Unifi Inc (UFI) 2012 Q3 法說會逐字稿

Good morning. My name is Terese and I will be your conference operator today. At this time, I would like to welcome everyone to the Unifi third-quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. (Operator Instructions). Thank you. I would now like to turn the call over to Ron Smith, Chief Financial Officer. Go ahead, Ron.

Thanks, operator and good morning, everyone. Joining me for our call today is Bill Jasper, our Chairman and Chief Executive Officer and Roger Berrier, our President and Chief Operating Officer.

During this call we 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 our home page.

Before we begin I need to first advise you that certain statements included herein may be forward-looking statements within the meaning of federal securities laws, including any statements and projections concerning the Company's new senior secured facility, Term B loan and anticipated redemption of its senior secured notes.

Management cautions that these statements are based on current expectations, estimates and our projections about the markets in which the company operates. Therefore, 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. I direct you to the disclosures filed with the SEC and our 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 will be discussed on this call and a non-GAAP reconciliation can be found in the schedules to the webcast presentation.

Before I go through the financial details for the quarter, I would like to turn the call over to Roger, who will provide you with an overview of the markets and the raw material trends. Roger?

Thanks, Ron, and good morning, everyone.

We are very encouraged by the positive signs that we saw throughout the economy in the March quarter and for the continued recovery in our key segments. According to the US Department of Commerce, estimates for all retail sales for the March 2012 quarter increased 6.4% compared to the prior-year quarter as American consumers stepped up spending despite the high prices at the gas pump.

Retail sales of apparel in the US increased 7.9% in the March quarter compared to the prior-year quarter, making this the best quarter for retail sales of apparel in the last five years. Apparel sales in the quarter were bolstered by the early arrival of spring weather and Easter falling in the first week of April.

Inventory levels at retail and within the supply chain have continued to decline with retail inventory dropping to 71 days in the March quarter compared to 73 days for the September and December quarters. Also the overall inventory levels in the supply chain, which includes producers, wholesalers and retailers, decreased from 67 days in the September and December quarters to 65 days in the March quarter.

This is important as it shows that even at our production levels the supply chain did not build inventory but actually reduced these levels during the quarter.

As discussed in our last call, the company made the strategic decision to adjust production in the December quarters -- or December quarter -- to levels below our sales rate, which led to a $22 million reduction in inventory.

With inventories in line with our targets entering the third quarter, this allowed us to operate our facilities at a higher utilization rate, resulting in a 7.1% increase in the Company's consolidated sales revenue in the March quarter compared to the December quarter.

Retail sales for home furnishings increased 8.9% in the current March quarter compared to a year ago, and also grew by 3.9% compared to the December quarter. While we are encouraged by the year-over-year increases in building permits in single-family housing starts, we recognize that there continues to be a high level of volatility in the housing market.

Retail inventory for home furnishings fell to approximately 102 days in the March quarter, down from approximately 106 days in the December quarter. So inventories are now well below the 112 to 115 days that we saw during the height of the recession, and they are the lowest they have been since the second quarter of 2007.

The automotive market in the US gained 13% in the March quarter. This is the first time since the recession that the seasonally-adjusted annual selling rate for lightweight vehicles in the US has exceeded 14 million vehicles.

Industry experts say that expensive gasoline has actually helped to increase the sales rate of new vehicles as consumers are looking to purchase more fuel-efficient cars and trucks. To meet this demand North American auto production increased 18.6% in the March 2012 quarter compared to the prior-year quarter. And production levels are at their highest level since June quarter of 2007.

In the automotive segment we continue to be very excited by the level of interest that we are seeing for our REPREVE recycled yarns, which has certainly been helped by the awareness generated by the program that we have with Ford Focus Electric and our recent visibility at key automotive shows.

We are also encouraged by several new REPREVE programs that we expect to be coming online during the next 9 to 12 months across our other business segments, including the Haggar men's dress casual pants, which will be featured in a Father's Day promotion at all Belk's departmental stores.

Turning to our global business, the Brazilian real has stabilized around BRL1.8 to the US dollar for the past two quarters, which is an improvement from the less than BRL1.60 level seen in the June and September 2011 quarters, which led many customers in Brazil to switch to imported fibers, fabrics and finished goods.

Domestic Brazilian production is much more viable and competitive at the current currency level, and we are seeing improvement in our volumes and performance from our operations there. We are continuing to work on enriching our product mix in Brazil, which includes a focus on our PVA products, where possible, continuing to move away from our commodity products, which are most impacted by our imports and fluctuations in the price of raw materials.

