Gildan Activewear Inc (GIL) 2003 Q2 法說會逐字稿

Good day, everyone, and welcome to today’s Gildan Activewear Second Quarter 2003 Results Conference Call. As a reminder, today’s call is being recorded. Our speakers today are chairman of the board and CEO Mr. Greg Charnandy; president and COO Mr Glenn Charnandy; and EVP and CFO Mr. Laurence Sellyn.

Before turning the meeting over to the management, please be advised that certain statements included in this conference call may constitute forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. We refer you to the company’s filings with the U.S. SEC and Canadian Securities Regulatory Authorities for a discussion of the various factors that may affect the company’s future results.

I would now like to turn the call over to Mr. Greg Charnandy. Please go ahead sir.

Thank you. Good morning, everyone, and welcome to our second quarter conference call. We are extremely pleased to report to you that we had an excellent second quarter and that we continue to be comfortable with the full year guidance of 270 to 280 per share which we provided to the market on our last conference call.

The net earnings of $20.4m, or 69 cents per diluted share, are record second quarter earnings for the company, despite the fact that we took a charge in the quarter of $1.1m after tax to close our Montreal sewing facility. We regret that we had to discontinue this facility but its cost structure was no longer competitive in today’s market and business environment.

During the quarter, we reinforced our business strategy of continuously reducing costs so that we can build in those cost savings into lower selling prices and superior garment features in order to drive our sales. We continue to maintain our leadership position in the overall T-shirt category, with a 29.1 percent share of the U.S. wholesale distributor market, and we believe that we are well on our way to achieving a similar leadership position in the sports shirt category where we have recently introduced a line of fashion sports shirts to complement our basic program.

Glenn will provide you with our market share statistics by product later in our presentation. On the manufacturing side, we continue to ramp up capacity at our new, fully integrated textile manufacturing facility in Rio Nance, Honduras, and most recently we have initiated a plan to increase capacity and to produce a higher proportion of colours in Rio Nance.

We view this project as a great success, not only because of its seamless start up and excellent cost performance, but because this project has created a template for Gildan to use again in the future to create additional low-cost, state of the art, textile capacity in off-shore locations.

In addition to the impact of our Rio Nance facility, we also benefited from lower yarn conversion costs, due to the recent investments which we made in acquiring and upgrading two Canadian vertically integrated yarn spinning operations.

On the corporate governance side during this past quarter, we added two new members to our board, namely Gerald Ross and Pierre Robitaille, thereby bringing our total to nine directors, of which six are independent of management.

Now I would like to pass the microphone over to Laurence Sellyn, our CFO, who will review our financial results and outlook.

Good morning. EPS for the quarter was 69 cents, or 73 cents per share before the charge for the closure of the Montreal sewing plant, which represented an increase of 30.4 percent from the second quarter last year. U.S. dollar EPS before the special charge was US $0.48 per share, up 37.1 percent from the second quarter last year.

The higher EPS compared to last year was due to a 21.4 percent increase in unit sales, an increase in gross margins before the special charge of 30.5 percent, compared to a 26.5 percent in the second quarter last year, and lower interest expense, reflecting the impact of the significant free cash flow generated by the company generated in the second half of fiscal 2002. These factors were partially offset by lower selling prices, increased SG&A expenses, and higher depreciation as a result of our capital expenditure program.

Sales were a second quarter record of $173.1m, up 10.5 percent from $156.7m in the second quarter of fiscal 2002. The higher sales were due to the increased unit shipments, partially offset by lower selling prices. The higher unit sales reflected 4.8 percent growth in overall industry unit shipments of T-shirts through the U.S. distributor channels in the quarter, combined with continuing market share increases as compared with the second quarter of last year.

