Unifi, Inc.
Q4 2019 Earnings Call Transcript

Published: 9 Aug 2019

[Operator:]

Good morning, ladies and gentlemen, and welcome to the Unified Fourth Quarter 2019 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.I would now like to turn the conference over to your host, Mr. A.J. Eaker, Vice President of Finance. You may begin.

[A.J. Eaker:]

Thank you, operator, and good morning, everyone. On the call today is Al Carey, Executive Chairman; Tom Caudle, President and Chief Operating Officer; and Chris Smosna, Vice President and Treasurer and interim Chief Financial Officer. During this call, management will be referencing a webcast presentation that can be found at unifi.com and by clicking the Fourth 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 and adjusted working capital 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 Al Carey.

[Al Carey:]

Thanks, A.J., and good morning, everyone, and thanks for joining us today. I'd like to take a couple of minutes to remind you of some of the high level items that we're focused on here at Unifi before I hand the call over to Tom. The team continues to strive towards its mission of being the world's leading innovator in recycled and synthetic yarns. And the good news is that this quarter, we've seen the playing field in the domestic market start to become more level as the U.S. Department of Commerce recently announced the affirmative preliminary antidumping determinations on imports of polyester textured yarn from China and India.We're going to continue to monitor the outcomes of these decisions, but we expect it to result in some pretty meaningful opportunities for us in the quarters and even the years ahead, and we've really seen some evidence of that very recently in our overall business.Next, we finalized our reductions on SG&A during the fourth quarter, and we're pleased with our current run rate of about $51 million a year. And I think this better aligns with our operating environment, and I'm proud of what the team is accomplishing with no reduction in quality service for our customers. Lastly, in June, we announced an upgrade to our texturing capabilities in the Americas to be the exclusive user of the new eAFK Evo texturing technology, which is expected to broaden our product portfolio and improve our operational efficiencies in the upcoming years.Also, an update, our CFO search, we're nearing the end of our process, and we expect to make a final determination soon. While working to gain market share, investing in our manufacturing excellence globally, keeping a focus on PVA and being a leader in sustainability, I feel confident that this coming fiscal year will be a very good one for Unifi and further our strategic abilities and grow revenue and restore profitability.So with that, let me turn it over to Tom.

[Tom Caudle:]