In looking at the US synthetic apparel supply share, which can be found on slide 3, regional volume of synthetic apparel from North and Central America is projected to grow at approximately 67% from the 2012 calendar year, which is consistent with the 7% growth that occurred in 2011.

If we look back a decade we can see that the sourcing balance for US synthetic apparel has shifted from being regional-centric to Asia-centric. However, the North and Central American region has stabilized in recent years and is expected to hold its share of synthetic apparel supply at approximately 18% into the foreseeable future.

We expect share growth from countries like Vietnam and Cambodia to come at the expense of China, which is expected to grow at a rate of approximately 5% for the year. While the region is holding share, the overall growth of global polyester remains at 3% to 4% as apparel consumed in the US continues to grow. To meet this increase we added incremental capacity to our Central American operations to supply this growth opportunity.

We will soon complete the texturing expansion of our Unifi Central America, and we feel very good about demand in the region based on the projections for synthetic apparel that I just mentioned. We have orders waiting for these new machines as they come online and all signals continue to be very encouraging for us in Central America.

Although our business in China has declined slightly during the past year, we anticipate improvements to our volume as the industry there starts to benefit from the completion of the inventory de-stocking that has taken place across the supply chain. We also began to see orders coming back in the March quarter from one of our largest customers in China that had been absent from the market as they adjusted their inventory level.

Given the volume recovery associated with stronger retail conditions and a pickup in orders from this customer, we believe that we are on track to see increased volume in China in the June quarter and into the first half of fiscal year 2013. Our sales and marketing activity in China is primarily focused on our premium value-added products, and this provides a supply option for those sourcing in Asia.

Domestically, we're on track to reach our goal of doubling PVA sales in three years. However, we are a little behind our goal in China and Brazil due to the economic conditions in each of those markets we mentioned earlier. We feel confident that both China and Brazil are getting back on track based on order projections for our PVA products over the next two to three quarters, which we expect will put us on the path to double the company's overall global PVA business in approximately 3.5 years from our July 2010 starting point.

Lastly, we saw an increase in raw material prices in both February and March, as was expected. Although prices have started to moderate during the June quarter we expect that the raw material pricing gap between US and Asia will remain significantly higher than historic norms, which will continue to put pressure on the commodity business at the low end of our product offering. We have been successful at recapturing lost margins associated with the historical increases, and we will continue to look at gaining additional volumes once the US to Asia price gap begins to return to more normalized levels.

With that as a backdrop, I will turn the call back over to Ron, who will discuss our key performance metrics and financial results for the March quarter. Ron?

Thanks, Rog. We'll begin the review of our preliminary financial results for the March '12 quarter with our volume and pricing highlights on page 4 of the presentation.

On a sequential basis consolidated volumes increased 10% in the March quarter compared to the December quarter. The improvements were a result of the positive changes in the retail environment across each of our business segments Roger mentioned earlier and the stabilization of the real around BRL1.8 to the US dollar, which has made our operation in Brazil more competitive and made imported fabric and finished goods less attractive there.

Quarter over prior-year quarter volume declined slightly as a result of the lingering effects of the inventory de-stocking in the supply chain and the timing of our normal holiday shutdown. The pricing improvements are a result of price increases required to cover margin loss due to increases in raw materials over the last year, as Roger noted. The net effect of these factors resulted in flat net sales in both the current quarter and year-to-date periods.

Turning to page 5, gross margin declined in the March quarter 110 basis points compared to the March '11 quarter, primarily as a result of mix changes at the segment level as the lower-margin polyester segment contributed to a higher portion of revenue in the quarter and pricing pressure in Brazil, resulting from decreased demand and lower utilization rates across the industry.

In Brazil, we have seen continuous improvement since the low point in the September quarter, but have not yet fully regained our prior-year volumes or margins.

On a year-over-year basis gross margin is 400 basis points lower as a result of the carryover effect of the lower capacity utilization rates, record high raw material prices and the currency impact in Brazil during the first half of the physical year.

As you can see from the comparison of the year-over-year gross profit trend to the quarter-over-quarter gross profit trend the carryover affect from early in the year have been corrected in the polyester segment and are improving in the nylon segment. In the international segment we believe that market conditions are improving, as Roger noted earlier, and expect to continue -- and expect continued progress over the next few quarters to get us back at or near our prior-year run rate.

Turning to page 6, other income statement highlights for the March 2012 quarter include an $827,000 reduction in interest expense compared to the March '11 quarter as the company continued to execute on its de-leveraging strategy and a $12 million improvement in earnings of unconsolidated affiliates.

