UFI - NYSE

Ladies and gentlemen, good morning. My name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to Unifi’s second quarter fiscal 2023 conference call. Today's conference is being recorded, and all lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] Thank you, and I will now turn the conference over to A.J. Eaker, vice President of Finance and Treasurer. You may begin.

Thank you, Abby, 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, we’ll be referencing a webcast presentation that can be found in the Investor Relations section of our website, 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.

Thanks, A.J. Good morning, everyone, and thanks for joining this call. I have a few remarks to kick this off, and then I'm going to turn it over to our CEO, Eddie Ingle. So, as you can see, quarter two of 2023 has been a very difficult environment to operate in, and you saw that in the pre-release that we had a couple of weeks ago, and also our materials for today. At this point, I think most of you have heard about apparel retailers and apparel brands that have had significant backlogs of inventory in their system and in their stores, and they've been trying to discount this inventory and clear it out all the way through the Christmas holidays. And this imbalance of inventory began all the way back in June of 2022. So, it's been with us for a while, and this has very definitely had a significant impact on our volume and our profits in Q1 as we reported before. And then it's also persisted, this issue is persisted and actually worsened for Q2. Now, there is good news. We have seen a pickup in the month of January in orders for our US operations, and it looks like we should see a gradual improvement through the balance of this fiscal year, and then a corresponding improvement in profitability as well. With regards to our Asian business, that same inventory backlog from US retailers, is having an impact on our China business, because a great portion of our business there is for US retailers. So, it's had a significant volume decrease for our Asian business. This situation has continued all the way through Chinese Lunar New Year holiday that ended last week. We expect to see some level of volume improvements coming very soon. We'll know more in the next couple of weeks, but we do know that many manufacturers are opening up this week in China. While all of this has been going on, our people were busy working on several ideas. One was working with our customers on future volume increases, and I'll tell you, there's a very definite increase from our customers for recycled material for their apparel, and it gives us optimism for our brand REPREVE. And this activity will show up in future sales, but I would say that the brand has actually gained momentum with our customers in terms of their interest all the way through the pandemic period and likely to include - to continue right now. The organization has also been very hard at work on cost reductions. We've managed our inventories aggressively, and we've been able to reduce North American labor and headcount by a voluntary attrition strategy and holding positions opened, and that gave us the opportunity to avoid excess costs. Additionally, the team has done a good job at generating cash, even in this tough environment, and we have a strong balance sheet thanks to a new credit facility. You'll hear more about that from Craig. We do believe the worst is behind us, and we're going to see gradual improvements in volume and profits in the next two quarters, and we also see the fundamentals for our long-term business to remain in place, despite all the turbulence that we have had over the last six months. In closing, I’ll just tell you this, the Unifi employees and the management team during this timeframe have done a very good job and we're proud of them. Everyone's working hard to offset these challenges, and they've kept an enthusiastic attitude, even though most of the challenges we face are well beyond their control. So, we are proud of them. So, at this point, let me turn it over - turn the presentation over to Eddie Ingle, our CEO, and he'll take you through the details of our performance.

