Earnings Call Transcript - UFI Q1 2023

Operator, Operator

Good morning. My name is Devin, and I will be your conference operator today. I would like to welcome everyone to the Q1 2023 Unifi, Inc. Earnings Conference Call.

A Eaker, Executive Chairman

Thank you, Devin, 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 in the Investor Relations section of our website at unifi.com. Please turn to Page 2 of that 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 Form 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'll now turn it over to Al Carey.

Albert Carey, CEO

Thank you, AJ. Good morning, everybody. I apologize for my voice. I've lost it. Quarter 1 has been a tough quarter, and it's been due to one big contributing factor, and that is the slowdown of retail orders for apparel, which is affecting our volume pretty significantly. This began in the summer, and it continues today. Retailers are reporting retail inventories on apparel being anywhere from 30% to 80% above a year ago, and therefore, many of them are going to be discounting heavily during Black Friday and the holiday season, hoping to clear out some of this inventory. However, it's uncertain exactly when normal ordering patterns will return. We've been affected just like all of those who are involved with the apparel industry. Our North American volume in July, August, and September was down 20%, and for Asia, it was down 40%. As you know, Asia does a tremendous amount of business in U.S. retail, but those COVID shutdowns are still affecting our business. So it's going to be kind of difficult to have any reasonable forecast or guidance with this uncertainty. However, I think it's logical to assume that the volume trend will improve after the holidays, and we'll be prepared to move rapidly. While all this has been going on, we're not just sitting here waiting. We're working on four very important initiatives that will strengthen our long-term business and shore up our profitability even in the short term. First, we've already begun a series of actions to reduce our costs in North America. These actions are going to have a big impact on our long-term future, but even in the short term. The first half of this year is going to be very tough on volumes and EBITDA. The second half will show improved volumes with strong EBITDA, thanks to the cost actions we're taking and the benefit of raw material costs that are going down. The second thing we're spending our time on is the REPREVE brand. We're seeing continued interest from our customers on REPREVE because they feel it helps them attain their 2025 sustainability goals, which is only two years away. We have actions that will pull REPREVE consumer brand awareness. We have information now that our direct awareness on REPREVE is 22% aided, and 215% unaided, and that's pretty impressive for a brand that doesn't receive very much advertising and marketing spend. But in the next few months, you'll see some significant improvement in REPREVE brand awareness through some of the programs we've put together. The third thing we're focusing on is that we completed the market study with an outside firm to identify new segments of business to improve our long-term sales and profits, called Beyond Apparel. We have subsegments that look like they'll have the most fruit to bear: auto, industrial, and home. While this is a long-term initiative, several opportunities are very likely to manifest in this fiscal year. Finally, we've been working on the renewal of our credit facility. This summer, Craig Creaturo and his team began work on that as they saw some of the business trends occurring. It led to an effort that he'll take you through in the next few minutes, but our credit facility amendment has been completed, and we feel very good about it. So all in all, it's a bit of a dilemma beyond our control. However, we think it will be temporary, and we'll be ready to get back to servicing customers immediately. But I believe in the same, don't let a crisis go to waste. The programs I spoke about earlier are definitely going to make us a stronger company in the near future. So I'll turn it over to Eddie at this point.

