Unifi, Inc.
Q3 2018 Earnings Call Transcript

Published: 31 Oct 2018

[Operator:]

Good morning, everyone, and welcome to Unifi's First Quarter Conference Call. Leading today's call is A.J. Eaker, Vice President Finance and Investor Relations. A.J.?

[A.J. Eaker:]

Thank you, operator, and good morning, everyone. On the call today is Kevin Hall, Chairman and Chief Executive Officer; Tom Caudle, President and Chief Operating Officer; and Jeff Ackerman, Executive Vice President and Chief Financial Officer. During this call, management will be referencing a webcast presentation that can be found at unifi.com and by clicking the first quarter conference call link. Management advises you that certain statements included in today's call will be forward-looking statements within the meaning of the federal securities laws. 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, forecast or implied by these statements. You are directed to the disclosures filed with the SEC on Unifi's Forms 10-Q and 10-K regarding various factors that may impact these results. Also, please be advised that certain non-GAAP financial measures, such as adjusted EBITDA, adjusted working capital, adjusted net income and adjusted EPS may be discussed on this call, and non-GAAP reconciliations can be found in the schedules to the webcast presentation. I will now turn the call over to Kevin Hall.

[Kevin Hall:]

Thanks, A.J., and good morning, everyone, and thank you for joining us today. The first quarter of fiscal 2019 saw revenue growth of more than 10% year-over-year. This marked the sixth consecutive quarter of year-over-year top line growth for Unifi. While sales growth is ahead of our expectations, we experienced another sudden jump in raw material cost globally, which has impacted our profitability in the short term, most notably regional Polyester, which was down more than 20% in gross profit. To put this cost increase in context, we have seen sustained rise in our raw material cost globally for the past 4 quarters, and we have been chasing these price increases for some time now. When cost stabilized, we are optimistic that our revenue growth will translate to earnings growth as well. Global PVA sales were up 10% year-over-year or 14% on a currency-neutral basis and represented approximately 43% of consolidated net sales during the quarter. Our strategic focus on our PVA portfolio is driving overall sales growth across the globe and we believe building a platform for long-term success. Part of our success within the PVA portfolio has been driven by our increased engagements with the design teams and sustainability leaders of our brand and mill partners as well as our own branding efforts, such as participation at recent industry trade shows like the Outdoor Retailer and Intertextile events in Shanghai. With sustainability at the core of our growth efforts, we are really excited about what can be accomplished with the circular economy or closed-loop method for creating stronger end-to-end recycling partnerships. Many of our circular economy solutions revolve around collecting bottles recycled at specific locations, converting those bottles into performance fibers and ultimately transforming those bottles into exciting products that relate to the community, where the bottles were originally sourced. For us, closing loop is opening doors and securing exciting new relationships. For example, in partnership with the Pac-12 Team Green, the University of Colorado, The City of Boulder and League 91 Collegiate apparel, we have created the first of several circular economy solutions leveraging Unifi's unique capabilities and partnerships. Through this program, we have taken bottles collected on campus, shift them to our recycling facility in North Carolina and provided to League 91 with REPREVE performance charm for using a new Colorado University collection of apparel for their bookstores. We expect this will be expanding to other Pac-12 universities as well. An example of unique program is The North Face Bottle Source Program. The North Face Bottle Source Collection supporting the National Park Foundation has diverted more than 160,000 pounds of plastic bottles from park-waste streams including, Yosemite, Great Smoky Mountains and Grand Teton National Park. The North Face is extending a life cycle of these plastic bottles by taking them from the waste streams of the parks and then working with Unifi to recycle them into fibers, which the North Face makes into T-shirts, hoodies and hooks. For every bottle-sourced product sold, the North Face is donating $1 to the National Park Foundation to support recycling and reuse program, so that consumers can feel good in their T-shirt in more ways than one. Turning our attention to retail. We continue to see great adoption of REPREVE and increased programming arriving on retail shelves. REPREVE and our true champ 365 technology are weaving their way into more and more Denim offerings this holiday season. We will be bringing some examples to our Investor Day in 2 weeks. Items that you can find today at Macy's, Kohl's, Levi's, Target, Abercrombie, Hollister and Express. Another great example of a recent REPREVE adoptions currently available at retail includes T-shirts from Jockey. These T-shirts have had a high-value REPREVE filament yarn and boast heather effects, generating an exciting apparel launch with recycled attributes. We will be talking more in the future about our REPREVE-plus-1 strategy, adding consumer meaningful attributes to our recycled platform, such as the Dockers brand introducing a new innovation in fall 2018, called All Seasons Tech, engineered fabric for warm and cold conditions. The line includes REPREVE plus SORBTEK 365 technology, which helps to keep the wear comfortable year-round. The collection of All Season Tech products will be co-branded with REPREVE and SORBTEK 365 hang tags, and the thermal-comfort benefits are featured in an educational product video created by the Dockers brand. We are also excited to be working with Intertex. This is a new partnership as we share a strong commitment to sustainability. One recent example of our work together is the use of REPREVE-recycled fiber in the padding of ZARA Kids winter jackets. REPREVE fiber fill is a newer product, which is gaining significant traction and includes co-branding with REPREVE. We have talked previously about the strong adoption of REPREVE into apparel brands of Target, such as Cat & Jack. This year, you can also find REPREVE at Target in Denim, Socks and Hosiery and across many products at home, such as sheets, pillowcases and soft-sided storage units. Target continues to be a terrific partner for REPREVE and a true champion of sustainability. Now moving onto the high-level review of our operational results during the quarter, our regional Polyester business had strong sales growth, driven by a few factors