In spite of capacity constraints, the company maintained its strong market share leadership position in the overall T-shirt category with a share of 29.1 percent versus 28.9 percent a year ago. Gildan continued to achieve significant penetration in the sport shirt segment. Although demand in this segment continued to be weak, with a further 9.5 percent decline in overall industry shipments for sport shirts, unit shipments of Gildan product from distributors to screen printers by 28.3 percent. Our share increased to 18.4 percent from 12.7 percent in the second quarter of last year. In the month of March, our share surpassed 20 percent, elevating us into the number 2 market share position for this category. Gildan's share in the fleece category was 10.7 percent, compared with 9.2 p a year ago.

Before the special charge, gross margins in the second quarter were 30.5 percent, compared with 26.5 percent in the second quarter last year. The increase in gross margins was due to the impacts of the Rio Nance facility. The cost performance of which is exceeding our expectations, together with lower cotton costs and lower yarn conversion costs due to the recent investments in acquiring and upgrading two Canadian vertically-integrated yarn-spinning facilities. These cost reductions were partially offset by lower selling prices, as well as the impact of the weaker U.S. dollar relative to the Canadian dollar.

Selling, general and administrative expenses for the second quarter were $20.6m, or 11.9 percent of sales, compared with $15.7m, or 10 percent of sales in the second quarter of last year. The main factors resulting in the increase over last year included the timing of accruing the provision for our results-based management incentive compensation program, together with higher insurance premiums and costs incurred for organizational restructuring. Although SG&A expenses in the first half of the year have been impacted by timing issues and non-recurring costs, we will nevertheless be increasing our focus and opportunities to manage and control future growth in SG&A expenditures in order to achieve our long-term model, which calls for SG&A expenditures to be approximately 10 percent of sales.

Looking forward to the earnings side for the balance of the year, we have indicated in our press release that we are still maintaining our full year guidance of 270 to 280 per share, after absorbing the impact of the special charge for the Montreal sewing plant closure. Whether we ultimately fall within this EPS, or whether we reassess our guidance, will obviously depend upon a number of variables, but specifically we would like to discuss the impact of the dramatic decline in the value of the U.S. dollar.

As we have previously said, we have a significant natural hedge as a result of the high proportion of our costs which are denominated in U.S. dollars, as well as the effect of currency in our European sales. With Rio Nance, the Canadian component is only 10 percent of our total cost of goods sold and it accounts for 40 percent of our SG&A costs. While all of our long-term notes are denominated in U.S. dollars.

For the balance of the year, we have largely hedged the exposure not covered by our natural hedge. The main variability that continues to exist vis-à-vis our fiscal 2003 earnings forecast, relates to the potential impact on gross margins of timing issues that arise when the U.S. dollar is declining rapidly and which temporarily mitigate our natural hedge. As a result of timing, production costs included in previously manufactured inventory reflect a higher U.S. dollar exchange rate than is reflected in current sales. In other words, there is a time lag before we can take advantage of our natural hedge.

With no offsetting change in any other assumptions, the timing impact on gross margins of the temporary differential in exchange rates between costs of sales and sales translates into a range of $2.80 per share, and to US $1.45 to CAN $1.00 exchange rate, to $2.70 per share, at a rate of approximately US $1.38 to CAN $1.00. Clearly this is a timing issue and all else being equal, margins will increase again once the exchange rate stabilizes at whatever level, with the impact on sales and cost of sales being back in alignment.

A final comment is that this exchange issue only impacts our Canadian dollar EPS and from a U.S. perspective, our U.S. dollar EPS is largely unaffected as our Canadian dollar EPS are converted back into U.S. at a higher conversion rate, reflecting the stronger Canadian dollar.

Turning to our cash flow and our balance sheet, during the quarter we used $25.8m our of our surplus cash reserves to finance a seasonal increase in receivables, and our ongoing capital expenditure program. The increase in receivables was entirely a function of higher sales. DSO were maintained at 46 days, down from 55 days a year ago and essentially the same level as the first quarter of this year.

Due to the tremendous success of the Rio Nance project and the impact it is having on lowering our manufacturing and transportation costs in excess of our original targets, we are taking advantage of the opportunity to further expand the ultimate capacity of this facility, and also to allow for a higher proportion of colours than originally planned. The expansion of Rio Nance is expected to position us with sufficient capacity to meet, although not exceed, our projected sales for the peak summer selling season in the current fiscal year. As we ramp up further, we will bring on capacity to enable us to achieve our plan of at least 15 percent unit sales volume growth in fiscal 2004.

