Unifi, Inc.
Q3 2017 Earnings Call Transcript

Published: 26 Apr 2017

[Operator:]

Good morning, everyone. On the call today is Tom Caudle, President; and Sean Goodman, Vice President and Chief Financial Officer. During this call, management will be referencing a webcast presentation that can be found at unifi.com. The presentation can be accessed by clicking the third quarter conference call link found on Unifi homepage. Management advises you that certain statements included on today’s call will be forward-looking statements, within the meaning of the federal security laws. Management cautions that these statements are based on current expectations, estimates and/or projections about the markets in which the Company 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 and the Company’s Form 10-Qs and Form 10-Ks 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 will be discussed on the call and non-GAAP reconciliations can be found in the schedules to the webcast presentation. I will now turn the call over to Tom Caudle.

[Thomas Caudle:]

Thanks, operator, and good morning, everyone. Thank you for joining us today. I will begin today’s call with an operational and strategic overview before turning the call over to Sean who will take us through the financial details for the third quarter and first nine months of fiscal 2017. Our financial results reflect continued success and strong execution against our global strategy to provide high-quality, innovative and sustainable products to our customers around the world. This strategy has not only enhanced our ability to serve our customers, but also it provides us with valuable business diversification. During the quarter and fiscal year-to-date, excellent results from our International operations in both Asia and Brazil have helped to offset persistent soft domestic market conditions. Volume and process growth remained very strong during the third quarter in China while our PVA business continues to grow by filament yarn and staple fiber as our customers benefit from the differentiation in the strategy that our REPREVE PVA products bring to their portfolio. In addition, we were gaining traction across a number of growth opportunities in Sri Lanka and Vietnam as we continue working with key global brands and retail partners to develop and implement PVA programs that would drive value throughout the supply chain. In Brazil, our third quarter results reflect the continuation of strong performance achieved throughout the calendar 2016. Our team in Brazil continues to successfully capitalize on the expansion of the synthetic fiber market and growing demand for PVA products, despite a volatile economic and political operating environment. In summary, we are again very pleased with our strong International momentum and financial performance and view the International segment as an important component of our long-term future growth. As for our US regional business, consistent with recent comments from new domestic retailers, the difficult apparel environment in calendar 2016 has extended into the first quarter of calendar 2017 pressuring our results. Inventory levels remain elevated and brands and retailers remained cautious with orders. Leaders in the apparel industry have marked 2016 as one of the most challenging years and have responded with foreclosures and other business transformations. Looking at specific domestic market sectors, we have experienced some headwinds throughout the first nine months of our fiscal year including Nylon ladies hosiery has been weak on account of consumer preferences and the intimate sector continues to struggle. Polyester bottom weight garment volumes are also down, especially in uniforms for military and work wear applications and low priced imports continued to challenge the commodity end of our portfolio. Combining these factors with a difficult raw material environment, in which virgin polyester cost have increased around 20% over the past 12 months, the domestic polyester market remains challenging. In this environment, we believe there is an increasingly important focus on product innovation and differentiation to provide value to our customers. Bright spots for the domestic market includes; automotive sales who we have seen increased adoption of REPREVE for interiors and REPREVE chip and flake products that are sold into non-traditional markets whereas including non-wovens and customer packaging. Expanding on our product and market developments activities, we’ve begun production and set out specialized performance fibers in partnership with Eastman Chemical Company. This is an extraordinary partnership with a leading chemical technology company that exhibit Unifi’s renowned complex manufacturing capability and culture of innovation from a financial perspective, this project will provide a modest contribution to our top and bottom-line growth. However, we look forward to increasing benefits as volume ramp up over time. Our new bottle processes center recently received a letter of no objection from the Food and Drug Administration allowing Unifi to sell bottle flake in the food packaging industry. This provides an additional potential revenue source as we balance the internal consumption and external sales of bottle flakes. Our bottle processing center has now been in operation for just over six months while we are extremely pleased with the quality and performance characteristics of the output, the ramp up period has taken a little longer than initially expected. This means that we have continued to incur some modest start-up related losses in quarter three of fiscal 2017. That said, we expect to approach breakeven in quarter four with steady state operations beginning by the second quarter of fiscal 2018. To-date, our facility has processed almost 1 billion bottles and we expect to reach a runrate of around 42 million bottles per week. We are maintaining our expectation that this project would generate an EBITDA payback in less than five years. Turning to marketing initiatives, our national REPREVE TurnItGreen mobile tour continues. Here we use a custom design, interactive trailer to engage consumers on the importance of recycling and highlight the high quality REPREVE based products made by many well-known brands. In the next few months, the tour is scheduled to travel to 30 large sporting and music events across the US, as well as at the corporate headquarters of Ford, Nike, Volcom, Fossil, Valeport and more. We’ve aligned our sports teams’ partnership with the key geographical markets where our brand and retail partners including California, Massachusetts, Michigan, Minnesota, New Jersey, Oregon and Texas. Our multiple touchpoints continue to result in increasing brand engagement and new REPREVE fans. A great example is the New Era Cap Company recently launched the first official NBA Hat wear made with REPREVE incorporating four recycled bottles per cap. This product is currently exclusive to the Portland Trail Blazers making it present at NBA Green Week. Additionally, we continue to see REPREVE in store pack garner, greater interest and adoption in the denim category with brands such as Express, Abercrombie & Fitch, Arizona Jeans, St. John's Bay, American Eagle Outfitters, Levis, and CL and Moore. We remain excited about the expansion of REPREVE and the bag it brings to our customers and our results. Looking outside of our synthetic fiber business, I would like to reaffirm our confidence in Parkdale America. The last few quarters have been challenging for Parkdale America familiar to the same reasons as have impacted our domestic business. However, we continue to believe that Parkdale America has grown by a strong management team that has invested properly in its assets, has a strong reputation with its customers and subsequently is well positioned to capitalize on the market recovery. We remain confident in our investments that has had a multi-year history of delivering attractive returns. I would like now to turn the call over to Sean to review our financial results.