This improvement is primarily a result of earnings from our investment in Parkdale America being abnormally high during the March '12 quarter and abnormally low during the March '11 quarter, both as a result of the timing impact of changes to cotton costs and the related changes in yarn selling prices.

The company is reporting net income of $7.5 million or $0.38 per share for the March quarter compared to a net loss of $4 million or $0.20 per share for the prior-year quarter. Adjusted EBITDA for the March '12 quarter was $10.3 million, within the $9 million to $11 million range provided during the company's earnings call in February 2012.

Turning to page 7, other income statement highlights for the nine months ended March '12 include a $2.6 million decrease in interest expense compared to the prior-year period and related to our deleveraging strategy and a $2.3 million improvement in earnings of unconsolidated affiliates.

The company is reporting net income of $213,000 for the year-to-date period compared to $11.6 million of net income in the prior-year period. The adjusted EBITDA trend during fiscal 2012 continues to improve, and we ended the nine-month period with two -- $25.7 million of adjusted EBITDA.

Turning to our working capital highlights on page 7, we're very pleased with the success of our working capital management programs. As of March 25, 2012, adjusted working capital remained flat compared to December 2011 despite a $17 million increase in accounts receivable related to the timing effects of the holiday shutdown just prior to the December quarter end and the 9.8% increase in sales volumes.

Turning to our balance sheet slide on page 9, as of March 25 cash on hand was $35.8 million, an increase of $11 million from the December 2011 quarter, and total liquidity was $89 million.

Total debt outstanding was comprised primarily of $35 million of borrowings under our current revolving credit facility and $124 million of 11.5% Senior Secured Notes due May 2014.

As most of you are aware of, on Tuesday of this week we announced the full redemption of the 2014 notes and the entry into commitment letters with Wells Fargo and Bank of America on a new $150 million senior secured ABL credit facility, consisting of a $100 million ABL revolver and a $50 million ABL term loan.

In addition, we announced the entry into a commitment letter with MacKay Shields LLC, solely in its capacity as investment advisor or sub advisor with investment authority for certain discretionary client accounts on a $30 million Term B Loan. The redemption date for the 2014 notes, the payoff of the existing revolving credit facility, and the funding of the new ABL revolver and the two new term loans, are expected to be May 24, 2012. The expected funds flow for the refinancing is included on page 10.

To fund the redemption, repay the existing revolver, and pay the fees and expenses related to the financing, we expect to utilize approximately $22 million in cash and borrowings of $60 million under the new ABL revolver, $50 million under the ABL term loan and $30 million under the Term B loan.

As a result of this refinancing, we will extend the maturity profile of our indebtedness out to May 2017 and expect to save approximately $9 million of annual interest expense. Generally speaking, the terms of the indebtedness are covenant light with no ongoing financial maintenance unless our excess availability and our ABL revolver falls below $15 million; scheduled amortization only on the $50 million ABL term loan, which is based on a seven-year amortization; and unlimited ability to prepay borrowings subject to early call premiums only on the $30 million Term B Loan.

Turning to our equity affiliates' highlights on page 11, the company recorded net earnings of $9.9 million from equity affiliate partners for the March quarter compared to a loss of $2.1 million in the prior-year March quarter. As previously noted, large movements in cotton pricing and the tendency of the cotton yarn customers to lock in prices months into the future sometimes leads to a temporary mismatch between yarn selling prices and raw cotton prices at our joint venture, Parkdale America.

In the March 2012 quarter, Parkdale America was on the positive side of this mismatch whereas the opposite was true in the March 2011 quarter. The comparison for the nine-month period ended March is more indicative of the normalized state of the business, with the nine-month period ended March 12 being up slightly from the March 2011 period.

On page 12 is our reconciliation of net income to EBITDA then to adjusted EBITDA, including equity affiliates, and finally to adjusted EBITDA. As noted earlier, our adjusted EBITDA for the March quarter and the year-to-date period was $10.3 million, and $25.7 million, respectively.

Now before I turn the call over to Bill, I would like to provide an update on some of the key dates coming up. We expect to file our 10-Q for the March quarter on or before Friday, May 4, and our quiet period for the June quarter will begin on June 22, extending through our earnings release conference call, which is currently expected to be on July 26.

With that, I will turn the call over to Bill. Bill?

Thanks, Ron. Polyester raw material prices at historic highs, a strong Brazilian real and high apparel supply-chain inventories and their de-stocking combined to make the first half of our 2012 fiscal year difficult. We did see an improving trend through the March quarter as all these factors improved, and we have seen growth in regional shipments of US apparel sales. We expect this positive trend to continue through the June quarter and into the next fiscal year 2013.

