Earnings Call Transcript - UFI Q4 2023

Operator, Operator

Good morning, and thank you for attending Unifi's Fourth Quarter Fiscal 2023 Earnings Conference Call. Today's conference is being recorded. Speakers for today's call include Al Carey, Executive Chairman; Eddie Ingle, Chief Executive Officer; Craig Creaturo, Chief Financial Officer; and A.J. Eaker, Treasurer. 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 2 of that slide deck for our cautionary statements and non-GAAP measures. I will now turn the call over to Al Carey.

Al Carey, Executive Chairman

Thank you, and good morning, everybody, and thank you for dialing into Unifi’s fourth quarter earnings call. I'd like to take a couple of minutes telling you about the environment that we're operating in because I have to say, it's one of the most unusual I've ever seen. And then when I'm done doing that, I'll turn it over to Eddie Ingle, our CEO. So you've seen the sales and EBITDA numbers for Q4, and you can see that they look very similar to Q3. And that's because volume remains depressed in North America, which drives a low level of EBITDA because we're not getting the throughput we needed to leverage our fixed assets. Now most of you are probably saying, what is going on with your business? And I fully appreciate that because Q2, Q3, and Q4 have been weak. Let me cut to the answer, and then we'll work backwards into the details. Inventories at retail have been massively high starting last fall on apparel. They're still high today. The retailers are working them down, but until they come down, ordering for yarn has been scarce. So you may ask, when will the inventory be done? Probably at the end of the calendar year. That's what we hear from our retail partners. When will orders begin flowing back into Unifi? Probably around the October timeframe. How big will the ordering be and how fast will it come back? I don't know. There's still a fair amount of uncertainty. But listening to retailers, I'd say it will probably be conservative at first, as they're going to be cautious when they start back ordering and especially after they just came out of a troubled time of heavy inventories. The other question you may be asking is, what about the sales trends on apparel? They've been off for a whole year. And in the last 2 quarters, they've been down 7% in units. So what's going on there? My observation is that over the last 12 months, the consumer has spent a great portion of their income. And again, the average consumer, who makes probably $55,000 a year, they're spending their money on important basics of food, fuel, housing, all at higher prices. So the discretionary income they have left seems to be allocated to things called experiences, and that is primarily travel and entertainment, leaving a lot less money for things like apparel. Now we feel certain that there'll be a rebalancing between goods and services here soon. We're already seeing some of that begin. At the same time that that's happening, the inventories will rebalance back to a more normal level. And then we can expect to see some steady state in our half 2 of fiscal year and the beginning of 2024 for the rest. So I think you can say that this synopsis that I gave you is probably accurate because it's a compilation of speaking to the majority of our customers, our partners, our mills, and analysts that follow the marketplace. And the majority are saying the same thing. So is there any good news for Unifi in all this? And the answer is yes. Since we're at the front of the supply chain, we can feel the pain first, but we typically catch the tailwind first. We began feeling the difficulty of this situation last summer. And now 1 year later, we're beginning to see some green shoots in terms of improved orders for volume in and around the October timeframe. Also, during the last 12 months, we didn't waste the crisis. Our teams have been working on several initiatives that are going to make our company better in the long run. The first thing I'd mention to you is that we have begun to get traction on building a business in categories that are outside of apparel, categories such as home, auto, industrial, and packaging. These categories are incremental to our current sales portfolio, and they also have much higher margins than the apparel categories that we sell today. The second thing our teams have been working on is an activity-based costing capability that allows our sales and operations people to collaborate very closely, looking at our inputs, true cost, capacity utilization so that we can optimize pricing for better profitability and also improve our market share. And I'll mention a third. We've developed several REPREVE product innovations. They offer consumer benefits that allow us to offer a premium on REPREVE but always use recycled material. So I would say that given this current difficult environment, we can now kind of see where things are going. And I would say that we feel optimistic about what's going on, and I'm very proud of our teams and the way they've worked through all this. And I believe that when we get on the other side of it, our company is going to be a lot stronger than it was when we started the journey back before the pandemic. So with that backdrop, let me turn it over to our CEO, Eddie Ingle, who will take you through the details of our performance.