As a result of incremental spending for Rio Nance, it is anticipated that capital expenditures for the full year are now projected to be in the range of $60m, instead of $50m as previously planned.

The free cash flow for the full year is now anticipated to be in the range of $15m to $25m. Our balance sheet continues to be strong. Even at the seasonal peak of cash utilization at the end of the second quarter, we have not been required to draw down in our bank facility, and our ratio for net debt to total capitalization at the end of the second quarter continues to be very conservative at 20 percent.

With our anticipated cash flow generation in the third quarter and fourth quarters, we expect to end the year in a very strong capital position with $80m to $90m of surplus cash reserves. We therefore expect to have strong liquidity with which to start to pay down our U.S. notes in 2004, as well as to satisfy any other usage of cash that is deemed to be appropriate as a result of completing our study to determine the next stage of our growth strategy, and the optimal deployment of our surplus cash reserves. Now Glenn will review market conditions and update you on our manufacturing plans and performance.

We are going to start with the market share. The T-shirt category was up roughly 4.8 percent for the quarter. The cotton category was up 6.5 percent, where the poly-cotton T-shirt category was down 0.5 percent. Gildan’s share within the category was 29.1 percent overall, up 6 percent from last year. Our 100 percent cotton share was 34.5 percent, up 7.4 percent, and our poly-cotton share was roughly 12 percent, down 0.5 percent.

Our current inventory on hand at the distributors in the market is roughly around 60 days today. The fleece market was down about 0.5 percent, and Gildan’s share within the market was roughly 10.7 percent, up 17 percent. The sports shirt category remains troubled, down around 9.5 percent, however most of the products that have pressure on the downward trend are high-end sports shirts, more expensive products which Gildan is currently selling. Gildan’s share within the market was 18.4 percent for the quarter, up 28.3 percent. As Laurence mentioned earlier, in March our market share, we were number 2 position in March and our market share was 20.2 percent, only half a percent from being the number 1 supplier to the channel.

Although we were so close to being the number 1 supplier to the channel, all of the new products, which are fancy sports shirts, have not yet been recorded a market share, as these products are just making themselves to market. We feel that as we go forward in the year, we will achieve our goal of being the number 1 supplier in this channel as well.

On the pricing front, we continue to apply what we call our everyday low price strategy. We’ve reduced prices this quarter on our basic colour T-shirts by roughly around 12 percent. We also spent roughly another 5 percent of our sales on promotional spending, i.e. count recounts, primarily on white cotton T-shirts. Although we aggressively price our products through the quarter, our margins still remain strong at over 30 percent.

Going forward, we feel that pricing will remain at today’s level, with some upside on the promotional spending side, as inventories in the channel remain very tight on the supply and demand side.

On the market review, we continue to penetrate the market and our market share. However, our Q3 has limited upside as inventories remain very tight. We are continuing to build up our capacity at Rio Nance to increase our capacity as we go forward. Our current run rate as of March 30th was roughly about 24m dozen on an annualized basis, and we will grow this through 28m by the end of September.

In Europe, we are on track to increase our sales this fiscal year by over 40 percent. We have started to penetrate the European market more aggressively, i.e. the French market, and we feel that we are penetrating the market with future growth and it will allow us to continue our momentum in the European market. We’ve also recently opened up and started operations of our U.K. warehouse, which will allow us to service better the U.K. market and increase our market penetration.

On the manufacturing side, we continue to build up our Rio Nance facility. The current capacity of Rio Nance is running roughly about 60 percent of its ultimate capacity, and will reach 100 percent of its capacity roughly by October, 2003. Like Laurence mentioned, we’ve increased our spending on this facility by roughly $10m this year. This will allow us to increase our capacity by roughly 15 percent from the original plan, and will also increase our percentage of colours to better service the market and reduce our costs.