Through this year we have continued to drive lean manufacturing and continuous improvement initiatives throughout our operations. As a result, we have reduced inventory by $22 million since June and our finished goods inventory turns have increased by 20% to 11.5 turns per year at the end of the March quarter. We expect to maintain that level, and we will work to make incremental improvements over the next few quarters.

In addition, we continue to make improvements in our costs, efficiencies, yields and flexibility. For example, as we have grown our PVA product line the complexity of our business, as measured by the number of lot changes we make in our texturing operation, has grown by about 40% in the last four years. In that time manufacturing costs of our textured polyester yarn has been reduced by $0.03 a pound as we have overcome both inflation and the inherent cost of the added complexity. We continue to focus on operational efficiency and our intent on continuing to drive more flexibility at lower cost.

In Brazil the weakening real has helped shift demand back to the domestic Brazilian textile supply chain, and we have seen an increase in demand through the March quarter, as noted earlier. That, coupled with government initiatives aimed at supporting domestic manufacturing, makes us optimistic about our Brazil business going forward, and results in Brazil may approach historic levels within the next few quarters.

We are increasing our texturing capacity by 50% in Central America to take advantage of the long-term volume opportunities in the Americas region. Regional share of synthetic apparel imports into the US has stabilized at about 18% . And unit volume from the region is projected to grow by about 6% to 7% in the 2012 calendar year. We are projecting continued growth over the next few years, though likely at a rate of 3% to 4%.

Although raw material prices remain high compared to historic levels they have moderated from the peaks that we saw in the first half of the fiscal year and this moderation should allow was to recover some lost margin in the June quarter.

We are also encouraged by the signs of recovery in our key business segments, as Roger mentioned earlier. Although the global economy is still fragile, we are encouraged by forward-looking orders for the June quarter and beyond in Brazil, China, Central America and the US.

As Ron noted, we are also very pleased with the recent announcement of the restructuring of our debt. In addition to the cash savings once the financing has closed we will have created a capital structure that allows the company significant flexibility in the development and execution of our strategic plans going forward. We believe this new financing will allow the company to accelerate our deleveraging strategy and will provide the future flexibility to explore strategic initiatives designed to leverage our core competencies, grow our defensible businesses and enhance shareholder value.

Looking forward, as we continue the improving trend we saw in the third quarter we now expect the fourth fiscal quarter 2012 adjusted EBITDA to be about $13 million to $14 million, with the total fiscal year 2012 being at or near $40 million.

In summary, the company continued to effectively manage its working capital and cash during the third quarter. We saw a recovery in market conditions which we believe will continue. We will restructure our debt and improve our long-term flexibility. And, finally, as always, we will continue to execute against our operational strategies. And that's a focus on driving continuous operational improvement throughout the company, growing in Brazil, Central America and China, and growing our REPREVE brand and the rest of the PVA portfolio to ensure we are well-positioned to take advantage of improving conditions in our markets.

And with that, I will the turn the call back over to the operator for any questions you may

(Operator Instructions) Allen Zwickler, First Manhattan.

Good to hear that the world seems to be spinning again for you. No pun on the spinning. I thought you'd like that.

Anyway, I have two questions. One is the $40 million of EBITDA that you just talked about, that, I guess you had made a presentation back a while ago and you talked about that amount. So I'm not trying to be a wet blanket, but basically, you are saying that -- and this was I guess back in February, so are you saying that you feel better about that, or that could be the low end?

This is Ron. I think where we're at, if you go back to say January, early February when we had our earnings call, we were expecting sort of a declining raw material environment.

Right.

What we did see was raw materials ticked up in March, or I guess in late February and in March. So we weren't in the same -- the raw material environment that we expected, so if you look at sort of where our new forecast is versus where that forecast is, I would characterize it as sort of better volume, slightly less margin because of that raw material price that went up.

Got it.

As we move through that, but I think -- from where we stand today those raw material prices are expected to fall back off in April and May, back down to where they were. So I would characterize us as feeling sort of better about where we're at today than where we were. But in this short time period it sort of results in the same type of forecast.

Okay. And is the run rate of, say, $13 million of EBITDA -- is that seasonal? I mean I've only followed you for 100 years, but is that something one could extrapolate out over a period of time? Or I mean -- I don't want to pin you down to a particular forecast, but is there anything special or not special about June that makes that you know a good run rate?

I would give you a couple comments, and you'll probably wind up unsatisfied at the end, I think. But typically we give our annual guidance for next year in the July call so --

That's fine.