Eddie Ingle, Chief Executive Officer

Thanks, Al, and good morning, everyone. Our fourth-quarter results reflect the pressures of continued demand weakness, as Al mentioned, across the apparel and textile supply chains, as brands and retailers continue their efforts to normalize their inventory levels. Now while it's been a challenging fiscal year, I'm very grateful for everyone on the Unifi team across the globe. And once again, I want to thank them for their unwavering commitments and hard work. While we recognize that globally, our business is suffering, alongside others in the textile space and retail environment, we presently see opportunities for capturing market share in each of the regions as we continue to move through the destocking of the supply chain and then charge towards normalcy. While you look at Slide 3 of the presentation, I'll make some comments on our overall performance at a high level. In Q4, we recorded $151 million in net sales, which was a modest decline when compared to the third quarter, and not unexpected, I might add. We believe our underlying performance has stabilized through a difficult market and a challenging operating environment, which is a byproduct of a few external factors and strategic actions we've taken. One of these factors is that for the last 2 quarters, we did not see any of the erratic increases in input costs that we have seen in the prior calendar year and are currently experiencing a period of low volatility in raw material pricing. As a result, we're in a solid position from a pricing standpoint, and this stability will serve as a catalyst for a quick rebound in performance when demand recovers. Bell bottom prices, which have been really challenging in the calendar of 2022 for us, have also been stabilizing to seasonally normal levels. As a reminder, the price we pay for bell bottoms in the U.S. and the yields associated with the recycling process are the most important input costs to our Americas business segments for pre-products. And this reduction has been a welcome relief and will play to our advantage as the REPREVE demand opens up in the coming quarters in the U.S. and Central America. From an operations perspective, we have taken several actions to maximize productivity and drive efficiencies across the business, including diligently managing our costs through several cost containment measures. We have also reoriented our capital spend to preserve cash and bolster our liquidity position to further solidify our balance sheet. And we will highlight a few of these actions in a few minutes. I should also mention that we are not backing off on developing new innovative products during this period, which I hope to be able to talk about as we move through the fiscal year. Our focus on innovative technologies with REPREVE at the core is now much more driven by the pairing of commercial opportunities with performance attributes that are responsive to the consumer demand that we're seeing. Turning to Slide 4 to discuss REPREVE and marketing. During the fourth quarter, REPREVE sales were $44.5 million or 29% of all sales compared to $49.6 million and 32% of sales in the preceding quarter. This reduction is primarily driven by an economic slowdown in China's textile exports, and we do not view it as a review of sustainability based on our ongoing commercial conversations. Any improvement at all in China sales will drive a commensurate rebound of our presales. Moving to marketing. We continue to drive REPREVE awareness globally. Ongoing media outreach, including fan tours and an influencer event in Los Angeles has resulted in a meaningful increase in media coverage based on our internal metrics. Beyond the U.S., we continue to execute marketing initiatives tailored for specific markets. And this ranges from the launch of REPREVE in Brazil to partnerships with local brands in China. During Q4, we exhibited at a variety of trade shows globally. And interest in sustainability was high across all shows and particularly, Textile Takeback, our innovative solution for tackling textile material waste, was particularly well received. Now as we close out fiscal '23, we are happy with the progress made on the marketing front and look forward to building on that momentum in 2024, both the industry and consumers who are actively focused on sustainability and REPREVE are now very well positioned to capitalize on this opportunity. So before I pass the call to Craig for his financial review, I want to take a moment to thank Craig for his service to Unifi. This will be his last earnings call. And as we noted in our SEC filing on July 26, 2023, he is moving to pursue another CFO opportunity. Craig has been a great partner for me and has helped us build a well-rounded finance team. So Craig, thank you for that and for all the work you've put in. Beginning next week, A.J. Eaker will serve as our interim CFO. We are fortunate to have a strong industry veteran like A.J., who has had almost 10 years of service at Unifi, in addition to his public company audit experience with a big 4 firm, and we have a great financial team to support us and A.J. as well. I'll now pass the call over to Craig. Thank you.

