the comparable year-ago period, and we will discontinue reporting equity income from Parkdale America in fiscal 2021. Now, let's review sales performance by segment on slide 7. Consolidated sales declined 5%, from $180 million in Q3 fiscal 2019 to $171 million in Q3 fiscal 2020. The Polyester segment revenue declined by 6.2%, primarily due to lower average selling prices connected to lower raw material costs. Nylon segment sales declined 19.6% due to a step down in volumes that we experienced in fiscal 2020 as two significant customers transitioned programs to overseas production in calendar 2019. Brazil segment revenue was significantly pressured by the weakening of the Brazilian real, driving a sales decline of 16.1%. Despite an extended Chinese New Year holiday and mid-government shutdowns, the Asia segment rebounded quickly and continued double-digit sales growth, reaching 18.6% more revenue than Q3 fiscal 2019. Therefore, Q3 fiscal 2020 represented the tenth consecutive quarter of double-digit sales growth for our Asia segment. Now, moving on to gross profit by segment on slide 8. Consolidated gross profit increased $1.6 million, or almost 12%, from $13.8 million to $15.4 million. For the Polyester segment, a more favorable sales mix and raw material environment led to a gross margin improvement of 280 basis points. Nylon results continue to be pressured by lower volumes, leading to weaker fixed cost absorption, which pulled down the gross margin rate to 160 basis points. In Brazil, the sales mix was slightly better, and raw material and pricing pressures were partially alleviated, while the Brazilian real weakened, allowing for significant improvement in gross profit and gross margin of $640,000 and 510 basis points, respectively. For the Asia segment, the margin rate held steady at 11.9%, and the previously mentioned sales growth drove a gross profit increase of over $700,000. We are proud of the Q3 fiscal 2020 results and are excited about the momentum created at the beginning of the quarter, stemming from the combination of our global strategy and asset-light model and the early signs of market share restoration in the U.S. when we began hitting our targeted run rate for trade action-related volumes. Now, turning to slide 9, let me revisit a few points from Tom's discussion regarding how we are looking into the future, our liquidity position, and the steps we have taken to protect our business. The economic slowdown and decline in global demand places short-term pressure on our ability to generate cash. We are fortunate that our financial health remains significantly better than one year ago, when we began taking cost reduction measures and better positioning the business to endure times like these. Our ABL credit facility remains a stable platform for supporting our liquidity needs, and the maturity date is not until December 2023, as a result of the refinancing we completed late in 2018. We do expect some use of cash in the months of May and June 2020. However, the steps we have taken to reduce capital expenditures and limit discretionary projects, including the recent cash from the sale of the Parkdale America investment, give us confidence in dealing with these short-term pressures. We are confident we have a meaningful buffer if economic activity remains slow for an extended period of time. On March 29, 2020, net debt was $100.3 million lower than both June 30, 2019, and March 31, 2019. Keeping in mind, that this position was prior to the receipt of the $60 million for the sale of Parkdale America investment. That transaction allows some headroom for enduring the near-term challenges ahead. Moving beyond our liquidity position and the renewed strength of our balance sheet, the pandemic impacts on our business remain uncertain regarding severity and duration. Accordingly, we have suspended guidance at this time. Quite simply, the visibility of our customers has become cloudy, and we do not have the same level of visibility that we normally do when we provide future-looking guidance. As the pandemic impacts subside and the economy and global demand stabilize, we will again consider providing guidance in a more predictable environment. I will now pass the call to Tom for some closing remarks.

Tom Caudle, President and COO

Thanks, Craig. I'd like to wrap up my prepared remarks today with a few big picture thoughts. It is important to understand that the medium to longer-term underlying fundamentals that drive our business are still in place. Many industries will be reshaped by this pandemic experience, and I think our industry will be as well, but in a positive way. Sustainability is here to stay. We already support the world’s leading progressive brands and continue to have daily conversations with potential new customers that know they need to catch up with their competitors. The world today is difficult, but one of the positives that has emerged is the spirit of community. We believe that this collective spirit will help us through these hard times and further accelerate sustainability trends. Our innovative performance fibers are underlying inputs for some of the largest multinational consumer brands. Unifi's diverse global operations and growing asset-light model allow the business to be agile and less capital-intensive. Our business is sound, resilient, and more adaptable to demand shifts than many of our competitors. We have built a strong reputation over 50 years of meeting our diverse customer needs across the world. As a result, we remain confident in our leadership team and our business model, as these inherent strengths will provide long-term stability and growth. Looking past the pandemic, we are optimistic about the recovery we have seen to date in our Asian business as the region emerged from the severe restrictions necessitated by the COVID-19 outbreak. We are encouraged to see China’s manufacturing begin to recover, and our supply chain remains strong and nimble. We continuously monitor developments as we take the learnings we've gathered in that region and look to leverage that for other affected areas as they reopen. We are evaluating different scenarios across the region to ramp up production carefully as demand returns. Each region will require thoughtful execution, but we are confident in the restoration of demand in the future for Unifi. The third quarter results reflect the underlying strength of our business. We remain committed to providing our customers with their needs while ensuring the safety of our workforce. The leadership team and I are committed to taking the necessary steps to navigate these near-term headwinds. We have a clear focus with the right strategy in place and a strong balance sheet to guide us through these uncertain times. We will now open the line for questions.