Edmund Ingle, CEO

Thanks, Al, and good morning, everyone. Our first quarter fiscal 2023 results, while disappointing, were generally consistent with the expectations we outlined for you last quarter and reflect the difficult operating environment we anticipated as we entered fiscal 2023. Despite the challenging environment, our global business model remains robust, and we are well positioned to capitalize when the industry sees a return to normalized demand levels. As you can imagine, it's quite a stressful time for our employees, and I want to thank them in advance for keeping their heads down and not getting distracted as we move through this environment. Now turning to Slide 3 for an overview of the quarter. Our net sales for the quarter were $179.5 million, down 8% compared to the first quarter of fiscal 2022. This decline was driven by lower volumes, which stem from a stressed demand environment and volatility across the global markets, particularly in the apparel market. As a reminder, many of the world's largest brands and retailers built up historic inventory levels in calendar 2022, given the supply chain issues they experienced in 2021. We've seen deep discounting at retail and online now to right size that issue. These actions led to cancellations and pushouts as retailers attempted to destock those excess inventories, and global apparel production fell. As Al noted and as we cautioned last quarter, this impacted our start to fiscal 2023, and we expect it to negatively impact our second quarter also. Offsetting some of this volume pressure was stronger pricing in the U.S. The pricing adjustments we made in July and August proved effective in mitigating the cost pressures we experienced during the June quarter, resulting in an improved pricing environment during the September quarter. We are encouraged by our pricing position, despite the benefits being muted by what we see as temporary lower demand levels. We will continue to navigate the fluid macro environment with agility, taking action to protect our margin profile when necessary. From a cost perspective, we saw a decline in both virgin raw materials and recycled bottles during the first quarter. Specifically, bale bottle costs have normalized to much more reasonable levels. Our expectation is that both energy prices and the geopolitical situation will remain volatile. However, we hope it will not be necessary to take pricing actions during this December quarter. We've worked hard to establish our strength in the U.S., and now we are working hard to alleviate temporary costs and volume challenges. Some of our proactive measures include reducing overall labor hours, labor incentives, and retention programs; curtailing noncritical travel and expense activity; decreasing discretionary spending for advertising, marketing, and recruiting efforts; prioritizing growth and high capital return expenditures while continuing to capitalize on opportunities. We are continuing to push hard in each area of cost savings. These measures will help offset the profitability pressures we are experiencing today while not sacrificing the underlying strength of the business for future recovery and growth. Now turning more specifically to Brazil and Asia. Brazil has continued to perform well, but we expect that segment will be battling competitive imports over the next few months. Entities in China and India have been pricing their exports much more aggressively, placing downward pressure on selling prices in the Brazilian market. For our Asia segment, the demand snapshot is very similar to the U.S. Product demand has weakened following high inventories in the supply chain, and the market is awaiting signals from brands and retailers for renewed ordering patterns. We are still seeing selected impacts from continued COVID-related lockdowns in China. Turning to Slide 4, which offers a long-term view of REPREVE Fiber. We believe our long-term positive momentum with the REPREVE brand remains intact with strong customer adoption and co-branding. We have sent $23.5 million in REPREVE hangtags to brand customers during the quarter. REPREVE Fiber products comprised 27% of net sales for the first quarter, which were negatively impacted by the demand disruptions I mentioned earlier. In particular, our Asia segment, which sells mostly REPREVE Fiber products, was adversely impacted by pandemic-related lockdowns followed by demand disruptions from brands and retailers. Once the commercial environment normalizes in Asia and the global supply chain stabilizes, we fully expect REPREVE sales to bounce back to the prior levels of sales mix fairly quickly. Slide 5 demonstrates our expectations for the quick recovery of REPREVE. We continue to see REPREVE momentum build with the launch of new co-branded products from Quiksilver, J. Crew, All Saints during the quarter. Brands recognize that consumers, particularly Gen Z, now expect sustainable options from their favorite brands. This is also evidenced by the growing popularity of our green bottle hangtags as we shipped more hangtags in the Americas in Q1 FY '23 than in any previous quarter. REPREVE brand partners are an essential component of our brand story. During the quarter, we executed social media partnerships with Guy Harvey, Igloo, Teva, Manduca, TOMS Shoes, and Zulu & Zephyr. We have several exciting partnerships planned for the upcoming months. On the activation front, we remain excited about our partnership with Bowl Season. We are working closely with executive directors from six college football games to promote sustainability initiatives. We are also gearing up for our Bowl Bound social media campaign that kicks off later this calendar year as college football teams secure the six wins required to play in a bowl game. The partnership will culminate at the end of the season with a mobile tour activation at a leading college football game. Our mobile tour continues to educate consumers and partners alike about the benefits of REPREVE through a diverse mix of events. From a consumer perspective, the Mobile Tour appeared at college football games on both U.S. coasts. Increasing awareness remains a key focus. We renovated our REPREVE website in early October, and the new clean look of the site is designed to resonate with both B2B and B2C audiences. This refined style is also evident across our social media platforms. Additionally, we have retained a new PR firm and are actively focused on securing both trade and consumer media coverage for both Unifi and REPREVE. This investment will pay dividends in the upcoming months and quarters. Q2 is already off to a strong start from a marketing perspective with several social media partnerships in October, including Quiksilver, Vitamin A, and Manduca in addition to product launches from both Crooks and Calvin Klein. We are especially excited about our new women's activewear collaboration with Asics that launched in early October with a comprehensive campaign that included digital, social, in-store, and public relations. Just last week, we announced a strategic relationship with material science leader, Hologenix, creators of CELLIANT, to introduce CELLIANT with REPREVE. CELLIANT with REPREVE has the infrared properties of science-backed CELLIANT infrared technology and the sustainability footprint of REPREVE from apparel and sportswear to fabric and more. With that, I will now turn the call over to Craig.