So we'll have our approval done and all that. I think from a -- where we would see the -- sort of the operating environment going forward, typically, seasonal, that June quarter is one of our better quarters. As Brazil historically has gotten to be a little bit larger part of the pie that sort of dampened down because there is some counter cyclicality or seasonality in Brazil. But I would say generally speaking that June quarter is a little bit higher than where things normally come out at, but not as much as historically because of the increase and importance of Brazil as they became more profitable and a bigger part of our business.

Okay. And then on a different topic, you have just restructured your balance sheet; I'm going to use that term if you don't mind. And so it doesn't appear that there is any sense of urgency, at least in the next year or two, to pay down debt, because you have already -- you know there's certain requirements that you have to do, and you have made a rather large CapEx expenditure last year. And my guess is that you don't need more capacity, unless something changed. So when you talk about flexibility, I'm assuming that within the new covenants there is a provision to reduce the share count. Is that fair?

I think I would back up a little bit off of that and say I think what we did was take away a hard stop there May 2012 with this new transaction. I think what we said from a longer-term strategy standpoint was we're focused primarily on deleveraging the balance sheet, getting out of 3 times levered down to a much less levered number. This not only allows us to accelerate that because you are saving $9 million of interest, but it also gives you the flexibility to the extent other opportunities develop to be able to pursue those.

So I think the -- so that is sort of the higher level. And I will let Bill talk a little bit more about how we feel about that longer-term strategy.

I think your technical question in there about share repurchases -- when we talk about covenant light in the structure, basically, that covenant light is if we have greater than $15 million of availability under the revolver, we have lots of flexibility, whether it is restricted payments like dividends or our share repurchases or whether it is restricted investments like further investments in new businesses or joint ventures or whatever.

So it is very covenant light, and it allows us lots of flexibility as long as we maintain that level of not only -- that level of availability, not only from an investment restricted payment standpoint, but also from a financial covenant standpoint of having to get over a financial covenant ratio, which is a fixed charge coverage ratio.

Yes, I guess I would -- taking a look at the next few years I mention a lot about flexibility. And the majority of that flexibility that we have achieved has really been through how we operate as opposed to capital expenditures, though we have made some capital expenditures in our spinning plant, which has allowed us to be more flexible.

I think if I was to look at the next couple years one of our primary focuses is going to be to pay down that debt. And I would be disappointed if we have not paid down a considerable amount of the debt in the next two years.

We are going to make some strategic capital investments. From a capacity standpoint, we may add a little bit of capacity, but it would be incremental I think. And I think I can assure you that our main focus right now, at least for the short term, and that's the next year or two, is going to be to plow through that debt. And, again, I would be very disappointed if we have not paid down a considerable amount of that in the next two years.

Okay. Thank you.

Chris McGinnis, Sidoti.

Thanks for taking the questions, and congratulations on the refinancing -- the expected refinancing.

Thanks. We appreciate it.

I guess probably this is for Roger but just in the quarter itself and maybe as you work through the inventory destocking, can you talk maybe about the end market demand you are seeing? Is it picking up as the supply chain fixes itself? And maybe due to the warm weather was there any pull forward from the spring selling maybe a little bit earlier? Can you maybe just dig into that a little bit more and how you see the market and maybe how the growth rates or the volume rates are at least holding at this level today?

Yes, sure, Chris. As we talked about through the March quarter, all the retail indicators whether it was apparel, home furnishings, automotive, we did see the improvement in the retail environment.

And as we mentioned in the December quarter we reduced our production capacities to pull down that inventory $22 million. So as we were entering the third quarter we were matched up pretty close to the retail sales rate, matched up to our production rate. So we felt good entering a quarter. As the retail environment was improving our production rates were also improving that matched up to that.

As far as the ongoing retail, the outlook still looks positive, as positive can be with the current environment. But what we are seeing from retailers and what a lot of retailers are communicating to us is they don't have any plans to start that restocking process.

I think what we are seeing is at the retail environment there is a lot of replenishment activity taking place. So as retail sales are improving we're seeing orders on the replenishment side, but we are not seeing a lot of aggression to restock all that inventory that everyone worked so hard over the last six to nine months to take out.

The one thing that keeps us very encouraged about this region is we touched on the [kafta] supply chain, in the North American, Central America supply chain. And the fact that for the last four years this region's share has maintained at 18%. So that is giving us a very good comfort level about the stability of the region and also the importance of this region to supply that replenishment activity to these apparel and retailers.

And you talked about the increased capacity there. Is it -- about 50% -- is that -- if I remember hearing it right in the opening comments, that --?