On the spinning side, we’ve completed our integration of our Long Sault facility build up through the acquisition of our new equipment. We are also in the process of completing our build up of our Henri-Bourassa facility that will be complete in the near future. These two facilities will allow us to be fully vertical in our Canadian operations.

Our sewing capacity continues to grow, keeping up with our textile capacity. We’ve just recently opened up an additional sewing plant in Haiti that will allow us to continue our build up momentum as well as, we are in the process of facilitating and increasing all of our other existing facilities to keep up with our build up plans, as well as to lower the overall costs of our sewing.

With that I would like to pass the floor to Greg for closure.

Thank you. In closing, we are pleased with our results of this past quarter and we are maintaining our outlook for the rest of the year based on the current value of the Canadian to U.S. dollar exchange rates. We believe we have sufficient production capacity and inventory available to satisfy the sales plan for our products for the rest of the year, and we are positioning ourselves to support our projected growth in fiscal 2004.

Looking forward, we plan to continue to reinvest in cost-saving measures which will allow us to reduce prices, improve product features and quality, and drive our sales and earnings growth plans. With that we would like to turn it over to any questions that may exist in the audience.

Thank you, sir. (Operator instructions) We will take our first question today from Dennis Rosenberg with Credit Suisse First Boston.

Hi guys, it’s Ed Kelly asking a question for Dennis. How are you? Congratulations on a nice quarter. Laurence, your comments on currency were just a little confusing. Could you walk through again what the impact the lower exchange rate has on your EPS estimate?

Well what we are saying is that there is a timing imbalance that occurs when the U.S. dollar declines as rapidly as it does, because we have a natural hedge, but there is a quarter time lag before we can fully take advantage of our natural hedge, because inventory is coming -- cost of sales is coming out of inventory at a higher exchange rate than the exchange is impacting sales. So the exchange impacts sales immediately, but we only get the benefit in our cost of sales a quarter later.

So this is negatively impacting our margins as we work through this catch up period. If our margins, our cost of sales and our sales were in alignment at the present time we would be 33 percent. With our cost of sales at $1.53 and our sales at $1.45, our margin is at 30 percent. If the cost of sales is $1.53 and sales reflect an exchange rate of $1.39 that brings the margins down to 28 percent.

This is all a timing thing until sales and cost of sales comes back into alignment, and once the exchange rate stabilizes at whatever level it stabilizes at, we will fully benefit from our natural hedge and our margins will increase again.

Okay. And now looking at the impact to the U.S. dollar earnings, I believe your conversion is done at the average exchange rate, so if you assume that rates stay at the current level, I guess your current guidance would translate into U.S. dollars of around $1.80 to $1.90? Is that right?

I think so, yes. That’s right.

Okay. Last question. Could you just detail the impact to gross margin of the increase in production in Honduras, the lower cotton costs, yarn conversion costs, all set by lower selling prices and a weak dollar?

Sure. The net effect of all of these things, as we said, was the 4 percent increase in gross margins. Favourable efficiencies, particularly the low cost structure of Rio Nance improved gross margins by 7 percent, so margins would increase by 7 percent due to efficiencies, and then another 4 percent from lower raw material costs for a total of 11 percent. We gave 7 percent of that back through pricing and exchange, about 5.25 percent for pricing and 1.75 percent was the impact of exchange.

Thank you.

Our next question comes from Claude Proulx with BMO Nesbitt Burns.

Thank you. Good morning. My first question, on the SG&A, can you do the same, between the three factors that you mentioned, the timing of the incentive for management, the high insurance and the organizational restructuring? And then, talk a little bit about what is organizational restructuring; what are you talking about in this case?

Okay. We had overall something like a close to $5m increase in our SG&A; $1.9m was due to bringing our performance incentive plan up to the return on assets we expect to achieve for this year. About $500,000 was increased insurance. About $500,000 was restructuring costs. What it meant by that is, as the results of the strengthening that is taking place at the VP level throughout the company we were able to eliminate a layer at the EVP level that wasn’t necessary because of the strength below them at the VP level. We also had about $700,000 of project-related travel due to the start up of Rio Nance and IT projects that are underway.