Thanks Al, and good morning, everyone. As Al noted, our second quarter fiscal 2023 results reflect the very difficult operating environment stemming from the continued demand disruption we have experienced, a result of inventory destocking measures, and slowed global apparel production. As I mentioned, our employees really have shown an amazing amount of resilience while enduring a very challenging period across the industry, and I want to thank them for their commitment to the company and their hard work. For many reasons, we remain confident in our business model, and we are optimistic towards the future growth opportunities of the business as a global leader in sustainable fibers. Now, turning to Slide 3 for a closer look at the quarter, our net sales for the quarter were $136.2 million, down 32% compared to the second quarter of fiscal 2022. This resulted in an unusually large amount of fixed costs becoming stranded, which we were not able to overcome in our domestic operations, unfavorably impacting our profitability. Last quarter, we cautioned that the higher than normal inventory levels across the world's largest brands retailers, would negatively impact our results in the second quarter. The magnitude of these macroeconomic trends was unforeseen, and the resulting adverse impacts to our business worsened in November and December, far beyond what we had anticipated. In the US in particular, demand disruption caused by destocking efforts from retailers, became more and more severe. This demand decline caused a slowdown in apparel production globally, and led to results that fell below our expectations. Now, while these challenges have created a difficult operating environment for our business in the near term, the disruptions to our business are expected to be temporary as retailers and apparel brands work through normalizing their respective inventory levels and supply chains. While this process plays out, our core business model remains intact, and we remain ready to meet increased demand as we return to more normalized levels. In the last few weeks, we've already seen in the US, as Al pointed out, notable improvements in weekly demand trends compared to the levels we experienced in November and December, which leads us to believe that demand levels bottomed out in the December quarter, and we are optimistic that our business is on the road to recovery. Profitability in the Americas during the quarter was primarily pressured by higher material costs from December, with the loss of asset leverage on lower volumes. We are glad to see that input costs stabilized during the December quarter, and our pricing is healthy against current levels, putting us in a solid position moving into the third quarter. Our expectation is that both energy prices and the geopolitical today situation, will remain volatile. However, we don't currently have any significant pricing actions planned. We continue to be proactive in our efforts to offset the impact of the temporary headwinds and challenges we've been experiencing in the US. During the second quarter, some of the cost saving measures we took included reducing external spend programs, minimizing overtime hours, extending production shutdown periods, delaying the backfilling of open positions to lower headcount temporarily, and lowering raw material purchases, and taking advantage of some of the payment term extensions we've received. Turning to Brazil and Asia, we continue to see strong demand in Brazil, with higher sales volume versus a year ago. This strength was completely offset by significant margin pressure from decreasing market prices in connection with excess capacity in Asia, while Brazil's inventory cost profile remained elevated from earlier months of higher cost purchases. In Asia, our operations performed well against the much lower demand as compared to any recent historical measure. The segment has maintained a strong margin profile, with a rich sales mix, and we are quite optimistic that demand will recover following the lunar new year. Now, I'd like to move on to Slide 4 to discuss REPREVE fiber. In the second quarter, REPREVE fiber products comprised 31% of net sales, significantly impacted by the lower sales in Asia. We have full confidence that REPREVE sales will rebound strongly in the near future once the operating environment normalizes, as we continue to see momentum in the REPREVE brand for new products, customer adoptions, and co-branding. In fact, in the fiscal 2023 second quarter, we shipped 19.8 million REPREVE hangtags to brand customers. On the marketing front, REPREVE continues to gain traction, with a mix of co-branded product launches, social media partnerships, activations, and PR placements. During Q2, several brands launched new REPREVE co-branded products, including Asics, Arcade Belt, Tom & Tailor, and H&M. The Asics launch was particularly successful, and we’re quite proud of that activation. In order to become more sustainable, Asics is committed to converting core styles from virgin polyester to REPREVE. The launch included several winter styles, and was supported by co-branded hangtags, digital marketing, social media, and PR. And we see this as the first step in a much larger partnership. For example, our mobile tour will activate at the Asics-sponsored LA Marathon in March. Our new PR strategy is certainly starting to bear fruit as we secured 56 placements, resulting in over 660 million impressions during the quarter. Additionally, our new creative direction is resonating particularly well on social media. A highly curated mix of REPREVE branded content, combined with imagery from key brand partners, is driving increased consumer awareness and engagement. Over the quarter, we partnered with Quicksilver Pottery Barn, Scotch & Soda, Beyond Yoga, Rigolo, and, (Ug), among many others. Now shifting to activations, our Bowl Season partnership cumulated with a mobile tour activation at the Duke’s Mayo Bowl in Charlotte at the end of December. I was there myself watching NC State play University of Maryland, with over 37,000 fans in attendance. Additionally, the game was broadcast live on ESPN to over 2.6 million people. 2022 was the first year of a three-year partnership, so we look forward to building on this for 2023 and 2024. On November 28, Unifi announced the expansion of Textile Takeback. Unifi's Textile Takeback program is designed to reduce waste generated from fabric production or at the end of an article's lifestyle - lifecycle. Through a strategic mix of diligent media relations, the Textile Takeback launch garnered 12 pieces of notable media coverage, with over 70.5 million impressions across the business and trade media. Trade shows remain a core tenant of our B2B marketing mix. While our tenant is not back yet to pre-COVID levels, we exhibited at both ISPO in Munich and The Running Event in Austin in November. This is the first time Unifi exhibited at The Running Show, and was well received by both existing and potential new brand customers. Looking ahead to Q3 and beyond, we are focused on building on the momentum in both REPREVE and seeing the business return back to more normal levels. With that, I'll now turn the call over to Craig. Craig?