Thank you, Al, and good morning. As we enter a new fiscal year, we expect to see more positive results, driven by the organizational changes we've implemented, our deliberate cost containment initiatives, a more stable raw material environment and lower levels of competition from imported yarn. We remain intently focused on our partner, innovate and build strategy and continue to execute against it throughout the organization.As I stated last quarter, our international operations have been fueling our growth. But with the changing domestic landscape, we are taking the necessary steps to invest in and optimize around maximizing our opportunities in the Americas. The use of the new texturing technology is just one example of that.Moving to the fourth quarter results, you'll see that legacy fiscal 2019 headwinds persisted, and we continue to fight against high volumes of low-priced imports, which caused us to miss our top line expectations. That said, our sales reflects strong PVA momentum. And for the first time ever, PVA revenues now account for over 50% of Unifi's sales.This is a testament to our commitment of being one of the leading innovators of recycled and synthetic yarn through offerings on both our REPREVE and PROFIBER platforms. We are also seeing some early signs of new volumes and programs in quarter 1 fiscal '20 due to both our continued commercial efforts across an exciting portfolio of products in the recent trade developments.Let's review a few key performance indicators for the fourth quarter. First, let me point out that we have updated our operating segments as a result of the growing scale of our international operations. The new reporting segments are Polyester, Nylon, Brazil and Asia. Fourth quarter consolidated sales decreased to $179.5 million compared to $181.3 million in the prior year, driven by lower volumes in three of our segments as well as FX headwinds. However, when we excluded the foreign currency translation impact, revenue increased $2.3 million or just over 1%.Additionally, we grew our full year top line by 4% despite the many headwinds we faced throughout the fiscal year, with underlying growth of 8% when they excluding the impact of foreign currency translation. We also achieved a 13% increase in PVA sales for the quarter, which, again, now comprise over half of our consolidated net sales. However, profitability was primarily pressured by the competitive import issues we've discussed, which also drove an unfavorable tax rate.While some issues are outside of our control, we recognize there are certain levers we can pull to continue to improve upon our profitability. For example, we achieved our goal of reducing SG&A by around 15% as we move into fiscal '20 off our prior run rate of $60 million. This collective effort, along with a heightened focus on operational execution across the globe helped us to achieve positive cash flow from operations in quarter four and has also set us up for significant improvements in our operating performance next year.As we work to revitalize our position in the Americas, we also remain committed to manufacturing excellence, high-quality products and improved operational efficiencies with a continued focus on innovation and superiority in recycling. All of this, if achieved, will help bolster profitability and improve our tax rate.Commercially, we continue to increase the adoption of REPREVE with our key accounts, including our long-standing relationships. Let me walk through a few examples. Patagonia is including REPREVE throughout backpack lines across their entire equipment line. Quicksilver is expanding beyond board shorts into outdoorware as well as backpacks. DeFeet International located nearby in Hickory, North Carolina has been using REPREVE and our SORBTEK technology in their socks for its sustainability, high performance, moisture wicking properties.Of interest DeFeet has also been supplying stocks to the Tour de France rider Julian Alaphilippe and his Quick-Step team performing quite well throughout the event. Hard Rock Cafe recently introduced T-shirts made with REPREVE. These Ts have 3 references to REPREVE. Each T has a REPREVE bottle hang tag, REPREVE is noted on the traditional branded tag and REPREVE is heat sealed on the inside collar.Lastly, in April, Unifi showcased the REPREVE mobile tour at Walmart sustainability summit in Bentonville, Arkansas, displaying the REPREVE recycling process to Walmart employees and suppliers. Walmart has publicly committed to a variety of sustainability goals, including increasing the proportion of recycled polyester content in apparel to 50% by 2025 across its U.S. footprint.This effort was demonstrated when Walmart introduced new vests for it associates that are made of REPREVE. The company showcased these in June at its Annual Shareholders Meeting and featured them in the press. As momentum continues to build, we're excited about the opportunities for REPREVE and our sustainability partners.Now let's walk through some high-level segment performance for the last quarter. First, Asia saw top line increased significantly, which was driven by continued growth in PVA, albeit with a lower margin profile. Brazil experienced a drop in sales due to a highly competitive marketplace. Unfavorable foreign currency exchange weighed on sales performance in both Asia and Brazil.The margin pressure we experienced in the international businesses was driven primarily by sales mix and pricing pressure amidst raw material cost fluctuations. However, our PVA portfolio continued to drive momentum into the future. The polyester business was dampened by the continuation of high levels of yarn imports, which play significant pressure on selling prices and profitability of our major polyester product line.Nylon experienced lower volume due to a customer transitioning certain programs overseas to full garment production. This volume loss will impact the segment in fiscal 2020, but our sales teams are aggressively backfilling that capacity. During the quarter, our domestic businesses experienced a more tempered raw material environment, and we are optimistic that this will continue throughout the next fiscal year.We anticipate a more stable raw material environment in our guidance, and we have not seen an indication that we will experience the elevated cost environment was present throughout much of fiscal 2019. Outside of the core operations, our equity affiliates experienced lower profitability as Parkdale's earnings were considerably lower than the fourth quarter of fiscal 2018. We do hope to see improved performance from Parkdale in fiscal 2020 as they continue to be a prominent supplier to the domestic textile market and have generated meaningful cash flow in the most recent 6-month period.I'd now like to provide a quick update on the status of the trade petitions that we filed in October 2018 and recent developments. Please turn with me to Slide 3 of our webcast presentation for a visual. As previously discussed, these petitions allege that dumped and subsidized imports of polyester texture yarn from China and India have caused material injury to the U.S. textile industry. In the months after our petitions were filed, we saw a significant spike in imports from China.We believe this surge in imports was due to efforts to stockpile imported yarn before preliminary duties were imposed. Accordingly, we received affirmative critical circumstances determination from the Department of Commerce on April 19. And on April 29, Commerce announced preliminary countervailing duties for Chinese and Indian imports.Specific to China, the preliminary countervailing duties of 32% and applied retroactive to the 90 days preceding the date that duties were announced. Then on June 26, Commerce announced a firmly preliminary antidumping determinations, that imports of polyester textured yarn from China and India are being unfairly sold below their fair value. Specific to China, these preliminary antidumping duties add another 65% to the cost of imported yarn, which brings the amount of duties above 100%, including the normal course duties in place today.Following these preliminary announcements, the investigation process will continue through the remainder of calendar 2019. We expect final determinations of dumping subsidization and injury to be made by the end of December 2019.I'll now pass the call to our interim CFO, Chris Smosna, to go into more detail on our financial results. Chris?