[Sean Goodman:]

Thank you, Tom, and good morning everyone. For the third quarter, we are reporting net income of $9.2 million and basic earnings per share of $0.30 compared to net income of $9.7 million and basic earnings per share of $0.54 in Q3 of fiscal 2016. In comparing the results for Q3 of fiscal 2017 to the prior year period, I would like to point out four specific items. These are shown in the bridge that we have prepared on Page 3 of our presentation. First, net income for the third quarter of fiscal 2016 included an expense around $250,000 associated with key employee transition costs. Second, in Q3 of this fiscal year, we had comparatively weaker performance from Parkdale America of approximately $1.5 million. Third, we had a favorable tax impact in this quarter related to refinance certain estimates for approximately $1.2 million. And finally, strengthening of the Brazilian Real drove foreign currency benefits of approximately $1.3 million this quarter. Adjusting for these four items net income for Q3 is approximately $1.8 million less than the prior year period. Slide 4 of the presentation shows a similar analysis for the year-to-date results. For the first nine months of our fiscal 2017, we are reporting net income of $23.2 million and basic earnings per share of $1.28, compared to net income of $24.2 million and basic earnings per share of $1.35 in the prior year period. Specific items to note are, key employee transition costs incurred in fiscal 2016, loss on sale of REPREVE renewable that occurred in Q2 of fiscal 2017, Parkdale America’s performance, start-up costs associated with the bottle processing facility this year, favorable tax impacts and foreign exchange benefits associated with strengthening of the Brazilian Real. Adjusting for these items, net income for the year-to-date period is approximately $1 million more than the prior year period. A few comments regarding our tax rate. Our GAAP effective tax rate in Q3 is 8%. For the nine months period it is 22%. These lower than expected tax rates are associated with three items. First, the relative outperformance of our International segment has positively impacted the overall tax rate. Second, as noted a few months ago, we recorded this tax benefit of approximately $1.2 million in Q3 associated with refined estimates, and third, consistent with our increased emphasis on product innovation and associated research and development we have benefited from an increase in research and development tax credits. Now assuming a constant business mix, continued investments in R&D and no changes to existing tax legislation, all sustainable tax rates should be in the mid-20% range. Turning to Slide 5 of the presentation, we can see the drivers of this quarter’s performance. I reminded that the discussions focuses on our core segments which exclude ancillary operations. You can refer to Slide 12 for the consolidated metrics. Total revenue of $160 million was consistent with the first quarter of fiscal 2016. Consolidated sales volumes as measured by pounds of products sold increased by 8%. This was offset by a corresponding decrease in the average selling price per pound. The overall decrease in average selling price is largely attributable to changes in our product mix with the highest selling price segment a result of nylon underperforming. As Tom noted, our International business with sales growth of more than 30% was offset by the soft domestic results. Looking at total gross profit, overall gross profit declined by $2.4 million or 10% due to lower gross margin base in the Domestic, Polyester and Nylon segments. This was partially offset by higher margins achieved in the International division. Now looking at the individual segments and starting with Polyester, the decline in average selling price for polyester was largely attributable to product mix. Specifically, we experienced volume declines of around 5% in the textured yarn business associated with the market conditions that Tom discussed in his remarks. However, this volume decline was more than offset by continued interest and associated volume growth in our recycled polyester chip and POI products. Both of these products are relatively early in the value chain and therefore carry a lower average sales price per pound in textured yarn products. This impacted our mix leading to an overall decrease in the average selling price for the Polyester segment. The significant margin rate decline in the Polyester segment was primarily due to higher raw material prices. In Q3 of fiscal 2017, our virgin polyester raw materials were approximately 20% more expensive than in the prior year’s fiscal third quarter. While raw material cost changes are generally unimpactful over the medium-term, there is a lag effect and this significantly impacted profitability in Q3. In addition, as Tom discussed in his comments, we experienced some margin pressure associated with the bottle processing facility in Q3. The impact of the gross margin was around 30 basis points. We expect to see this impact dissipate in the fourth quarter and we should see positive contributions from this investment in fiscal 2018. Now looking at the Nylon segment, Nylon sales continued to be under some pressure. However the business appears to be stabilizing with the year-over-year volume decline of just under 4% this quarter, compared to almost 20% in the first half of fiscal 2017. The average selling price decline is associated with a change in sales mix including the transfer of PVA programs to the International segment. The Nylon gross margin decline was associated with lower