Thank you, Eddie, and good morning, everyone. The quarter we just completed exhibited the impacts of reduced demand by retailers and brands. Softer than our first fiscal quarter, the activity flowing through the apparel supply chain, drove significant margin pressure and lower than expected profitability. Outside of the short-term disruption, we believe underlying demand for our products remains strong, and our management team is focused on managing operating costs and working capital to remain nimble as we continue to pursue our long-term goals. Before reviewing the segment performance, I would like to discuss two (indiscernible) items in the income statement. First, when we refinanced our credit facility during the second quarter, banking and transactional fees incurred were approximately $800,000, and $273,000 were recorded as debt extinguishment costs to interest expense, driving a portion of the non-routine increase in interest expense. Second, we recognized additional benefits from our efforts in recovering prior period tax payments in Brazil. In the December quarter, we filed amended Brazil tax returns to recover certain components of income taxes paid. As a result, we expect to receive the associated cash refund of approximately $3.8 million within the next 12 months or so. You will note that this item has been included in our adjusted EPS calculation to improve the understanding of tax expense that relates to the current fiscal year. Let's turn to Slide 5 of the webcast presentation to begin the review of our reportable segment performance. For the Americas segment, revenues decreased 25.7%, driven by significantly lower sales volumes. Price and mix impact demonstrated generally higher selling prices, with the volume reductions partially offset by a higher proportion of chip and flake sales. In Brazil, sales levels were strong, with an 8.1% increase from volume that was offset by lower average selling prices in connection with the anticipated pressure from Asian imports that we mentioned in the prior earnings call. For our Asia segment, sales volumes were challenged by the overall apparel weakness, while pricing and mix remained strong. Accordingly, consolidated net sales were $136.2 million, with the vast majority of the decrease since December 2021 quarter, characterized by near-term apparel production weakness. Turning to Slide 6 for the quarterly gross profit overview. Consolidated gross profit decreased from $16.9 million to negative $8.0 million, with gross margin declining from 8.4% to negative 5.9%. The Americas segment’s expected decline in gross profit and weaker gross margin percentage, were attributed to the shortfall in product demand, and the associated impact on fixed cost absorption. We took actions to reduce labor hours to appropriate levels, while minimizing overtime, allowed attrition to help normalize our employment levels, and made diligent efforts to control operating costs during this difficult quarter. In Brazil, the gross profit and margin rate demonstrated the pressure on selling prices from low cost import competition. Brazil's cost of goods sold were impacted by higher input costs at the start of the current fiscal year. Our selling prices required adjustment to the more current market dynamics. 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 great choice for the Asia region. Outlined on Slide 7, and as we described in our earnings release, we completed the refinancing of our asset-based lending facility during the second quarter. This new facility increases our borrowing capacity from $200 million to $230 million, moves the significant majority of our short-term outstanding borrowings to 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 this current period of demand softness. It's helpful to note that the leverage ratio drives our interest rate pricing but is not a covenant for compliance purposes. Fixed charge coverage ratio only springs into consideration if our available borrowings fall below an established trigger level. At January 1st, 2023, quarter end trigger level was $23.0 million, and our available borrowings was $64.7 million. Thus, $41.7 million could be borrowed before the trigger level became applicable. Accordingly, we have great flexibility and runway on our new credit facility. We ended the second quarter with $3.4 million borrowed against our ABL revolver, and $115 million borrowed against our term loan. Moving to Slide 8 and our balance sheet highlights. Under our balanced approach to capital allocation, we expect to continue to invest in the business (indiscernible) and organic growth, maintain a strong balance sheet, and remain opportunistic for share repurchases and or M&A prospects. As a reminder, $38.9 million remains available for repurchases under the current share repurchase program, with no repurchases conducted in fiscal 2023 so far. During this demand suppressed environment, we continue to assess the proper timing of vendor payments and the magnitude of our capital expenditures, ensuring we conduct the most advantageous purchases and investments. As noted in our outlook, we are expecting sequentially less cash flow for capital expenditures in this third quarter of fiscal 2023, along with further reductions in the subsequent fourth quarter of fiscal 2023. I will now pass the call back to Eddie to make some final comments. Eddie.