Okay. The other thing is, the golf shirt segment, in the past the message was, the promotional market is suffering from the economic slow down, companies are spending less on advertising on promotional events, things like that. We’ve seen that now for more than probably a couple of years. I mean, are we near the bottom? Why is it still going down today?

Well I think it is still the same thing happening, basically. There still continues to be less spending on the corporate side, that is where basically the market is being affected. Where in our case, we are really creating opportunity, we think. Because our products are being priced at the price they are at, what we have done is not only are we penetrating the existing market but we think we are creating new opportunities for people to buy our products at more aggressive prices and bring them to market and create new opportunities. That is why we think we are being successful in the market.

We see that the corporate side is basically, I would say it is going down. I mean eventually it is going to get to the point where it is sort of going to level out and hopefully that will come soon because we don’t want to see the market erode. What the opportunity is that we see forward is how we are going to create new opportunity and create demand for our products and actually accelerate the market demand as we go forward.

The last question is, obviously you are targeting a lot, these golf shirts, but you don’t seem to be focusing as much on fleece. Is it intentional? Is it because you see fleece as a less attractive market, because maybe the weather is more of a factor in the sales of fleece?

No, on the contrary. I think that is our next area of opportunity we see as a company. We are definitely totally underdeveloped there and that is an area where, in the near future, are going to be definitely planning our expansion plans around.

We’ve done some product enhancements in our products recently. To just go back to the fleece market, when we first entered it we were only in what we call the cotton category, which represents only about 80 percent of the market. Then we entered the 50/50 category, but the 50/50 category is split between heavyweight and lightweight products. When we entered the market we went into the lighter weight category, which basically we were very successful when we launched our products.

What we have done going forward is basically two things. We’ve upgraded the weight, and one thing that Gildan has always been successful for, although we’ve been what we call the low price relationship to our value, but we’ve always been the ones in the forefront of increasing value in our garments. What we’ve done, basically, is we’ve taken the weight up of our fabric of our 7.5 ounce shirts, we’ve raised the weight of that shirt to about 8.5 ounces and basically we feel that with the superior quality and the price point that we are at now, it is going to allow us to penetrate more market share.

As well, through the acquisition of our Henri-Bourassa spinning facility, all of our fleece now is being produced on what they call jet spun yarn which is pill-free. All of our competitors are still using open-end yarn that pills, or most of our competitors are using open end that is actually much more of a pilling effect on the fabric. So from the quality point of view, we think we are going to provide superior quality and value at better prices than the market is currently seeing, and therefore as we go forward we are hoping to penetrate the market much more aggressively.

It is going to take a little bit of time to get that job done, but over the next 12 to 24 months we will see our share dramatically increase, we think, in this category.

Thank you very much.

Our next question comes from Andrea Harbour of Sprott Securities.

Hi, guys. Can you split out what the European sales were on a dollar basis?

We prefer not to provide the segmentation of our sales by market for competitive reasons, Andrea, but we will say that we are on track to achieve full year sales as we had indicated, in the range of $50m. We are achieving significant penetration in all of our target markets in Europe.

Okay. And then just on the SG&A line, you indicated your long-term trend, or long-term target, is 10 percent. I sense it will take a while to get back there, or get to that level. So for this year, should we be looking at sort of something consistent with where you were at in the second quarter for the balance of the year?

I would say that for the full year we would like to be between 11 percent and 11.5 percent and next year close to the 10 percent.

Okay. That’s all I had. Great quarter.

Our next question comes from Martin Goulet of National Bank Financial.

Thank you Good morning. With the increase in capex in Rio Nance for fiscal 2003, do you see further also expenditures in Rio Nance in fiscal 2004, and what would we be looking at for capex in that year?