volumes impacting production efficiency together with changes in the product mix that include a 125 basis points impact from the transition of PVA programs to the International segment. The International segment continued to perform very strongly in Q3 driven by the success of our PVA product portfolio. The average selling price increase is primarily associated with foreign currency gains in Brazil. International gross profit grew by more than 50% compared to the prior year with substantial sales growth compounded by a strong margin rate driven by the enhanced PVA product mix. Foreign currency translation improved net sales and gross profit in the International segment by $4.5 million and $800,000 respectively from Q3 of fiscal 2016 to Q3 of fiscal 2017. On Slide 6, the nine months comparative results here show similar trends to the three months results. Revenue declined by approximately 1% with strength in the International segment offset by relative weakness in the Domestic Polyester and Nylon segments. Total gross profit increased by around 1.5% with the success of our global PVA portfolio again partially offset by the soft domestic market conditions. The overall gross margin rate increased by 30 basis points to 14.3%. For the nine months period, the bottle processing facility adversely impacted the polyester gross margin rate by around 50 basis points and the total gross margin rate by around 20 basis points. When looking at the performance of individual segments, it’s important to remember that in fiscal 2017, certain domestic PVA programs moved from the Nylon segment to the International segment to meet customer-specific supply chain requirements, this reflects the successful execution of our strategy of providing a consistent product wherever in the world it is required. These sales at last has simply moved from the Domestic to the International business. This transition adversely impacted the Nylon segment gross margin rate by approximately 170 basis points. For the nine months period of fiscal 2017, foreign currency fluctuations improved the net sales and gross profits in the International segment by $7.8 million and $1.3 million respectively. Note that overall global PVA sales remains in line with our expectation of 10% to 15% annual growth. Turning to Slide 7 and looking at our equity affiliates, at the end of the third quarter of fiscal 2017, the company had approximately $118 million recorded for investments in the unconsolidated affiliates. These investments consist of our 34% ownership in Parkdale America and our 50% interest in two joint ventures that supply raw materials to our domestic nylon operations. Our pretax share of Parkdale America’s income for the third quarter of fiscal 2017 was $1.3 million, approximately $2.3 million less than same period last year. For the nine months period of fiscal 2017, our pretax share of Parkdale America’s results was $900,000, approximately $4.3 million less than the prior fiscal year’s nine months period. The Nylon joint ventures experienced pretax earnings declines in both the three months and nine months periods associated with high raw material cost and the soft Nylon business conditions. During the nine months period of fiscal 2017, we received a total of $1.5 million in distributions from our equity affiliates. On Slide 8 we review the company’s balance sheet highlights. Adjusted working capital while the $138 million was approximately $7 million above March 2016 and approximately $11 million above the level at the end of June 2016. As a percentage of annualized sales, adjusted working capital was 19.7% broadly consistent with the prior period shown. The increase in inventory from both March and June is primarily related to higher raw material costs. Moving to net debt and total liquidity, we ended the third quarter with around $134 million of debt to principal and net debt of roughly $104 million, slightly below net debt at the beginning of our fiscal 2017. As of the end of the third quarter, our weighted average interest rates for outstanding indebtedness was approximately 2.6%. Total revolver availability and liquidity was $67 million and $97 million respectively. Before turning the call back to Tom, I would like to provide an update on the raw material tariff situation in Brazil. The South American Trade Association known as Mercosur did not approved the reduction in POI import tariffs from 18% to 2% that we were expecting. At this stage, the tariff on imported POI raw material remains at the 18% level. In spite of this, our business from Brazil had a highly successful quarter as we were able to largely offset higher tariffs with an improved product and pricing mix. That said, some competitive pressure is to be expected from imports given the higher raw material costs and relative strength of the Brazilian currency. Looking at the remainder of fiscal 2017, we expect headwinds to continue into Q4 of fiscal 2017, namely, ongoing demand and uncertainty in the domestic polyester and nylon markets and competitive pressure in Brazil from imports and high raw material costs. At the same time, we expect the margin pressure that we have seen in the domestic polyester markets to abate somewhat as raw material costs stabilize. Based on this, we continue to expect revenues, gross profits, operating income and adjusted EBITDA for fiscal 2017 to be broadly in line with fiscal 2016. Anticipated capital project outlays for fiscal 2017 remain at around $40 million and we expect net debt at the end of fiscal 2017 to be in line with that at the end of fiscal 2016. I will now turn the call back over to Tom.