Operator, Operator

Your first question comes from Chris McGinnis from Sidoti & Company.

Chris McGinnis, Analyst

Good morning. Thanks for taking my questions and nice quarter. Tom, I know we get your wisdom for about another year, but I just want to say congratulations on the upcoming retirement and thanks for all the help over the years.

Tom Caudle, President and COO

Thank you, Chris. I appreciate it. We appreciate your support.

Chris McGinnis, Analyst

Thank you. To think about the business and with the disruptions across the businesses and closures on the state levels, as we're starting to see some states open up, can you just talk about the conversations you're having with your end customers as we're starting to see things maybe resume or get back to normal? And can you just provide a little bit of insight into that part of the market? Thanks.

Tom Caudle, President and COO

Yes, Chris. This is Tom. We really have very strong relationships with our customers, and during these uncertain times, we are communicating with them on a daily basis, just so that we don't overproduce and build inventory. There haven't been many cancellations of orders, but I would say there have been more deferrals, with orders being pushed out during uncertain times. We're not getting a lot of surprises right now because we are communicating—I'd say over-communicating—with our customer base right now, so that we're all in lockstep as we move forward.

Chris McGinnis, Analyst

Okay. And then just your thoughts around—does this change the supply chain at all in maybe moving it to one region over another longer-term? Can you give your thoughts around that? I know you have a flexible supply chain, but longer-term does this change, maybe positively, as it comes back more in North America? Just your outlook or thoughts around that?

Tom Caudle, President and COO

Currently, the U.S. and Central America region is probably a little stronger just because of PPE demands and some of the things that we're supporting with our government needs in the healthcare industry and military and first responders. However, I think when retail comes back, we'll see China crank up again, and we expect good things for our overall business around the globe.

Operator, Operator

Your next question comes from Daniel Moore from CJS Securities.

Daniel Moore, Analyst

Craig, good morning, congrats again on solid certainly results in a tough environment. And Tom, I echo my sentiments; I'm sorry you have to deal with this for another four quarters, but congrats.

Tom Caudle, President and COO

That's no problem, Dan. I appreciate it.

Daniel Moore, Analyst

Number one, even if maybe you want to— I know you probably want to stay away from hard and fast numbers—but even directionally in terms of volumes, if we look across the segments, Polyester, Nylon, Asia, Brazil, could you rank order the kind of volume declines that we've seen so far in the quarter? And any color as to progress in terms of opening back up and how you see which of those might turn the spigots back on earlier rather than later?

Tom Caudle, President and COO

Dan, other than Central America, all of our plants are open for business and operating at varying levels of demand right now. So, if that answers your question?

Daniel Moore, Analyst

Yes. I mean obviously to the extent that you have any additional color as far as order of magnitude of volume declines, that would be helpful. If not, I’ll go to the next one.

Craig Creaturo, CFO

Dan, this is Craig. I might be able to add some additional details there. I mean in the U.S., as Tom mentioned our facilities are up and running. We are continuing to serve the areas where there's more critical demand, definitely in the medical area, personal protection, those types of areas. Obviously, other parts of the business, the traditional apparel and auto are slower. In Brazil, we are running, but we are definitely facing lower demand levels in that country. In China, after what is kind of a borderline road comeback that we had here in Q3, the business is up operational, and our business is doing well. However, we are suspecting and sensing and seeing a slowdown because the ultimate end customers of a lot of the China production are in the U.S. and Europe. With those markets being slower in most of the areas that we service, we're seeing slower production there. So I would reiterate, really only our El Salvador operation has been shut down for the last several weeks. Currently, we’re unsure when that will be allowed to come back online; that's a government-mandated shutdown in that country. It may be as early as later this month in May, but we’re not exactly sure.