Craig Creaturo, CFO

Thank you, Eddie, and good morning, everyone. The quarter we just completed was full of challenges that stemmed from reduced demand by retailers and brands that have pushed out orders and delayed programs. This unexpected development led to volume weakness in the Americas, driving significant margin pressure and lower-than-expected profitability. Outside of the short-term disruption, we believe the underlying demand for our products remains strong, and our management team is focused on controlling costs and remaining nimble as we continue to pursue our long-term goals. Let's turn to Slide 6 of the webcast presentation. Here, we will begin the review of our reportable segment performance. For the Americas segment, a 2.9% decrease in revenues demonstrates the positive impact of robust pricing efforts we highlighted throughout the last several quarters, offset by lower volumes and connections with brand and retailer demand flow-through. In Brazil, we're facing fewer market demand headwinds, and the just completed quarter demonstrated a more normalized level of strong revenue performance. The double-digit volume growth of 16.6% is indicative of our strong presence in the region and the demand for our innovative products. In Asia, sales volumes were challenged by recent COVID lockdowns and overall market demand pressures, while pricing and mix remain strong. We still expect continued interest in sustainable yarns and our ability to support local customer demand will allow for robust underlying revenue performance when the short-term disruptions subside. Turning to Slide 7 for the quarterly gross profit overview. Consolidated gross profit decreased from $26.1 million to $6.6 million, with gross margin declining from 13.3% to 3.7%. The Americas segments decline in gross profit and weaker gross margin percentage were attributable to the shortfall in product demand and the associated impact on fixed cost absorption. We have maintained a strong workforce during these difficult times as we believe that demand will return in the near future, and that drove some cost inefficiencies in our facilities. However, we expect that the additional training and investments in our people will pay future dividends when volume returns. In Brazil, the gross profit and margin rate demonstrated the expected normalization that we have discussed in prior quarters, and the gross margin of 17.5% is more indicative of the historical rate for this segment. 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 constrained demand. Our asset-light model continues to prove to be a good choice for the Asia region. Moving on to Slide 8, which provides a brief update on our balance sheet and capital allocation priorities. We ended the first quarter of fiscal year 2023 with $54.5 million borrowed against our ABL revolver and $62.5 million borrowed against our term loan. As we described in our earnings release, we completed the refinancing of our asset-based lending facility on October 28, 2022. As presented on Slide 9, among other benefits, this new facility increases our borrowing capacity from $200 million to $230 million, moves the significant majority of our short-term outstanding borrowings into the expanded term loan, continues the favorable borrowing rate structure and overall loan flexibility that has been in place for several years, extends the maturity date to October 2027, and provides helpful liquidity during the current period of demand softness. I would like to say thank you to our banking partners for their support of Unifi with the new credit facility, and I would like to thank the Unifi Finance and Legal Group for their efforts on this activity. 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 a reminder, $38.9 million remains available for repurchases under the current share repurchase program. Lastly, I'll spend a moment reviewing the tax rate. As the demand pressures drove weakness in the Americas segment gross profit, our U.S. earnings declined. Our lower profitability levels create greater sensitivity in the effective tax rate calculation. The negative tax rate for the quarter reflects expenses incurred for profitable foreign operations while the valuation allowance fully offsets the assumed benefit on U.S. losses. Now I'll pass the call back to Eddie to take us through the last slide of the presentation and make some final comments.

Edmund Ingle, CEO

Thank you, Craig. Before we turn the call over to our Q&A session, let's turn to Slide 10 of the presentation to discuss our outlook and expectations for the second fiscal quarter. The operating environment and demand trends we're seeing, both domestically and internationally within the apparel markets, are expected to remain fluid for the rest of the calendar year as major apparel brands and retailers continue to deal with inventory destocking measures, with the timing of apparel production and demand recovery remaining uncertain. Our visibility remains constrained, but we expect to see a similar operating environment in the second quarter, then we expect to see a recovery take hold in the second half of fiscal 2023. This aligns with prior trends during sharp macro environmental disruption, where we have historically seen two quarters of demand impact and then bounced back strongly as inventories need to be rebuilt. Given these short-term challenges, we believe it's prudent to temporarily shift our guidance to a quarterly basis until we regain some visibility and can make better predictions under an annual approach. For the second quarter of fiscal 2023, we expect net sales to be 10% to 15% lower than what we reported in Q1 of fiscal 2023. Additionally, our expectation is that pressures on fixed cost absorption will drive lower profitability in the Americas, leading to another quarter of unfavorable EBITDA. While the current operating environment is challenging, the long-term growth potential of Unifi has not changed, and we remain optimistic about our future and our position as a global sustainable fiber leader. Again, as inventory levels diminish and demand stabilizes, we expect to see our revenue and profitability accelerate in the second half of the fiscal year. We are pleased to have the additional liquidity afforded by our amended credit facility, and 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 across the globe. We will now open the line for questions.

Operator, Operator

Our first question comes from Daniel Moore with CJS Securities.

Daniel Moore, Analyst

Thank you. Good morning. Let me start with some of the cost reduction actions. Can you give a little bit more color and quantify the cost savings from some of those actions, and whether those are temporary or if some are more permanent in nature?