[Thomas Caudle:]

Thanks, Sean. While we are pleased with our fiscal 2017 results to-date, the Domestic market remains challenging. We remain focused on our global PVA growth strategy and we feel that we are well positioned to benefit when the Domestic environment rebounds as it inevitably will. I will now turn the call over to the operator for questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Chris McGinnis with Sidoti. Your line is open.

[Christopher McGinnis:]

Good morning. Thank you for taking the question.

[Sean Goodman:]

Good morning, Chris.

[Christopher McGinnis:]

I guess, can we start maybe just on the polyester side and the margin decline year-over-year and Sean, I know you broke out the impacts of the recycling center, but could y our maybe just walk through the other buckets in maybe a percentage and help us give us maybe a little confidence in that reason, I mean, talking about maybe next quarter and thereafter?

[Sean Goodman:]

Good morning, Chris.

[Christopher McGinnis:]

Good morning.

[Sean Goodman:]

The key driver of the margin pressure that we had in Q4 was related to the raw material prices. As mentioned in my comments, the raw material prices were fairly 20% higher this quarter than they were last year at the same time. What happened is the raw material prices increased, it takes a period of time for us to reflect that in selling price increases. The normal period of time we expect is around 90 to 120 days just depending on the individual contracts with individual customers. What we are seeing now in Q4 is that those selling price increases take effect, they started towards the end of Q3 and so we are looking at significantly better margins in the Polyester segment in the Q4 period.