Daniel Moore, Analyst

And if my recollection—yes, go ahead.

Al Carey, Executive Chairman

This is Al Carey. I was just going to add that, as you speak to some of the retailers, they're waiting to open the stores. When they do, most retailers will want to order and begin planning for what I'd call the back-to-school and Christmas timeframe. I don't think any retailer wants to be out of stock during that key period of time. The question will be how do the consumers come back? How fast do they return? Do they recover their jobs and spend again? So we are kind of watching that, but we're ready to open and get moved. I expect that fall, Christmas orders will start coming in. The Nylon business has been a negative for us because of some of the shifts with customers moving offshore; however, we stay optimistic about that as we have an executive focused on getting our Nylon business back through new customers and some new ideas. The other part is some of our innovation; we've got two key innovations that I’m really excited about. One is Nylon, and how do you do a REPREVE Nylon? The other is REPREVE Ocean plastic. Those were getting tremendous interest from our customers before this all happened; obviously, right now they’re focused on getting back into business, but I expect those to help us going forward.

Daniel Moore, Analyst

That's very helpful. If my two teenage daughters have anything to say, they'll be back in the stores sooner rather than later. Maybe just shifting gears—the decision to sell Parkdale has always been kind of deemed a strategic fit. We applaud the decision to aggressively raise cash given the uncertainty. It sounds like you feel comfortable with your liquidity position just to remind us, Craig, of your total liquidity right now? And any plans to add additional safety nets around that liquidity position?

Craig Creaturo, CFO

Yeah. I think it was a good decision that we made; it was really something that we felt was a logical extension. You have a joint venture relationship with two parties, and it just made sense for one to eventually take over. It's been a great relationship for Unifi and Parkdale, something that spanned over 20 years, and it came together very quickly this quarter. It does provide us quite a bit of flexibility. In the slide presentation on page 9, we show the liquidity update from the end of March, and that information is before layering in the additional proceeds that we received from the sale of the Parkdale investment. We're feeling like we're in good shape from that perspective. Our financial performance has improved significantly, with increased cash flow for the last nine months compared to the prior nine months. Lots of costs have been pulled out of the business appropriately, and we were already taking those reducing measures before COVID-19 emerged. Therefore, where we are now, plus some additional room that we have from the Parkdale sale transaction, gives us confidence that we are in a very good shape from that perspective.

Daniel Moore, Analyst

Got it. Central America, if I recall, was somewhere in the 10-ish, 12-ish percentage of total revenue. Is that ballpark correct?

Tom Caudle, President and COO

It's a little lower than that, I believe.

Craig Creaturo, CFO

Yes, exactly.

Daniel Moore, Analyst

Got it. Helpful. Lastly for me, I should probably wait until July and let Eddie answer this, but given the addition of the new CEO, any changes in strategic direction you might consider? You touched on Nylon; it sounds like you're still excited about that, but any subtle shifts in direction or things that he can add? If you have any color that would be really helpful.

Tom Caudle, President and COO

Sure. I don't expect us to have a new strategy. The good news is that Eddie has been here for 30 years and even up until two years ago. I think the top priority will remain the same. We need to get the asset-light Asian business really moving, which seems to be doing well, and get the North American assets fully utilized by taking advantage of a pickup in the anti-dumping volumes, but also leveraging these innovations on sustainable products. These are the two things we need to put a lot of focus on. I think you'll see Eddie continue what we've been doing. Although, I've told him to bring all your new ideas. I remember when he was here, we spent a lot of time making sure our inventories were at appropriate levels. I think he will bring some new thinking to that aspect and help us, as that's an area we could improve on. I don’t expect significant changes in the strategy—again, it's pretty much what we discussed together at your conference.

Daniel Moore, Analyst

Understood. Okay. Great. Appreciate the color. Stay safe, and I look forward to the next update. Appreciate it.

Tom Caudle, President and COO

Yes, thank you.

Operator, Operator

There are no further questions at this time. I would now like to turn the call back over to management.

A.J. Eaker, VP of Finance

With no further questions, we'd like to thank everyone for participating today. Our next earnings release for the fourth fiscal quarter ending June 28, 2020 is tentatively scheduled for Wednesday, August 5, 2020, with a conference call to follow the next morning, Thursday, August 6, 2020 at 8:30 Eastern Time. Thank you for joining today's call.

Tom Caudle, President and COO

Thank you, everyone.

Operator, Operator

Ladies and gentlemen, this does conclude today's conference. You may now disconnect.