[Chris Smosna:]

Thank you, Tom, and good morning, everyone. As Tom noted, sales results this period were below our expectations, but our profitability and cash flow are exhibiting momentum that we hope to carry into fiscal 2020. Our initiatives are taking hold and certain corrective actions are helping to produce meaningful change across the business. I will dive into the drivers of our performance in my discussion today and will begin on Slide 4 of the webcast presentation, where you can see a high-level overview of net income.Moving from left to right, net income declined from $10.8 million in the fourth quarter of fiscal 2018 to $1 million in the fourth quarter of fiscal 2019, and you will note that of this decline, approximately $6 million or more than $0.30 of EPS was driven by income tax. First, the prior year fourth quarter included a $3.4 million tax benefit resulting from the reversal of an uncertain tax position.For the remaining items in the bridge, we have applied a 30% tax rate to the items noted, to increase the relevance of this analysis and presented separately, the impact of the significant change in the effective tax rate, which I will explain in a few moments. The pressures that we experienced across our operating segments drove a meaningful decrease in our gross margins, and we were unable to reach a similar level of gross profit as was achieved in the prior year fourth quarter. I'll discuss the margin bridge on the following slide.Next, operating expenses decreased by approximately $2.1 million on an after-tax basis. This decrease primarily reflects the step down in our compensation expenses as the fourth quarter of the prior year, including a fully loaded overhead structure. However, our fourth quarter included $900,000 of severance charges on an after-tax basis, directly related to our cost reduction plans, helping to reset our SG&A run rate.Then, as Tom mentioned earlier, weaker earnings from Parkdale contributed to approximately $800,000 of less income or around $0.04 of EPS. Lastly, from a tax perspective, the overall decline in domestic earnings created an unfavorable mix of foreign earnings taxed at higher rates. This, combined with our inability to take advantage of specific tax credits offsetting the U.S. taxation of certain income earned overseas, had an unfavorable impact on our effective tax rate. Due to our lower pretax income in the fourth quarter, the amount of tax expense recognized significantly impacted the effective tax rate. Looking forward, increase in our domestic earnings has the potential to meaningfully improve our effective tax rate, and we've noted that in our guidance, which I will detail in a moment.Moving to Slide 5. We have provided a bridge for gross margin. As Tom noted earlier, growth in our international operations have necessitated a shift to 4 reportable segments

[Operator:]

[Operator Instructions] And our first question comes from the line of Christopher McGinnis, Sidoti & Company.

[Chris McGinnis:]

You guys commented on you're starting to see some positive, kind of, I guess, momentum or least indication from the new tariffs and the penalties there. Can you just talk a little bit about how that's changing? How you expect that to change kind of the environment? And what are the other options that customers have that maybe wouldn't benefit you? How do you not come out positive out of this? I guess, if you don't mind walking us through that.

[Tom Caudle:]

No, Chris, we are starting to see momentum. As a result of the antidumping petition. The -- we've actually seen some orders get booked now. And we can -- we expect to see continued improvement throughout the quarter and this fiscal year. I guess, we would say it's kind of what is meeting expectations or is looking the same as we would have expected it to happen. Customers that have been importers and the importers who have been selling these products from India and Asia and from China, are also looking for other alternatives to offset the loss of the use of the yarns predominantly from China and India and are looking at Malaysia, Indonesia, Vietnam and other places.And that's one of the reason that you see this delayed effect that the volume do not -- that did not come all at once or once the preliminary antidumping was announced. So it will all balance out with time. We have the rate built into our 2020 forecast and budget, so we're optimistic. There's more -- not only we booked some orders, but the activity around clothing has increased pretty substantially. And we expect to have experienced positive results going into this year.