Craig Creaturo, Chief Financial Officer

Thank you, Eddie. I want to say thank you to both Al and you as well as the rest of the Board of Directors for allowing me to be a part of the Unifi leadership team for the last 4 years. We're in a good spot to make a CFO change. A.J. has long been a valued member of the Unifi team, and he is someone who will use his leadership and abilities for the betterment of Unifi. My comments today will be shorter than normal, so we can give A.J. time to make some financial commentary of his own during this call. Let's move into the financial results beginning with Slide 5. We have provided the year-over-year comparison on net sales and gross profit for each fourth quarter. As expected, consolidated net sales were 30.6% lower from Q4 fiscal 2022 to Q4 fiscal 2023, primarily resulting from the weak demand environment and the associated decline in pricing. Fortunately, as you will hear from Eddie, the expanded Chip and Flake product line sales are enhancing the portfolio in the Americas segment, which also contributed to the lower average selling prices in the quarter for this segment. The Brazil segment maintained strong volume levels throughout fiscal 2023 but experienced pricing pressures from competitive Chinese imports, in connection with the lower utilization levels in China driving down the average selling prices of their exports to countries like Brazil. The Asia segment was most impacted by apparel weakness, driving lower sales volumes but it maintained a strong pricing and margin profile, thanks in part to Unifi's innovative pipeline. From a gross profit perspective, on Slide 6, the volume pressure in the Americas and Asia segments, along with the selling price pressures in Brazil, negatively impacted gross profit. Turning to Slide 7 for the sequential sales comparison. We can see the stability that was expected to occur from Q3 to Q4 of fiscal 2023. On the whole, sales performance was generally flat across the segments during the noted 6-month period. Although the Americas segment experienced yarn volume declines that were mostly offset by chip and flake sales, which carry a lower fixed cost absorption factor. Slide 8 demonstrates the change in gross profit, which is predominantly characterized by weaker fixed cost absorption in the Americas based on the lower yarn sales concept we just covered. I will now pass the call to A.J. A.J.?

A.J. Eaker, Treasurer

Thanks, Craig. As we move away from the segment analysis, I'll remind everyone that we incurred an impairment charge in this fourth quarter in connection with a highly specialized asset for which the investment was fully returned but carried a longer original useful life than today's environment would support. The impairment was recorded in operating income, outside of gross profit, was noncash and nontax and below any particular segment results. Now let's spend a moment discussing our balance sheet and liquidity position on Slide 9, where I will cover the high-level points before passing the call back to Eddie for his closing commentary. We're pleased to have refinanced our asset-backed credit facility in October 2022, where we continue to have significant liquidity available to complement our global cash on hand. Our diligence around working capital and cost control has been critical in our ability to produce operating cash flows in the suppressed fiscal 2023 environment, and we've made an immediate impact on free cash flows by delaying elevated CapEx spend until the demand environment is much more amenable. Accordingly, we're confident that our business remains well-positioned for realizing profitable growth opportunities when the apparel industry and its supply chains normalize. I will now pass the call back to Eddie to take us through the last slides of the presentation and make some final comments.

Eddie Ingle, Chief Executive Officer

Thank you, A.J. I'd like to take a moment to review some of our new key commercial and operational initiatives we have implemented in the Americas business. As we move through the fiscal year, we expect to see continued recovery in revenue and profit growth from our commercial initiatives beyond the normal environment we're seeing today. We can already see some of the operational initiatives beginning to reduce manufacturing costs, and we expect this benefit to increase and become more reflective in our financial results as we move through the new fiscal year as our volume levels normalize. Those are outlined on Slide 10. And as you can see from this slide, the commercial initiatives center around growth and improving the commercial process. As we face the hard reality of a longer demand challenge environment, we look for areas of opportunity within the business where we could really drive near-term growth in volumes and diversify our portfolio. The preferred phase of such commercial diversification was the expansion of our business into the nonwovens, specialty films, and packaging markets. Now while Unifi has been selling REPREVE resin and flake for quite some time, we traditionally have seen these products mostly as a feedstock to our REPREVE business. And I'm pleased to say that the team responsible for this initiative has had some meaningful wins here. In the fourth quarter, REPREVE resin and flake sales were strong and represented more of the Americas quarterly sales mix than ever before. And we will continue pursuing this revenue opportunity along with our high-quality REPREVE yarn products. In addition, there are continued efforts to build what we call our Beyond Apparel business, which we are finding to be a margin-accretive. Further, we've implemented new sales processes that support Unifi and improve our customers' experience. Lastly, we are spending more time with customers to find ways in which we can bring more value to them. It's a long road, so we feel that we are well on our way to implementing changes that will drive long-term value. I'd now like to detail some of our other operational priorities. Despite the pause in CapEx spend towards new Evo installations, a significant number of these machines are already in place, and the benefits are positively impacting our underlying results with faster speeds, lower energy use, and fewer labor hours. Some of our other key operational initiatives include continuing to manage our headcount conservatively while not sacrificing quality lead times or long-term performance. Following customer production activities, for example, like many of our customers, we shut down during the production for the week of July 4 and focusing our attention on working capital through effective planning and staying close to the real demand out there in the marketplace. Now let's turn to Slide 11 of the presentation to discuss our expectations for the upcoming September quarter. Our forecast for the first quarter of fiscal 2024 includes sales and profitability performance that is about the same as the just-completed fourth quarter. Sales volumes are not expected to change significantly in any of our business segments. And on the tax fronts, we are expecting continued volatility in the effective tax rate. Capital expenditures will continue to trend down, a clear benefit of our prudent spending measures that A.J. mentioned earlier. As we move through fiscal 2024 and anticipate the demand environment to improve in calendar 2024, our plan for the full fiscal year is very much weighted towards the back half of the fiscal year. We are confident in our position as the 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

And our first question comes from Anthony Lebiedzinski from Sidoti & Company.