Edmund Ingle, CEO

Thanks for the question. Yes, the cost reduction actions are predominantly temporary because we do see this business bouncing back. For example, we're taking extended shutdowns at our Christmas period and we're also going to take some plant shutdowns during the Thanksgiving holiday. We have pushed out quite a number of activities to later on in the year or perhaps into 2024. So while much of these cost savings will be implemented in Q2 and some into Q3, we do expect the impact to predominantly benefit us in Q3.

Daniel Moore, Analyst

Got it. Helpful. REPREVE, you mentioned obviously some of the momentum with new partners and the hangtags. Revenue did decline about 33% or so. I understand the inventory challenges, obviously. Can you reassure us what gives you confidence that you're maintaining, if not continuing to grow, market share in the Asia region?

Edmund Ingle, CEO

Yes, it's a great question. Initially, the slowdown in the market due to COVID lockdowns began in the middle of March last year, extending through the middle of May and into June. This eventually turned into a slowdown in orders from the U.S. and European brands. As we went through the quarter, there was a strong initiative by these brands to cut back on their orders and push out orders. We know these cutbacks can't go on forever; at some point, the brands have to start restocking their inventories. As we mentioned on the call, we have a high expectation for significant discounting during the holiday season, which will help clear out inventory. We anticipate seeing orders return in Asia either before the Chinese New Year or shortly thereafter. For REPREVE, we don't expect demand to change significantly as that bounce back happens.

Daniel Moore, Analyst

Okay. And then on the credit facility, obviously proactive. Can you tell us what covenants are there, if any, regarding leverage ratios or any other considerations we might be thinking about on the amended facility?

Craig Creaturo, CFO

Dan, the covenants are the same as the previous facility, meaning there is one fixed charge coverage ratio covenant, but it's a springing covenant. As long as our excess availability exceeds the trigger level, which we have plenty of headroom on now, there are no compliance issues. So really, it's very similar to the facility we just replaced.

Operator, Operator

Our next question comes from Anthony Lebiedzinski with Sidoti & Co.

Anthony Lebiedzinski, Analyst

Good morning. Thank you for taking the questions. Given the current weak demand environment, are you confident that you will be able to hold your pricing? Are you seeing perhaps your customers looking for any discounts? So I'm just wondering about your confidence level in your ability to maintain pricing steady?

Edmund Ingle, CEO

A great question. We've spent a lot of time and effort getting to the price point we needed to over the last 12 months. We are going to be under pressure to manage prices down, but we are doing our very best to make sure that we stay strong and maintain the margins that are appropriate to the raw materials cost that we have in place.

Anthony Lebiedzinski, Analyst

Okay. Got you. And then in terms of your CapEx spending plans, I know you gave guidance for your current quarter. Are you still on target to finish the rollout of the Evo texturing machines, and I'm just wondering if CapEx should come down next year because of that?

Edmund Ingle, CEO

Thank you for the question. We've certainly cut back on all of the CapEx programs that we can move out, with the exception of issues that may be maintenance-focused or centered around safety. We have not pushed out spending on Evo; that currently is ongoing. But as you can imagine, we are evaluating the timing of that. However, no decisions have been made about the overall CapEx.

Anthony Lebiedzinski, Analyst

Got it. And then I think last quarter, you talked about that there would be some inventory write-downs in the quarter. Did I miss that? Or was that something that was meaningful here in the quarter that you just reported?

Craig Creaturo, CFO

Yes, Anthony, those write-downs did have an impact on the business. However, the bigger impact for us was the lack of volume, especially in the Americas. We have been pulling back quite a bit on the amount of raw material we've been purchasing. As our demand has gone down, we have been quick to react and reduce those purchases. Yes, we are now buying at lower prices, but that impact will not help us as much in the just completed quarter; it will help us a little as we head into December and beyond. While we have adjusted our inventory purchases down, those adjustments are flowing out slower than we expected and historically have due to this demand softness. Yes, that did impact our financials in this quarter, and it was factored into our guidance for the December quarter as well.

Anthony Lebiedzinski, Analyst

Got you. Okay. You mentioned at the beginning of your prepared remarks about a market study done with some segments beyond apparel. Out of the auto, industrial, or home segments, which one do you think will have the nearest impact in terms of your business?

Edmund Ingle, CEO

As we looked at those three segments, we believe home will provide us the quickest jump. We are currently eyeing some programs, primarily due to the quick decision-making possible in that market, while automotive takes a longer time to set those programs in place.

Operator, Operator

There are no further questions at this time. With that said, we conclude the Q1 2023 Unifi, Inc. Earnings Conference Call. Thank you for attending today's presentation. You may now disconnect.