Thank you, Craig. And before we turn the call over to our Q&A sessions, I'll give you an outlook and the expectations we have for the third fiscal quarter. As we discussed on this call, the operating environment and demand trends we're seeing, both domestically and in our international regions within the apparel and retail markets, are still working through demand pressures. Although our demand signals remain choppy, we are expecting stronger results in the second half of the fiscal year. For the industry, we're expecting the operating environment and the textile demand trends from the apparel market will recover at a modest pace during the calendar year. And with this, we expect modest sequential operating improvement from the second quarter to the third quarter. For the fiscal third quarter, we expect revenue to increase sequentially after we get past the normal slowdown in Asia during the lunar new year. We expect significant sequential operating performance improvements on an operating income and adjusted basis, and our effective tax rate is expected to remain volatile. While there remain near-term demand challenges that we need to navigate, the long-term growth potential of Unifi has not changed. We remain optimistic about our future and position as a global sustainable fiber leader. The drivers of our business remain valid today. Of course, everyone on the Unifi team is looking forward to the time when we have a more normal environment, where we can leverage our strengths. We’ve been pleased with our increased liquidity through our amended and expanded credit facility, and we will continue to 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. Thank you.

Thank you [Operator Instructions]. And we will take our first question from Daniel Moore with CJS Securities. Your line is open.

Thank you. Good morning. Thanks for taking the questions. Maybe start with, you obviously give great color in the challenging, clearly challenging macro. Any more detail on what kind of “modest” sequential increase in revenue and significant operating improvement looks like for fiscal Q3? I guess I'm wondering, do we expect gross margin overall and or EBITDA to turn positive, or is that visibility a little bit more difficult at this stage?

Dan, I'll take part of that question, and then I'm going to hand some of it over to Craig. From a volume perspective, the three segments, Brazil is certainly coming back nicely. They didn't suffer as much as the other business segments during Q2, or they were down not as severely down. So, we expect the volume to come back there nicely. In Asia, it was very strange what happened during the end of calendar Q4 around COVID. That resulted in lower production levels even further than normal in January, but we are expecting a very, very decent increase in the volumes relative to the December month, which was better than the November month. So, we're beginning to see quite a nice uplift there. And in the US, I'm going to refer to the first sort of two weeks of December relative to where we are now, we are seeing a nice uptick relative to the beginning of a December month outside of the holidays. So, quite positive all around in all our segments.

Yes, the a little more color on the retailers, units were up 1% for the first three weeks of January. So, it’s a very small window to look at, but it's definitely - it's better. It's better than it was.

And to - Dan, to add to your question, as far as additional commentary of color around the outlook, I would say for our Q3, we are expecting to return to positive gross profit. We do feel like the signs that we've seen, especially here in early January, where we're seeing our January sales volumes up 5%, 5% to 10% or so versus where we thought they would be, I think that is giving us comfort that we will be returning to positive gross profit here in this March quarter. I think we're continuing to watch - as Eddie was mentioning, we expect kind of a similar but slightly lagging rebound in Asia. Haven't seen that just yet, as we're still finishing out the lunar new year, and Brazil did have a - they had a tougher quarter here in this December quarter. As we noted, a lot of that was input costs kind of flowing through and some challenges on more competition lower price. That's really got to a more reasonable level, and we definitely expect them to start to return to more normal profitability. So, all that adds up for a much noticeable improvement in gross margin in Q3.