Anthony Lebiedzinski, Analyst

So first, Craig, it's been a pleasure to work with you and best of luck going forward. And Eddie and A.J., I look forward to continuing to work with you and the rest of the Unifi team. And Al, it was also great to hear your synopsis at the beginning of the call. So I guess, I wanted to follow up first about one of the points you said. You're seeing some green shoots in the business. And in the release, you also talked about some positive recent market share development. So I wanted to start off with that, and I'll have a few other questions as well.

Eddie Ingle, Chief Executive Officer

Yes, I'll take that, Anthony. As we've mentioned, we're still navigating a very challenging environment. The green shoots we're seeing are related to new product launches that we're gradually introducing to the market, and there's a lot of interest in those. The markets Al referred to, including automotive, home, packaging, and industrial, are key areas of focus for us. In the home sector, we're already observing significant interest in the new products we're rolling out. We have some placements with REPREVE Our Ocean in a leading mattress brand and REPREVE ChillSense, which is our climate control yarn. Additionally, alongside the growth we've experienced in REPREVE resin and REPREVE flake, these represent REPREVE plus opportunities that are generating consumer interest. We'll provide more updates on that as we progress through the fiscal year.

Al Carey, Executive Chairman

I want to add that we've spoken to many customers, and most of them are indicating that the orders will begin soon. I'm not sure how large those orders will be. Some retailers made significant mistakes in their orders last year, and they likely want to avoid ending up with excessive inventory again. I expect we will start seeing orders in October, or possibly earlier with some luck. Additionally, Eddie mentioned a lot of new business, and there's significant interest in our new products in what we are calling Beyond Apparel. It's exciting to finally see progress in this area.

Anthony Lebiedzinski, Analyst

Awesome. And then so just to quickly follow up as far as the segments, Beyond Apparel, which ones out of the ones that you listed that you think have the most near-term potential?

Eddie Ingle, Chief Executive Officer

Yes. Currently, we are experiencing notable interest in the home sector, both in value-added services and the core aspects of that business. As Al mentioned, we anticipate significant volumes and will be able to discuss this further starting in October. By the next earnings call, we will provide more detailed information. To briefly answer your question, the home market is where we are seeing a lot of interest, along with the packaging sector due to our REPREVE resin.

Anthony Lebiedzinski, Analyst

Got it. Okay. All right. It sounds like you have some other new products in REPREVE, which is great to hear. Regarding Chip and Flake, you noted strong adoption. Can you discuss, without going into specifics, what portion of your sales that represents and what the margin profile of that product is?

Eddie Ingle, Chief Executive Officer

The margin profile actually is quite healthy. We're very pleased with that. It's above our normal margin profile from a gross profit point of view. What's nice about it also is the fact that we're not just selling into 1 market; we're selling into the nonwoven space, into the film space, and into the specialty packaging space as it relates to some cosmetic end users. So it's very diverse. And the story really is all about sustainability and the innovation that we can bring. And some of these end users are also very interested in our new trust verification system and the fact that we have a tracer in there that can verify it is recycled materials. So it really plays out well to the REPREVE story that we've been working on, on the fiber side. That seems to be translating nicely over to the packaging side. And one other thing, we design our resins to perform at a very high level in our yarn business. I tell people, we make yarn at 3,000 meters a minute. And these product attributes that we have are surprising. It's because they're playing the clarity of our resin; the purity of it is playing well into these new markets.

Anthony Lebiedzinski, Analyst

Got it. Okay. In terms of pricing, it decreased in the Americas and Brazil, but increased in Asia. I believe part of that is due to the Chip and Flake increases. How do you see the near-term pricing dynamics moving forward? I would like to get your thoughts on that.

Eddie Ingle, Chief Executive Officer

Yes. In Brazil, driven mainly by the very depressed pricing from China of competitive products, the imports that are coming in. We are seeing, just in the last few weeks, some opportunities to raise prices down there, but it's still early days yet. We do expect, once China really returns back to normal production levels as the supply opens up, they're very reactive to pricing, and that will result in higher prices in Brazil. In the Americas, it's mostly driven by the higher sales of packaging that we talked about or pre-COVID resin in the packaging space. So the yarn business, the prices are mostly stable.