[Christopher McGinnis:]

Great. And then, I guess just, you broaden up the Brazilian tariff and I think pretty strong margin profile in Q3 what sounded like would be – maybe be a headwind. How much of the headwind are you expecting in terms of the back? I guess, maybe over the next couple quarters would that change and then that competitive landscape changing as well?

[Sean Goodman:]

Yes, we were very pleased with the performance of Brazil this quarter, as mentioned in the previous quarter, we did expect significant pressure from the raw material price increases associated with the higher import tariff and the favorable performance in Brazil was associated with both the mix of products, higher PVA and value-added products and also we were able to pass on some price increases as well. So this really helped our performance in Q3. In Q4, we expect Brazil to continue to be strong both from a volume and margin point of view. However, we would expect little bit of margin pressure relative to the markets in Q3 associated with increased competition from imports primarily related to the stronger Brazilian Real and also our higher cost position. But in general, I would not expect more than about 100 to 200 basis points impact on the International division in the fourth quarter.

[Christopher McGinnis:]

Okay. And lot of the growth in the International, I guess the volume change, can you maybe just breakout how much was attributable to Brazil?

[Sean Goodman:]

Yes, so the volume change, we had positive volume change both in Brazil and in Asia. What I would say is that the Asia volume change was higher than the Brazil’s volume change. We are looking at a volume change in Brazil of roughly in the sort of 10% to 15% range.

[Christopher McGinnis:]

Okay. And could you just remind us when you’ll have maybe the exiting of the competitor in the marketplace and when those comps maybe get a little bit more difficult?

[Sean Goodman:]

That was about three quarters ago and the comps are more difficult in Q4 if you look at our Q4 comparisons, International segment, you will see that the comps are more difficult in the fourth quarter. Looking at the outlook for the fourth quarter while we do expect both Asia and Brazil to continue to be strong, bear in mind that we do have significantly tougher comparisons in that quarter period.

[Christopher McGinnis:]

Okay, great. And then just two more, I’ll jump back in the queue. Just related to the CapEx program, you are almost at the end of 2017. Can you maybe just walk through what you’ve accomplished and how much I guess, you start to think about in 2018? Are there lingering projects where should we see a cash flow kind of really starts to come through on the company? And also, it’s just the peak I guess that level you expect that the company right now?

[Thomas Caudle:]

So Chris, we’ve been starting to predict we just had an average leverage ratio between 1.5 and 2 times out of the past few years and I expect that to remain fairly stable at around that level. Talking about the CapEx, as you rightly say, we are coming to the end of our CapEx program. The three year CapEx program of that period of time we spent $150 million. I think it’s very reasonable to expect in the future years 2018 and beyond that that our average CapEx spend would be lower than the average CapEx spend over the last three years as we are coming towards the end of the CapEx program. We will provide an update to the market at an appropriate point in time once we finalize our CapEx plan for 2018 with more specifics on what those numbers would look like.

[Christopher McGinnis:]

Thanks for taking the time this morning. I’ll jump back in queue.

[Operator:]

Thank you. Our next question comes from the line of Marco Rodriguez of Stonegate Capital. Your line is open.

[Marco Rodriguez:]

Good morning guys. Thank you for taking my questions. Just a couple quick follow-ups on some of the last questions here. On the poly side on the gross margins, you obviously talked about all of the different impacts and leverage you have there on the gross margin side and your expectation that some of the pricing should be readjusted coming into Q4. Are you expecting perhaps is the margins there for polyester get back up into that double-digit range where you’ve been in fiscal 2016 or there is still some headwinds from the retail environment that might kind of keep a lid on that?

[Thomas Caudle:]

Chris, this is Tom. We expect our margins to improve going forward. In the news we continue to see retail closings and things happening in the market as the inventory levels are not – have not reduced the rates that would kind of stimulate growth in the area. So, if – we anticipate that margins will be similar going forward. But we still have some headwinds to encounter for sure.

[Marco Rodriguez:]

Gotcha, okay. And switching gears here to the Nylon segment, you guys have been pretty clear with the secular issues in the hosiery area, obviously some shovels – just trying to get a little bit better feel from you guys, on your expectations of volumes for that area for, let’s just call the next one to two year, I am assuming the expectation for you guys is just a continued kind of negative volume growth on a year-over-year? Any kind of color there?