Yes, Bill referenced the 50%. What we did is we put down 8 texture machines in our El Salvadoran operation. And based on the demand that we're seeing and the future orders that we're looking at in Central America, we increased that production, in the process of increasing that, from 8 machines to 12 machines, so adding four more machines.

I guess just the next question on Brazil, how much longer do you think the conversion rates will continue to kind of be impacted? Do you see those ever getting back to the I guess the peak margin that you operated at before?

Yes, we've definitely see an improving trend in Brazil in our conversion rates. The one thing we did mention when the Brazilian real went to below BRL1.60, we saw a flood of imports coming in. And those imports were in the form of yarn, fabrics and garments.

And as the exchange rate came back to the BRL1.8 to the US dollar, those imports are still slowly coming into the market. They decreased, but they have not gone back to the low numbers that they were before.

So this has continued to put pressure on our margins. Even though, as the real has come back we see our margins improving, we still have work to do to get the margins back to where they have historically been.

I think the other thing I'd add to that is some of the government incentives that have been in place and some of the reactions they have had down there have been very positive and will be beneficial to our business going forward. So although we may not get the underlying back exactly where it was at, we do feel good about some of the improved -- some of the trends that have happened down there with some of the government support we've seen.

All right. I guess the $13 million to $14 million guidance, do you expect the conversion or the gross margin to continue to kind of ramp at the pace that you have seen sequentially, at least from this -- in Q3, (multiple speakers) move in Q4?

I think that is pretty fair. And I would give you one more piece of color behind that. Like we talked about, Q4 will have -- the polyester segment will have a little less conversion -- or gross margin in the period because of that -- we're paying for that little bitty bubble in inventory. But we think the Brazilian segment, which is one of our higher -- sorry the international segment, which is one of our higher-margin segments, the improvement in that is going to sort of more than offset it. And that is part of what drives us from the sort of $10.3 million, up to that $13 million to $14 million level that we're talking about.

But there will -- improvement in international, improvement in nylon, continued strength in the polyester segment. I think the polyester segment is running pretty close to where our expectations are for that business. The only issue is going to be that sort of bubble paying for that one little blip in raw material prices there and -- in February and March that comes through our inventory systems in the fourth quarter.

One other just on the international itself. I know that -- you talked about China in reference that, the last couple quarters it seems like inventory destocking was holding maybe a big sale. Is that -- part of that improvement in the gross margin due to that -- I guess the rebound in the China sale?

Yes, as far as the, yes the rebounding and the volumes, certainly, the destocking also is taking place in Europe, the Europe retail sales. Some of our Asian supply over there feeds into the European market. We have a couple of REPREVE branded programs that ends up in retail sales in Europe. And we had that one large customer who had a lot of inventory. And because of the sales rate in Europe it was actually a little slower than they anticipated. It has taken a couple quarters to work through their inventory where originally we thought it would take just one quarter. So as we are moving into the second half of the year into the fourth quarter we're starting to see some of those orders come back, which has given us encouragement that we will see China on an improving trend now.

Just on Parkdale real quickly, was the pickup in profitability, was that more of an accounting and not as much of their business itself? Ron, do you mind just going through that a little bit?

Yes. I would -- I think last year's quarter was more of accounting not really matching the economics. I think this year's quarter was more of the -- just a timing effect of they had longer-term cotton prices locked in. And some of the actual economics moved from the December quarter over into the March quarter. So I think there is still -- both of them were timing related, but the one this quarter sort of did much the economics, but it was still timing related in that sort of December programs got moved out into the March quarter, whereas last year it was more the way the accounting -- we knew -- I mean they told us when we had that negative and we told you guys when we had that negative in the March quarter last year this is an accounting issue; it will come back in June, and it did. This one is not necessarily as much accounting as it is more just sort of actual volume moving between quarters.

All right, great. And is that -- is the Parkdale asset at least going back in the direction of that $90 million of EBITDA? I know that we talked -- last talked -- it was in the maybe $70 million to $75 million range.

Yes, I think the -- if you look -- and I don't have the number in front of me right now -- but I think the trailing 12 -- let me back up one step and say, we just filed their amended 10 -- we filed an amended 10-K to provide to the investors, Parkdale's complete annual financial statements for the year, calendar year ended December 11. So if you go back through that and sort of do an EBITDA calculation out of that, that is close to that $90 million run rate that it is on.

I think the way I would characterize it is they had a very strong start to the year because of some of this volume getting pushed over into the quarter. The forecast we told you guys about at that time was that they were expecting to get back close to that $90 million level but they did not think they were going to get all the way back to there, so I think that is probably where I would stay at that same part.