Our plan basically, I think, at this point in time is we are going to maximize the existing facility that we are currently in right now. There might be small amounts of dollars, again just related to the mix of what we try to produce in the facility, as we increase the amount of colours we are producing versus the whites, because it takes additional equipment. Basically from a capex point of view, we are continuing to invest into our future capacity, so therefore we will probably remain, in the next year, I would say roughly about $35m to $40m in capex. That is roughly where we will be.

Okay. In terms of market share, at the expense of whom, mostly, are you gaining share -- I guess I should ask my question differently. Is there somebody else than Gildan gaining market share, or everybody is sort of receding? Also, I noticed that in 50/50 T-shirts you seem to have flipped just a little at the expense of whom?

Well what happened is the 50/50 category was slightly down so we really didn’t flip, it was just with the market. That is because basically the promotional dollars being spent were so aggressively -- on 100 percent cotton T-shirts -- that sort of the 50/50 category was left off to the side a little bit.

As far as the other competitors in the market, we prefer not to discuss their situation and just to focus really on how we are increasing on market share.

Okay. In terms of the natural hedge, Laurence, that you mentioned, given that there is a time lag, if the dollar stays at where it is right now, does that jeopardize the 15 percent to 20 percent EPS growth that you guys would like to achieve in fiscal 2004?

No, we feel confident that whatever rate the dollar stabilizes at, if it remains flat at that level, from that base, we will achieve 15 percent EPS growth in 2004. This is just a timing thing that we are filtering through the system that we have, the temporary time lag while the dollar is declining very rapidly.

Okay. That is all for me. Thank you.

Our next question comes from Raena Schnapp of CIBC World Markets.

Hi, good morning. Given the demand trends, how much incremental capacity would you have liked to have today, i.e. what do you think you could have done if you weren’t constrained by capacity?

Well right now, our original forecast has been increased during the quarter. We’ve oversold ourselves so far in both Q1 and Q2 in terms of dozens. Basically, that is very hard to quantify because when there are a lot of fill rates that take place in the marketplace, so if we are not filling in our distributors with specific SKUs, we lose sales within the market, so it is hard to measure how much we could have done.

We definitely could have achieved more sales within the quarter, even in the quarter we just passed, we feel we lost opportunity of not having enough inventory. We are still going to be quite satisfied with our goals, because we are still going to be exceeding our shipments from last year and having quite good unit growth. But it is hard to measure what the loss is, but there is definitely an impact. I can’t give you a specific answer.

Okay. Thanks.

Our next question comes from Stephen Kitsy of Simcor.

Hello, gentlemen. I just want to have a little bit better idea on the exchange rate and the impact on the earnings. If we had another further fall in the U.S. dollar, say another 5 percent in the next two months or so, and it hit $1.31, would we be looking closer to earnings of about 260 for the year?

We are looking, it could be maybe not as low as that, but below the 270 level unless there were favourable factors offsetting a further decline in the exchange rate. We are just looking at that factor as stand alone, it would take us below the low end of the guidance rate if it happened rapidly.

But that is just based on the inventories.

And this is a timing factor, because of the fact that this will hit our sales faster than it will hit our cost of sales and not allow us, on a temporary basis, to take advantage of our natural hedge.

Okay. Thank you.

(Operator instructions) We will take a follow up from Claude Proulx of BMO Nesbitt Burns.

Thank you. Was there any impact from the war in Iraq, like we saw for instance after 9/11, or during the Gulf War?

I don’t think that there was an impact one way or the other, to be honest with you. Again, it is hard to measure what the impact is. It wasn’t anywhere -- like September 11th, it was a phenomenon, you know, and we really felt the demand because of it. In this case we really didn’t feel anything, to be honest with you. The market is strong, so whatever reason is driving that market is very hard to evaluate.

Okay, thank you.

(Operator instructions) Gentlemen, it appears there are no further questions at this time. I will turn the conference back over to you for any additional or closing remarks.

We would just like to close by thanking everyone for attending. We would like to wish everyone a good summer and we will see you at our next call. Thank you very much.

That does conclude today’s conference. We would like to thank you all for your participation, and have a great day.