[Jeff Ackerman:]

Thank you, Kevin, and good morning, everyone. As Kevin noted, our margin and profitability performance this period was lower than anticipated. However, we understand the drivers and are taking action to mitigate these current headwinds. Like Kevin, I'm proud of the sales we saw this quarter, underlying momentum continues, and while we did benefit $8.3 million from an additional fiscal week domestically, our international operations were unfavorably impacted by foreign exchange headwinds to the tune of $6.7 million. With sales outperformance as a backdrop, I will move on to our profitability walk through. My discussion will begin on Slide 3 of the webcast presentation, where you can see a high-level overview of these results. Net sales were $181.6 million, which was a 10.6% increase from first quarter 2018. The top line growth was primarily driven by volume increases related to global PVA growth and domestically by an additional week in the quarter, partially offset by foreign currency translations. Gross profit was suppressed by raw material cost increases, as Kevin discussed. Disproportion in growth on lower margin products and integration costs for the recently acquired Dyed business. Within operating expenses, SG&A came in as expected and the increases were primarily due to investments made in fiscal 2018 to support expansion of the Company's commercial capabilities in the form of increased customer engagement, marketing efforts and our innovation pipeline. Also in the first quarter, we realized a net foreign currency transection gain versus a loss in the first fiscal quarter of 2018. The decline in net income related to equity affiliates resulted from a $2.9 million difference in pretax earnings from Parkdale. In the prior year, Parkdale experienced a more favorable price to cost relationship on sales, contrasted against the current period, where they continue to chase raw material costs with pricing actions. Lastly, we were impacted by a higher effective tax rate and an increase in interest expense with a combined total impact of $1.8 million. Compared to a year ago, we saw a large swing in our tax rate due to the unfavorable impact of the recent tax reform. The tax rate was also impacted by our decision to repatriate foreign cash in preparation for the upcoming refinancing of our credit facility. We expect to see significant improvement throughout the rest of fiscal 2019 and in fiscal year 2020, as we work to trim the effects of tax reform. In the meantime, it may be more helpful to think about our cash tax rate, which we expect to be in the mid-30% range. Slide 4 shows the sales and gross profit highlights for the first quarter. Total segment net sales were up 10.5% from the prior year on 12.4% higher volume, while gross margin declined 320 basis points. Sales results of our Polyester polymers and International segment continue to drive underlying revenue growth. Sales in Asia were strong on both staple fiber and filament programs. These sales are a key component to long-term relationships based on sustainable solutions and our PVA portfolio globally. In our Polyester segment, we saw 14.1% sales growth driven by an extra week and growth in Dyed Yarn and lower margin POY in polymers. Balancing the needs of our customers and the regional landscape has been important, so we are encouraged by the continued sales growth of the Polyester segment. Nylon sales and gross profit results were in line with our expectation within increase in sales year-over-year, mostly due to the extra week. Now let's look at the components of our gross margin performance, which declined 320 basis points at the Company level. In Polyester, our conversion margin was hampered by a continuing rise in raw material costs, which impacted gross margin by 180 basis points net of pricing. Additionally, the segment also experienced higher-than-anticipated costs associated with the integration of the recent Dyed business acquisition, a 50 basis point impact and a mix impact of around 90 basis points. Nylon continued to experience year-over-year degradation due to a weaker mix and higher raw material costs. These factors contributed to the 470 basis point decline in gross margin. The international segment remained a margin leader for us, but raw material increases and sales mix resulted in a decline of 150 basis points. The International segment had strong pull through on filament programs, but even stronger performance on staple fiber to continue driving growth. Overall, REPREVE and PVA, which carry above average gross margins, are still seeing high demand around the globe. Slide 5 shows equity affiliates. As we've talked about earlier, earnings from equity affiliates decline due to costs pressure for Parkdale. The joint venture continues to experience a difficult regional environment and chase raw material costs with pricing actions. Total distributions in the quarter totaled $504,000. Now Slide 6, which covers a few balance sheet highlights. Working capital was $202 million, and adjusted working capital was $174.3 million. Adjusted working capital as a percentage of sales is currently 24.8%, up from 21.3% in the first quarter of 2018, primarily due to selected-inventory bills. We ended the period at $141.1 million in debt principal and net debt was at $98.8 million. Total liquidity and revolver availability were at $88.7 million and $46.5 million, respectively. In addition, using swaps that terminate in May 2022, we have effectively fixed LIBOR at approximately 1.9% on $75 million of our debt principal. Our weighted average interest rate was 3.9%. Looking beyond our cash and debt positions, I'll remind you that we still have $27.6 million authorized and remaining under our share repurchase program. While we prioritize growth investments, we remain open to considering multiple levers to drive long-term value. Looking at the rest of fiscal 2019, we are still on track to achieve our revenue expectations. However, in light of the polyester raw material cost increases last month, we have lowered the top end of our range of expectations for profitability. Let me provide a few guardrails around the second quarter. We expect our underlining sales momentum to continue into the second quarter and rest of the year, but the second quarter will see 2 meaningful headwinds