I mean they are seeing some volume pressures in their business. And I think one of the things that we did talk about on the call, but there has been a little bit of shift in the very high raw material price environment of cotton. There's been a little bit of shift from cotton over into polyester from a fiber share standpoint; that would be -- that shift as cotton prices came back down, nobody's really sure where that is going to settle out at.

All right. And I guess just lastly, could there be -- I think we've talked about this before -- but the working capital for them should start to come through favorably for the remainder of the year. Could there be maybe a distribution at some point? Or would they ever consider doing that?

Yes, I think the -- a couple points on that. One is they had $55 million of debt at the end of the quarter and I think it was $37 million of cash. So their net debt has decreased dramatically from where they got to.

That debt was incurred as a result of the HBI transaction that has been very beneficial for both parties as well as the high cost of raw -- of cotton.

Even though cotton pricing has abated pretty substantially, the nature of that business they lock in the cotton prices out over long periods of time, and so if you look at say what the retailers were saying, the December quarter was when they finally paid their highest price for their raw materials for that cotton. So that was the peak and it started to come down since then.

We expect it will continue to come down. It will take another three or four months before the price they're actually doing business at gets down to where sort of the trading price of cotton is now, just by that lock-in, long-term mechanism.

So, yes, there will continue to be -- we expect there to continue to be declines in working capital. Yes, they will continue to pay down debt and get out of that debt.

I think from a dividend standpoint, we do expect -- they have continually been paying sort of the tax distribution dividend. We obviously expect that. And then once they get through that debt we are hopeful for additional excess dividend distributions, but it is not something that has been declared or is on the table right now. I think that is more towards the second half -- the end of the second half of this calendar year when that would happen.

All right, great. Thank you very much for your time today. I appreciate it.

(Operator Instructions) John Curti, Singular Research.

A couple of questions on the income statement. The other operating expenses was up about $500,000 year over year. I just wanted to know what was in there. And then also fairly low tax rate. I wonder what was going on there as well?

Yes, I think from the other operating expense standpoint, that line is where the pre-renewable investment is coming through, so that would be the change on that. We didn't talk much about that. I think we're very excited with how that has been progressing and where we are at with that.

We expect this planning season where we've planted additional acres to try to develop our protocols and the economics around those protocols. We are waiting on the -- we've ran through that process and we are waiting on the germination results of that process. So we're sort of anxiously waiting and very excited about sort of where we're at from the protocols and the economics of those protocols. But that's the biggest difference in that line item.

As far as the tax rate goes, a couple things on the taxes. From a tax standpoint, we have -- we've talked about this in the past. We have somewhere around $30 million of net operating loss carry forwards. Those net operating loss carry forwards have a deferred tax valuation allowance against them because of our ability -- our expected ability to realize those -- we have not had sort of cumulative three years net income. And when you don't have that environment you fully reserve against those.

As we move forward whether it is next quarter or a couple of the future quarters we are likely to sort of unwind that transaction -- or unwind that reserve because from an accounting perspective we get over the hurdle of more likely than not that we will be able to use those NOLs to offset future taxable income. So that will be something that comes through that line going forward in the future.

In the interim, because we are in that position where we're reserving all those net operating loss tax forwards, you're going to have unusual tax answers, because like this quarter, we had income in the US that you didn't have a big tax expense related to. And you had -- the Brazil -- you had full tax rate in Brazil.

In other quarters when the domestic operation has had lower income and Brazil has had higher, you've had higher. So it is really difficult to do the comps of those.

I think where you should think about us is over the next sort of this year and fiscal 2013 the tax environment will be -- only our international tax segment we'll be paying taxes from a cash tax standpoint, where we will be using NOLs in the domestic business. As we move over into '14, pretty much the entire business will be paying sort of net income tax at that 35% to 40% rate.

35% rate in '14?

Yes.

And then to go back to China again a little bit, just want to get a little more clarification there, the timing in terms of getting back to prior levels and/or the ability to -- with the existing customers and/or the ability to acquire new customers.

Yes. We anticipate in the fourth quarter we are getting closer to our historical run rate in terms of volume and margins in China.

And then looking out into our fiscal year 2013 that we started in July, we continue to get new opportunities and new development programs. And we're expecting to continue on the path of growing China, particularly around our PVA products, which is our brands.

And one of our most important brands is REPREVE, and we're getting a lot of development activity and new program activity on REPREVE domestically but also in China.