Super helpful. I appreciate it. And Craig, you just jumped - led into my next question, which was Brazil. I know it's impossible to tease out, but any color on sort of the magnitude of the impact from increased Asian competition as all that extra volume sort of flowed through - flowed around the world versus just timing in terms of mismatch in terms of COGS and pricing. Just trying to get a sense for how much is in your control as you increase prices and how quickly those margins might snap back.

Yes, I'll jump in and answer that question, Dan. Our fiscal Q2 in Brazil was quite unusual. It was similar to what happened to Q4 fiscal 2022 where there was the Chinese and Asian importers into Brazil were putting yarn on the market at incredibly low prices. And that really - we are very market-driven down in Brazil, and that resulted in us reacting as we should have to the market conditions. The situation is changing now. We will flow through that higher price raw material in Q3 that we purchased, and that will improve the margin significantly down there. And the volumes are, as we said, coming back nicely also. So, that will change the profit profile down there.

Got it. Maybe one more, and I can jump back in queue, but just what was the sort of volume versus pricing in the quarter? And - or do we expect pricing to be maybe a little bit more of a headwind going forward as input costs have declined? Just kind of where we are. You mentioned stabilized, but have input costs stabilized, pulled back in? What's the latest, both from a virgin perspective, as well as bail bottle pricing?

Yes. In Brazil, the input costs will be declining as we move through the quarter, really significant impact from probably Q4 more than Q3. In the Americas, we have passed through all of our higher priced raw material inventories in Q2. So, we're expecting - we know that in Q3, we'll have a more stable, more normal raw material cost. And our pricing is nicely positioned relative to our raw material costs. What we're looking forward to is seeing this volume come back so we can take ad advantage of that.

Got it. Thank you. I'll jump back in queue with any follow-ups. Thanks.

Thank you. [Operator instructions]. And we will take our next question from Anthony Lebiedzinski with Sidoti. Your line is open.

Hey, yes, good morning, and thank you for taking the questions. So, your inventory first, it was down sequentially, and certainly on a year-over-year basis as well. So, have you sold most of the high cost inventory by now? How should we think about that?

Yes, I would say in the US, where we had a particular problem, the inventory has flushed through. In Brazil, it's going to - because we have a longer supply chain, it does take a little bit longer. And their profile, we saw the impact in the high price inventory in Q1 in the US, which we flushed out in Q2. They saw really the margin pressures because of their raw material costs, really impacted in Q2, and we're coming out of that as we move through Q3. So, we feel quite good about that in both regions. In China - in Asia, we haven't had that situation occur.

Got it. Okay. Yes, thanks for that. And then as far as Asia, as far as what you're seeing there, we've heard from other companies that many companies have taken more extended periods of shutdowns around the lunar New Year. So, is that really what, what's, what's happening here, and are you seeing any signs now that I think we're just past the lunar new year, that things have picked up?

Yes. So, two comments on that. You're right. A lot of our, not just suppliers, but also our customers, did take extended shutdowns in January, and the lunar new year was early also. So, and along with the number of people that are out in the workforce, even if you wanted to get some stuff made, it was sometimes difficult to get it made. We are seeing in February - we're only just a week past the lunar holiday. The signals we're getting are quite good. There’s huge demand for REPREVE. The innovative products we have over there are certainly garnering some new interests. When we make product in Asia in February, there's usually a six-month lag. So, we know that companies, brands, and retailers, are going to be gearing up for fall sales, and they're going to start placing orders in the February, march timeframe. And we have seen reductions - we've heard on the street that there are reductions in inventories. There’s still some work to do at the brand and retail level, but they've certainly made a lot of changes to their inventories over the last six months. They'll continue to do that over the next six months. But they need to order now in Asia to meet the demand they're going to have for fall and for Christmas. Thank you.