[Chris McGinnis:]

And is there a possibility, I know it's -- I guess, from my understanding, it's largely on the lower end of the commodity business. But is there an ability to maybe bring in the PVA product? Or is it just a commodity business overall? Can you maybe you dive into that a little bit about maybe that opportunity? And congratulations on getting it over 50%.

[Tom Caudle:]

Thank you. What we're talking about on the antidumping side is predominantly the lower end of the market. There's always the opportunity, I guess, for somebody to find a supplier somewhere who might be able to produce a product that would be considered PVA or some PVA, but we don't expect that to be anything of consequence in the big scheme.

[Al Carey:]

This is Al, Chris. Getting the volumes back in our plants will end up helping us improve our profitability and gross margin, so that volume is critical to us, even if it is primarily a commodity lineup.

[Chris McGinnis:]

Sure. I assumed there as an opportunity, maybe a selling opportunity for you to upgrade to the PVA. And then just 2 more questions. One, just on the operating income range for 2020, what gets you to the low end? What gets you to the high end, just in terms of your thought process as you look out the year? Obviously, I know coming off of 2019. We've got a long way to go, but it's a pretty good range. So I was just wondering if you could elaborate on that as well.

[Chris Smosna:]

Yes, this is Chris. The operating income guidance that we gave between $22 million to $27 million, which is 100% growth from fiscal '19 is primarily being driven by improved gross profit, so the trade positions are expected to lead to increased volumes. That will lead to better fixed cost absorption. And we're in a stabilized raw material cost environment, which will help on pricing as well. And also, in addition, both index and nonindex pricing has caught up domestically.On top of that, we're focusing on all aspects of continuous improvement in our operations to reduce our costs from procurement to manufacturing processes to new technology. So all that, we do think is going to lead to better operating income as we go into FY '20. The range is a little bit wide, but that's just because of some of the uncertainty that we have around the volumes that we're going to get from the impact of antidumping and how those volumes come in across the year. But we are confident in the guidance that we provided.

[Tom Caudle:]

Chris, I would like to make one point as well. Some of these programs, these commodity programs when they do come back to the region may very well get quoted with some PVA or REPREVE products as well. That is a real possibility, so we could grow PVA in some segments as a result as well.

[Al Carey:]

And Chris, this is Al. We very cautiously put in the plan pickup in volume from the antidumping because we don't know how fast it will come in. Other experiences with antidumping shows that it's very gradual. And in the case of our business, there was a tremendous amount of dumping between October of last year and all the way into the first quarter of this year. We even found customers buying low-priced imports all the way up to about 3 weeks ago. So we're just trying to be cautious on how much volume we get quick. We have a very gradual expectation that takes us through the balance of the year.

[Chris McGinnis:]

And then just one quick question on the SG&A costs for the quarter. There's, I think, $1.3 billion to $1.4 million in severance costs. Should we back that out and thinking about the cost for SG&A in Q4, and that would bring you under the $51 million run rate, I guess, for 2020? Can you maybe just talk about maybe the cadence for 2020s SG&A?

[Chris Smosna:]

Yes, this is Chris. We think the SG&A for fiscal 2018 will be around that $51 million range. We did have the $1.4 million severance charge, which was actually reflected in other expense and we -- that's obviously going to reduce our SG&A in '20 as we won't have that expense going forward. It did require a small reduction in our workforce.We're also taking measures to cut noncritical expenses, certain professional fees, consulting fees, T&E, et cetera. And all that, we think, will lead to a more agile expense structure and better position us for the future and benefit our bottom line, so we saw a little bit north of $52 million for fiscal year '19. We think we can improve a little bit on that.

[Operator:]

Our next question comes from the line of Daniel Moore with CJS Securities.