Within China, the business that the Chinese companies are doing in Europe, the people that you are doing business within China, do a pretty -- does a pretty good chunk of their business go to Europe? Or do you have a fair number of Chinese customers that are producing product that come into the US or for -- within consumption within China?

It is a mixture of both in terms of Europe and coming back into the US. We're working with brands and retailers here in the US but also in Europe. They make decisions to source in Asia, particularly some of them source in China. And as they're making those decisions to source in China we want to be there as a key yarn supplier, particularly around our PVA products. So as they're making the fabric and making the garments in China, we are there as a yarn supplier supplying our PVA-type products.

And we're seeing both European brands and retailers sourcing in China and also US brands and retailers sourcing in China.

There is some activity around local Chinese brands starting to look for value-added products. I would say historically those Chinese brands and retailers are more focused on commodities. And commodities is not really our business segment in China.

It's more on the value-added side, but we're starting to see some of the Chinese brands express interest in some of our premier value-added products.

And then that is one of the things that we'll be focusing on in the next couple years as we look to grow our business in China, is how we can expand into more of the Chinese local brands.

Your slide presentation today, you had segment gross profits. Do you have the revenue numbers for those segments? Or are those going to be disclosed in the 10-Q?

Yes, they will be in our 10-Q coming out on Friday, next Friday, sorry.

All right, thank you.

Thanks.

Eric Pisauro, Regency Group.

I had a question about depreciation expense. I think in previous quarters' calls there was some discussion about the fixed assets and how you have been recognizing high levels of depreciation, but at some point that is going to stop; your assets will be more or less fully depreciated. Can you speak to that?

Yes, I think the -- if you look to the nine months it's a little over $20 million, close to $28 million to $30 million, for the year-to-date period.

I think the one that we talked about -- I think it was two calls ago, if you do an earnings multiple, and I somebody -- I believe it was Allen was talking about -- sort of doing -- applying an earnings multiple.

If you do an earnings multiple you just have to be careful with our -- using our net income number because from a depreciation and amortization perspective most companies -- if you have had consistent capital investment your depreciation and amortizations are roughly equal to your CapEx.

For us, we spent over $1 billion of CapEx back in the late '90s. We're still paying -- some of that was 15-year special use stuff. Some of it was obviously forty-year buildings and improvements.

So for us, our depreciation level is much higher than what our maintenance CapEx level is. That maintenance CapEx level is in that $6 million to $7 million a year on a consolidated basis. When we look forward we put a number in more like $10 million to $12 million a year because we are making capital investments, in stuff like what Bill mentioned earlier, around the REPREVE recycling center; a solid project at our POI spinning facility in order to create more flexibility to make more PVA products; a small lot project in our PVA -- our spinning facility.

We are making slightly more than maintenance CapEx, but we are definitely doing the maintenance CapEx levels required to maintain our equipment for going forward. So I think that is what you're asking. And just make sure when you think about our earnings you take into account that our depreciation level is much higher than what our sort of maintenance CapEx level is.

That's very helpful, but just as a clarification though, so there is not sort of a depreciation drop off that is a year or two away? That $1 billion investment is still basically there being depreciated at its regular rates?

There is, but it's not -- it's out over the next few years. I would even classify it as if you go back five years ago, depreciation was over $50 million. So it is been on a declining path.

Once you move past that ten-year mark, which happened over the last few years, once you move past that 10-year mark you did see most, like a lot of the machining and equipment, became fully depreciated.

But some of that 15-year stuff, the special-purpose stuff like the spinning plant, and then obviously the forty-year stuff, it's coming off over a much more gradual slope. But when that 15-year stuff starts to drop off over the next couple years you will see a little bit more decline, but it is not a $10 million decline. $30 million goes down to $26 million or $25 million.

Great, thank you.

Thank you. At this time, there are no further questions.

Okay. Operator, this is Bill. I think in closing, I just want to reiterate that we did anticipate that the second half of this fiscal year would be better than the first, and we're seeing that, as well as an improving trend.

I think looking forward as the region maintains share and as US retail continues to grow, even though at a small rate, we would expect to see that improving trend continue.

I think looking back we have made considerable improvement in this business over the last few years, and I think that is a testimony to the dedication and hard work of all of our employees. And really that improvement put us in the position to restructure our debt on very favorable terms, which gives us the ability to ultimately deleverage our balance sheet more aggressively and more quickly, while also providing the flexibility to make investments as we defend our PVA business and grow our PVA business and continue to improve shareholder value.

And with that, I will thank everybody for being on the call, and have a good day.

Ladies and gentlemen, thank you for joining today's conference. Thank you for your participation. You may now disconnect.