[Kevin Hall:]

As a reminder, we will be hosting an Investor Day, November 15th in New York. The event will provide a platform for a deep dive into our business and the global environment in which we operate. We will further detail our strategic growth plan and we'll include presenters from across our organization. It will be a great day, and I look forward to seeing many of you there. With that, we'll open the lines up for your questions. Operator?

[Operator:]

[Operator Instructions] And our first question comes from Daniel Moore of CJS Securities. Your line is now open.

[Daniel Moore:]

I was writing as fast as possible. Jeff, I think you said poly -- in the poly segments mix was in 90 basis point headwind, can we just maybe break out more generally of -- across the business of the 320 basis points decline in gross margin impact of rising input costs versus mix versus some of the integration costs?

[Jeff Ackerman:]

Yes, so again, polyesters are our largest business as you look around the globe. So that raw material costs have that impact. And so as we said for the Polyester segment, it was about 180 basis points there, and in mix, it was about 90 basis points. I would say that for Nylon, the impact was primarily on mix. And then, if you looked at our International business that again was really mix. So we continue to see strong growth. In Asia, we're pleased with that. We're pleased really with how Nylon came in and as well as Polyester. So volume growth across the board for Asia, they continue to see strong filament sales that are even stronger growth in the polymers and staple fiber, which carry a little bit lower margin.

[Daniel Moore:]

And then kind of looking forward the guidance, I believe it implies a little bit of a leveling off, if not improving of the price input cost relationship, just talk about trends you're seeing in PET pricing and signs that may give you confidence and ability to hit the lower end of the prior guidance range?

[Jeff Ackerman:]

Yes, so as we've been watching what has been happening in the market for the PET costs globally, what we've seen is and looking back historically, we feel like this is at a relatively high level on a historical basis. So pretty much at -- I won't say it's all-time high because it has been higher. But given just where it is, we feel like it's at pretty much at a high level. Now if oil goes to $100 a barrel then of course it could rise again. But at this point just based on historically, the ranges in which PET have a smooth, we feel like this is at the high end and we're anticipating it just stabilizing from here.

[Kevin Hall:]

Dan, this is Kevin. I'll put a little bit of background from the commercial side of it too. I think as you look across the retail landscape right now, folks are anticipating a good holiday season. As I talked to a lot of the folks that are with different brands and retial partners we call on, that -- their words are the consumer hasn't given them any indication why they shouldn't anticipate that. And so they really wanted to be prepared this year for holiday. And in general, they moved holiday and pretty strong, shelves are stocked pretty well, and they don't want to be out of stock at traditional retail this year. They wanted to really capture that. So I think all those things play very positively. What it did was to put a real pickup in demand in our September period versus what we had seen historically and that really moved the cost higher. And so good news demand was there, bad news is the cost really spiked in September, which was frustrating, because we had really just gotten to a place where we were catching up with it and now we've got to move again. But to Jeff's point, we think that this will start to stabilize a little bit. We can't predict commodity prices, so we got to pretty caveat on this, which is they can always go up from here, but they appear less likely at this point to move up because of just a big strong move that we had.

[Daniel Moore:]

So most of the price increases up until recently more supply-driven, but you're saying this is a little bit of a demand spike as well?

[Kevin Hall:]

There was both in there, yes.

[Daniel Moore:]

Got it. And then lastly for me. Just a Parkdale JV, good color and appreciate it. May be just to remind us of variability to raise prices to offset input cost inflation, do you expect profitability to remain challenged in Q2 and the balance of the year? Obviously it's tough to forecast cotton prices, but just help us understand, you've given color in the past and how quickly you can pass along prices in your business, similar color for Parkdale would be helpful?

[Kevin Hall:]

Yes, I'll touch on that first and then Jeff can add into. So it's interesting on Parkdale, because what -- in their business, they lock in on like a longer-season basis. So this was kind of a worst case for them where they locked in at a price, and as the season went on, the cost went higher through the season. So if you think locking the price it in spring, as you're making for the holiday season, the costs just continue to go up on you. And then it came back down right towards the end of the seasonal period. So they had a little bubble in there that they had already priced their seasonal operating -- operations. So it was tough for them to digest that. And been in conversations with them, they're looking to take pricing, and they -- as I said before, they are a well-run organization. It's just they're experiencing some of the same commodity issues. I just think they had an even more of an interesting move within their seasonal build pattern this year. Jeff, I don't feel if anything else you want to add.

[Jeff Ackerman:]

No, there is a lot of similarity there in terms of how they get impacted by their raw material costs and their ability to price, so a lot of similarity there.

[Operator:]

Thank you and that concludes our question-and-answer session. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.