[Thomas Caudle:]

We still think that headwinds are challenging in the Nylon business. Sean mentioned earlier that the shrinkage seems to have subsided. And we were kind of 4% this quarter – this past quarter compared to 20% in the first half and so, we think there is some upside there. This is going to be driven by market conditions.

[Marco Rodriguez:]

Gotcha. And can you maybe talk a little bit about the order patterns that you are seeing across your different segments thus far into the quarter compared to last quarter?

[Sean Goodman:]

Marco, I would say that the order pattern and the volume levels in looking after Q4 are very similar between Q3 and Q4, fairly stable would be my characterization of that. The big change would be the margin benefit that we expect to see especially in the Domestic Polyester business.

[Thomas Caudle:]

And I would just say, I think we continue to be pleased with our PVA growth and we are going to stay focused on that going forward.

[Marco Rodriguez:]

Gotcha. And just to make sure, I also understood on the margin impacts on the poly side, I mean, presumably better – your PVA is obviously doing very well. You mentioned the growth in the 10% to 15% rate. I am assuming that’s a slightly higher or a better margin profile than your average poly products. But if I heard you and understood you correctly, the pricing and mix declines you’ve seen is primarily just the raw material. In my understanding was correct or are there something else I am missing?

[Thomas Caudle:]

No, that’s exactly correct, Marco. It’s the raw material and really what it is the raw material going up with the price increase lagging that increase in raw material price. So long-term, long-term meaning more than 90 days, not that long, but over of the period of 90 days or so, it corrects such that you get back to a more normal level of margin. But in the short-term within the quarter, one has margin pressure associated with the difference between the raw material cost and the selling prices.

[Marco Rodriguez:]

Gotcha. And a last quick question and I’ll jump back in the queue. I just wonder if maybe you could talk a little bit more about the movement you guys have made recently with the bottle flakes into the food packaging business. Can you maybe talk about just kind of market sizes, growth rates, competitors out there? Thanks.

[Thomas Caudle:]

Marco, as we have said earlier, this is a new business going into the packaging. I don’t know that that we have a lot of information specific about the overall market size of some of these new markets that we are trying to enter into today. I think as this thing evolves, we will be able to talk more about the market themselves and how we will be able to penetrate those markets going forward based on the flake and the quality of products that we are taking to the market boasting our competition.

[Marco Rodriguez:]

Gotcha. Thanks. I appreciate your time guys.

[Thomas Caudle:]

Thank you.

[Sean Goodman:]

Thank you.

[Operator:]

Thank you. And we have a follow-up from the line of Chris McGinnis. Your line is open.

[Christopher McGinnis:]

Thanks again. I guess, just a follow-up on Marco’s question. In terms of bigger picture, longer term, when you think about REPREVE and what that brings to the market, it’s an opportunity maybe on the branding side of it and maybe could you just talk about that and the opportunities with that REPREVE brand and maybe what inning you think REPREVE is within the marketplace? It still seems like it’s early adoption and maybe the opportunity you feel longer term.

[Thomas Caudle:]

Chris, I think we agree with your observation that it is in its early stages from an adoption standpoint. And we think there is a lot of potential going forward with other brands, other retailers, and expanding on our REPREVE offering in the marketplace. So, I mean, it’s on a global platform, we continue to grow almost all in PVA and REPREVE. So we are very excited about the future what it holds for REPREVE. From a brand perspective, we continue to evaluate how we approach that in the future and I don’t know we have a specific answer today. But if there are any major changes in our position in that area I’d be more than happy to update you when appropriate.

[Christopher McGinnis:]

Great. Thanks again for taking the time this morning and nice quarter.

[Thomas Caudle:]

Thanks, Chris. I appreciate it.

[Sean Goodman:]

Thank you.

[Operator:]

Thank you. And I am showing no further questions at this time. I would like to turn the call back to Mr. Caudle for closing remarks.

[Thomas Caudle:]

That’s all operator and we appreciate everyone’s participation today. Have a great day.

[Operator:]

Ladies and gentlemen thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a wonderful day.