Got it. Okay. Yes, thanks for that. And then, so in the quarter on a consolidated basis, your price mix was up 4.5%, but you talk about material costs stabilizing. So, what is your confidence level as far as your ability to hold pricing, or do you think that perhaps given the current weak macro environment, that you may have to adjust your pricing because of competitive pressures perhaps?

It's a question that we ask ourselves all the time. We are very strategic in how we're pricing. It’s always a balance between volumes and the opportunities. But we are being very thoughtful around pricing, and I think we've made changes to how we approach the market, which are very different from how we used to approach the market several years ago. So, I will tell you, we're being very thoughtful and we're being considerate to our customers. At the same time, we are waiting for volumes to come back, which will allow us to be a little more strategic in our pricing.

Understand. Okay. And then last question. So, obviously I realize that you're very heavily tied to the apparel markets, but that being said, just curious as to what you've seen from other vertical markets. Is it similar downward trend that you saw in the quarter, and do you think with this current macro environment that we're in, will this make it more difficult for you guys to expand beyond apparel?

Yes. So, I think everybody in the US were trying to reduce their inventories as they went through December. So, we saw a lot of that destocking taking place, orders being canceled as people were trying to manage their cash through the quarter. Some of the markets we’re chasing beyond - what we call beyond apparel, would be home. We have seen some nice interest coming out of the holiday season in mattress. We have seen an uptick in some demand in automotive. And I think there are two things. One is, they've gone past their inventory targets that they wanted to achieve, but also there is some uptick in some demand in some of those different markets. And we are still very focused on beyond apparel, on trying to be less dependent, particularly in the US, on some of the apparel markets that we service.

Got it. Well, thank you very much and best of luck.

And we will take follow-up questions from Daniel Moore with CJS Securities. Your line is open.

Yes, thanks. One of my follow-ups was covered and you gave good detail. Obviously, CapEx is going to tick lower as we go through the balance of the year. Just any comments on what cash flow might look like for the back half, either for Q3 or the back half of the year in terms of the operating cash flow and free cash, either usage or generation as it relates to that liquidity position. Thanks.

Yes. I think, Dan, we've been doing a lot of things to help put ourselves into a good cash position. In the release, we noted that we generated $7 million of operating cash in the first six months of this fiscal year. By comparison, we had used $4 million in that FY same six-month period in FY ‘23. So, we feel like we've done a lot of good things there. We did talk about the specifics about the things that we are doing here in the US, being careful on inventory purchases. We've got lower amounts of inventory. We've got lower price per pound as the pricing has moderated. We've taken the actions labor wise. And really specifically, we've allowed about a 10% reduction in our US workforce, and that's really again, through attrition, through being slow to kind of evaluate, and make sure that we're backfilling where we need it. We've asked people to take on some additional responsibilities. And really, I think back to Al's comments about really everybody stepping up and doing well, that is what we're seeing. So, we've been able to do that, and that's about 10% or around 200 people here domestically. So, those are some of the things that have set us up to be in a good spot. From a cash generation perspective, we're actually thinking and anticipating that as the business comes back, we'll have higher levels of sales, then we'll have higher levels of accounts receivable, and we'll need to start to build a little bit more inventory to be ready for that than we have. So, over the next couple of quarters, we know we’ll be utilizing or using some working capital to do that. And again, we've got plenty of head room. Good things that we've done here recently are setting us up to be able to grow that business as it comes back. So, again, we're also very fortunate, and I think as we touched on a little bit, both of our Brazil operation - both our Brazil operation and our Asia operation, are very self-sufficient. They don't need or require cash from this region. So, that's very helpful. Even in spite of some lower demands in both of those regions, both of them are doing fine financially. So, we are looking forward to seeing that business come back, and we know it's going to take some working capital address to address that, but we're prepared to do that.

Perfect. Thanks again.