[Daniel Moore:]

Wanted to start with mix. You continue to shift toward PVA products, obviously, up over 50% now. Also, we continue to shift toward more of the lower margin entry-level chip and staple fiber. I guess, what is your guidance for '20 imply in terms of progress of moving up the value chain towards more value-added, higher margin PVA product? And are you seeing any tangible of those new wins? Or is there a higher percentage that's higher value added, higher margin? Like, when do we expect mix to turn more favorable for you?

[Tom Caudle:]

Dan, this is Tom. Yes, I think you see in the numbers that China is driving a substantial amount of the PVA volume growth. We are growing the bottom end of that business more chip and more staple [fiber]. And the opportunities continue to be very strong in Asia, as well as an improving environment here in the U.S. and Central America. The -- one of the key items that will help us improve margins in Asia is going to be improving the supply chain over there, and we're very optimistic about what we're doing over there in that regard that will help us in very near-term to get those margins to a better place.

[Chris Smosna:]

This is Chris again. Just want to clarify on the SG&A question that the severance expenses recorded and other expense and non SG&A and by incurring the severance that will reduce our go forward rate. So I do want to clarify on that as well.

[Tom Caudle:]

Dan, does that answers your question?

[Daniel Moore:]

Helpful. Yes. But the -- I guess, shifting gears a little bit. Can you talk maybe about the proprietary texturing equipment you expect to install this year? What are the -- maybe a little bit more color on incremental capabilities and competitive differentiations. And do you see any disruptions or can you simply build enough inventory during the installation process.

[Tom Caudle:]

The last texturing technology we bought of any magnitude, Dan, was in the mid-90s. The reason we really haven't spent a lot of money to upgrade is there's not been anything substantially changed in that technology since then, better than what we had. This EvoCooler technology is actually a step change in technology. It increases our flexibility, the speed at which we can operate and process fibers, the quality levels that we obtain from running the light fibers on these machines.We are -- it really is -- it's also the technology is something that we can integrate into our own management systems and all the automation we have in place, so it's just going to supplement all the other things that we do, so we are excited about it. It won't be installed until beginning the latter part of this fiscal year going forward. And we're also changing out this technology through that time period, and it will not be disruptive, and we also have exclusivity from 3 years of signing this purchase in the Americas with an opportunity to buy more and lengthen that exclusivity as well, which gives us, I would say, a substantial advantage.

[Daniel Moore:]

Very helpful. And last for me...

[Tom Caudle:]

I would like to mention one other point that we are doing all is within that $25 million CapEx spend that we've talked about year-over-year.

[Daniel Moore:]

Understood. Helpful. Last for me is, obviously, the guidance is predicated on a "stable" raw material environment, which has presented challenges in the recent past. So can you give us a sense of what oil price range or other raw material price ranges are contemplated in the guide? And has anything changed in terms of your approach or methodology versus maybe prior years?

[Chris Smosna:]

Yes, this is Chris. Generally speaking, the price of oil, and we kind of have baked into our guidance, it's about $60 million to $65 million -- sorry, in dollars per barrel. So we have that baked in. We are in a stable raw material cost environment. And we feel -- we don't see any indicators going into fiscal '20, that there's going to be any kind of increase or run up like we experienced from fiscal '18 through the first 2 quarters of fiscal '19, so we feel pretty good about the environment that we find ourselves in.

[Daniel Moore:]

Got it. Helpful. And I will sneak one more in. You mentioned good momentum into Q1. How do we think about the cadence of guidance? Is the kind of revenue and EBITDA growth that you're expecting for Q1 similar to the full year? Or is it maybe a little bit more of a ramp as the year goes on.

[Chris Smosna:]

It's a ramp-up as the year goes on, our fourth quarter is typically the strongest. But Q1, Q2 and Q3 will be a slight increase and then going into Q4, which will be stronger.

[Operator:]

And our last question is from Marco Rodriguez with Stonegate Capital.