Anthony Lebiedzinski, Analyst

Okay. That's good to hear. And then in terms of the competitive environment in Brazil, have you seen any changes there lately?

Eddie Ingle, Chief Executive Officer

Yes, we had one competitor exit the market. While they still have inventory available for sale, we anticipate that this will create an opportunity for us to increase our volumes as we approach the end of the year. We expect to discuss the impact of this in more detail during our October call.

Anthony Lebiedzinski, Analyst

Got it. Okay. That's good to hear. So looking ahead, how should we approach the path back to profitability? If I reflect on fiscal '16 and '17, the revenue during those years was slightly higher than this year's report, but the operating margins back then were around 7%. How do you envision returning to being EBITDA profitable or just EPS profitable? I know there has been some headcount reduction mentioned. Could you walk us through how you see this unfolding?

A.J. Eaker, Treasurer

Sure, Anthony, it's A.J. Volume is definitely our biggest piece here that will get us back to profitability. You're aware of the Evo installations that we've completed over the last couple of years, and they're very much a path to profitability as well. When you think about the long term, we still very much believe that the underlying drivers that we've spoken of over the last few years will contribute to further growth recovery from where we are, as well as much of the other lean initiatives and efficiencies that we found in both the manufacturing space across our facilities as well as our SG&A structure. So we do feel confident that that path to profitability does still rely on the underlying drivers that we've talked about over the last couple of years.

Al Carey, Executive Chairman

Anthony, this is Al. I just wanted to add to that. As the Beyond Apparel categories become a bigger part of our mix, then that helps as well.

Anthony Lebiedzinski, Analyst

Got it. Okay. And then as far as your debt, obviously, you refinanced that last year, which was terrific. Now I assume that yours is well in compliance with your debt covenants. I just wanted to make sure that that's not an issue that you see anytime soon?

A.J. Eaker, Treasurer

Yes, Anthony, it's A.J. again. Absolutely still in compliance from a debt perspective. As you mentioned, very favorable that we were able to refinance the facility just under a year ago, providing us great runway both in this constrained environment as well as positioning us for growth as we head into the next couple of years. On top of that, we still have a significant balance of global cash that we can help assist with that liquidity. And we haven't had to institute any extreme measures at this point. So still feeling quite comfortable from both a compliance perspective and the remaining liquidity.

Anthony Lebiedzinski, Analyst

Got it. Okay. And then just to quickly follow up. I know the vast majority of your cash is outside the U.S. If needed, can you easily repatriate that? Or like how should we think about that?

A.J. Eaker, Treasurer

Sure, Anthony. You'll note in fiscal '23, we did repatriate almost $20 million from our operations in Asia. Part of that was connected with the refinance that we completed. We still believe those processes, those procedures to repatriate cash are still applicable and relevant. As we move forward, we still believe that everything would be just fine in terms of repatriating, as needed, from those subsidiaries.

Operator, Operator

Your next question comes from the line of Chris Reynolds from Neuberger Berman.

Chris Reynolds, Analyst

I have a question regarding the reshoring of apparel production, which has been a long-term trend benefiting you. Are you still viewing this as a positive development? Additionally, could you provide an update on how your company is engaging with the CAFTA treaty for your apparel cut customers producing in the Caribbean?

Eddie Ingle, Chief Executive Officer

Yes. The two major pieces of legislation that benefit us in our location are CAFTA, as you mentioned, and what was NAFTA and is now USMCA. These were very beneficial to us before the destocking occurred. Our volumes in Central America were growing significantly, particularly in El Salvador, which was really benefiting from that. However, it seems that the most significant impact of the destocking by retailers has hit Central America harder than other regions. Even so, brands and retailers remain very interested in sourcing from Central America, and we’re seeing more discussions about producing products in Mexico, which also has a compliant yarn agreement and benefits us. Overall, reshoring is still happening; you just can't see it due to this destocking situation.

Chris Reynolds, Analyst

Okay. Just one follow-up question on a question that was asked before about some of these new categories that you’re moving into. Do you have to hire a different salesperson to sell into the home or auto market? I know you’ve had limited exposure there in the past. And are there upfront investments in marketing that you need to make to capitalize on some of these new opportunities?

Eddie Ingle, Chief Executive Officer

Yes. As A.J. mentioned, we have done a great job managing our SG&A over the past years. While our business revenues have declined, we are indeed investing in both Asia and the U.S. by hiring new talent to help us accelerate growth in those markets.

Operator, Operator

And this ends our question-and-answer period and also concludes today's conference call. We thank you for your participation, and you may now disconnect.