UFI - NYSE

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

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.

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, and that's affecting our volume pretty significantly. This began in the summer, and it continues today. Retailers 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 and hopefully, clear out some of this inventory. But 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, September was down 20%, and Asia, 40%. As you know, Asia does a tremendous amount of business in U.S. retail, but also those COVID shutdowns are still affecting our business. So it's going to be kind of difficult to have any kind of reasonable forecast or guiding with this uncertainty. However, I think it's logical to assume that the volume trend improves 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 4 very important initiatives that will strengthen our long-term business and will shore up our profitability even in the short term. First one is, 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, and that's because of the cost actions we're taking and also because of the benefit of raw material costs that are going down. 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 2 years away. We have actions that will pull REPREVE consumer brand awareness. We have information now that our direct awareness on REPREVE is 22% unaided -- I'm sorry, 22% aided, 215% unaided, and that's pretty impressive for a brand that doesn't receive very much A&M spend. But in the next few months, you'll see some significant improvement and the REPREVE brand awareness through some of the programs we put together. The third thing we're spending our time on is, we completed the market study with an outside firm to identify new segments of business. That would improve our long-term sales and profits and it's called Beyond Apparel. We have a subsegments that look like they'll have the most fruit to bear is auto, industrial and home. And while this is a long-term initiative, there are several opportunities that are very likely to manifest in this fiscal year. And then the final item we've been working on is 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. And it led to an effort that he'll take you through in the next few minutes, but our credit facility amendment has been complete, and we feel very good about it. So all-in-all, -- dilemma. It's a bit 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 just a minute ago, are definitely going to make us a stronger company in the near future. So I'll turn it over to Eddie at this point.

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 amount 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 normalize demand levels. And 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, but especially, 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 that they had experienced in 2021. And 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 are expecting 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, and 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, which occurred 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 that 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; curtaining noncritical travel and expense activity; decreasing discretionary spending for advertising, marketing and recruiting efforts; prioritizing growth and high capital return, capital expenditures and lowering lower material purchases while continuing to take advantage of opportunities. And 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 adoptions and co-branding and $23.5 million REPREVE hangtags sent to brand customers during the [inaudible]. REPREVE Fiber products comprised 27% of net sales for the first quarter and 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, and Gen

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 remain strong, and our management team is focused on controlling costs and remaining nimble as we continue to pursue our long-term --. 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 the overall market demand pressures, while pricing and mix remain strong. We still expect that the continued interest in sustainable yarns and our ability to support the 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, move 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, Wells Fargo Bank, Bank of America and First National Bank of Pennsylvania 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 decline. Our lower profitability levels create greater sensitivity in the effective tax rate calculation. And the negative tax rate for the quarter reflects expense 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. Eddie?

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 brands, apparel brands and retailers continue to deal with the inventory destocking measures and the timing of apparel production with 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 is in line with prior trends during sharp macro environmental disruption, where we have historically seen 2 quarters of demand impact and then have 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 Instructions] Our first question comes from Daniel Moore with CJS Securities.

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

Thanks for the question. Yes, the cost reduction actions are predominantly temporary because we do see this business bounce back. We are taking -- 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 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.

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

Yes, it's a great question. What is -- what started out as a slowdown in the market because of COVID lockdowns back in the middle of March of last year that extended really through the middle of May and into June, turned out -- turned also into a slowdown in the orders from the U.S. brands and the European brands. And as we went through the quarter, it seems that there was a really strong initiative by these brands to just cut back on all of their orders and push out orders. This -- we know this to be true that they can't -- these cutbacks can't go on forever. At some point, the brands have to start restocking their inventories. As we said on the call, there is a high expectation that during the holiday season, there will be a lot of discounting. And as they move through their inventory, we will be seeing orders return in Asia either before the Chinese New Year or shortly thereafter. REPREVE, we don't expect any -- we don't expect the demand for REPREVE to change as that bounce back happens.

Okay. And then on the credit facility, obviously, proactive. Just tell us what covenants are there, if any, in terms of leverage ratios or any other things we might be thinking about on the amended facility?

Dan, the covenants are the same as the facility expired, which is there is 1 fixed charge coverage ratio covenant, but it's a springing covenant. So as long as our excess availability exceeds the trigger level, which we have plenty of headroom on that now, there's really no issues compliance-wise. So really very similar to the facility we just replaced.

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

Good morning. And thank you for taking the questions. So just wondering, given the current weak demand environment, are you able to -- are you confident that you will be able to hold your pricing? Or are you seeing perhaps your customer looking for any discounts? So I'm just wondering about your confidence level in your ability to hold pricing steady?

A great question. We've spent a lot of time and effort getting to the price point we needed to over the last really 12 months. We are going to -- we are 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.

Okay. Got you. Okay. And then in terms of your CapEx spending plans, I know you gave guidance for your quarter -- the current quarter. As far as just thinking about the rest of the year and next year, are you still -- I assume you're still on target to finish the completion of the rollout of the Evo texturing machines and just kind of -- just wondering if CapEx should come down next year because of that.

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 some issues that we have maybe potentially from a maintenance point of view or certainly, on any safety initiatives we have, any CapEx centered around safety. We have not pushed out. The Evo spending currently is ongoing. But as you can imagine, we are evaluating, as we move forward, the timing of that. But right now, no decisions have been made about that.

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

Yes. So Anthony, that -- those write-downs and that did have an impact on the business. The bigger impact for us really was the lack of volume, especially here in Americas. And we have been pulling back quite a bit on the amount of raw material we have been purchasing. So as our demand has gone down, we have been pretty quick to react and reduce those purchases. So yes, we're now buying at lower prices, but those -- that impact will really not help us -- didn't help as much in this just completed quarter, it'll help us a little bit as we head into December and beyond. So yes, it was -- definitely, we have been purchasing inventory at higher levels. We had to adjust that. We are -- we have adjusted that. Unfortunately, though, that inventory is flowing out slower than we expected and slower than we historically have because of this demand softness. So yes, that did have an impact on our financials this past quarter. We'll do so. That was factored into our guidance for the December quarter as well.

Got you. Okay. And then my last question. You mentioned at the beginning of your prepared remarks about the, I think, a market study done with some segments beyond apparel. So in terms of whether looking at the auto, industrial or home, I mean, which one do you think -- out of the ones that you cited, which ones you think will have the near closest impact in terms of the impact on your business? I mean out of these, which one do you think will have -- will see the impact sooner rather than later?

Yes. We -- as we looked at those three different segments, we think home is the one that will give us the quickest jump. We're eyeing some programs right now, and a lot of the reason for that is because of the quick decision-making that, that market can take place, whereas automotive, it takes a long time to get those programs in place and set. Home, as I said, is the one we're focusing on right now.