[Marco Rodriguez:]

I wanted to follow-up on a prior question just on China and PVA sales. You had mentioned that a key item there for improvement in margins in that particular segment is improving the supply chain out there. I was wondering maybe you can kind of walk through some of the details as far as what sort of assessment needs to be taken, what sort of time line you might be thinking about where that can kind of see a meaningful improvement.

[Tom Caudle:]

To talk about Asia specific, I mean, because we're asset-light in Asia, it allows us to be more agile and move our supply chains around as business necessitates or dictates. So we are constantly quantifying and qualifying new suppliers, and it did -- we're very fortunate to have the flexibility that as the situations change, we can move supply chains around where they're more competitive, so that is the crux of it.

[Marco Rodriguez:]

So, I guess, then the next question, in regard to that, is that the current supply chains have become somewhat inefficient for you, so you just need to find different suppliers. Is that what I'm understanding?

[Tom Caudle:]

As we grow and expand the market, it just dictates that we find more suppliers, qualify more suppliers and find more competitive supply.

[Marco Rodriguez:]

And then you had mentioned in your prepared remarks, some very nice increasing wins from existing clients with PVA adoption. I was wondering if maybe you can kind of walk through a typical case, if you will, of a client that decides to increase their use of REPREVE and PVA products for you. I mean, obviously, the client -- the customers like the Patagonias of the world are pretty focused on that sort of a product for their end customers, but just kind of trying to understand a little bit better the process that the particular client might be taking to increase our PVA sales over time, how long that typically takes. Or is that just sort of -- they need to test out a few products for a few years? Any sort of color there would be helpful.

[Tom Caudle:]

I think with all the brands, most of the brands and retailers that are changing and setting specific sustainability goals, I think REPREVE is the top category that people would be talking about because we are a globally recognized brand with traceability and credibility. We are a public company that stand behind the brand and its authenticity. And so I think the example would be not only the Patagonias, the Quicksilver, but we've actively talked about Walmart and other people that the Ford motor company, and all the things that we've discussed in the past, and there are very few brands at retail, we are having conversations with about REPREVE and sustainability on a global basis.

[Al Carey:]

Marco, this is Al. I was just going to say since I've been involved, I can see a noticeable pickup in the interest on REPREVE. And I think the reason is many of these companies have now stated 2025 sustainability goals. And they really got to get moving to attain those goals. And our product in REPREVE has this traceability characteristic that I think gives them a lot of confidence that they won't be caught greenwashing or end up not having true sustainable recycled products. So it's been a definite positive and it's gradual. It's picking up as time goes on.

[Marco Rodriguez:]

And then last question, just kind of more of a housekeeping item with the changes in terms of reporting for segments, breaking out the international into Asia and Brazil. I don't know if I missed this either in the press release or as you see in the presentation. Are you going to provide any sort a historical look on how those numbers look maybe in fiscal '19 and '18, or anything of that nature?

[Chris Smosna:]

Yes, this is Chris. When we prepare our financial statements and file our 10-K, we do -- we will take that into account so that we have comparative periods in the result.

[Marco Rodriguez:]

So comparative periods of the 10-K will show the year-over-year just for the annual, but not for the quarters?

[Chris Smosna:]

No, we -- for the 10-K, it doesn't show quarterly performance.

[Marco Rodriguez:]

But you don't publish anything then, I guess, then for the historical Qs, we'll just have to track that as you publish our Qs going forward?

[Chris Smosna:]

That's correct.

[Operator:]

And it looks like we actually do have a follow-up from Christopher McGinnis from Sidoti & Company.

[Chris McGinnis:]

I just quickly wanted to ask about Parkdale and what's happening there. I would -- are they faced with the same issues around maybe a competitive dynamic? Or maybe is that industry just acting a little bit differently? Can you maybe just dig in what's happening there and sort of the process there?

[Tom Caudle:]

No, I think they are seeing some cost pressures, which is affecting their earnings, but they're still a strong operator in the region and in their business. Hopefully, they'll have better results in future periods, but they're generating very strong cash flows. And we continue to do be not satisfied, but optimistic about their results.

[Operator:]

I'm not showing any further questions. So this does conclude the program. You may now disconnect. Everyone, have a great day.