Gildan Activewear Inc (GIL) 2004 Q2 法說會逐字稿

Welcome to Gildan Activewear's second quarter results conference call. As a reminder, today's call is being recorded. Our speakers today are President and co-Chief Executive Officer, Mr. Glenn Chamandy, and Executive Vice President and Chief Financial Officer, Mr. Laurence Sellyn.

Before turning the call over to 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 may 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. Securities and Exchange Commission 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. Glenn Chamandy.

Good afternoon. This is Glenn Chamandy. Welcome to our second quarter conference call. Laurence will present the formal comments on our second quarter and our revised forecast for the full year, and then we will proceed directly to respond to your questions. For the question period, in addition to myself and Laurence, we also have with us for the first time on the call, Gregg Thomassin, who is our Executive Vice President and Corporate Controller. Gregg has become an important member of our senior management team over the last five years.

And without further ado, Laurence will now start with the presentation.

Good afternoon. I will start by reviewing our second quarter results and the factors impacting our financial performance for the quarter, and then discuss our outlook and guidance for the balance of the fiscal year.

Our EPS was a record for the second quarter of the fiscal year. Before the adjustments resulting from upward revaluation of opening inventories and fixed assets due to the change to U.S. functional currency, EPS was U.S. 53 cents per share, up 17.8 percent from our strong second quarter EPS of 45 cents per share a year ago. The functional currency adjustments totaled 5 cents U.S. in the quarter, of which 3.5 cents related to the upward revaluation of opening inventories at the beginning of the fiscal year, with the balance being due to higher depreciation as a result of a revaluation of opening fixed assets. The opening inventories have now been fully consumed in cost of sales.

The increase in EPS compared to last year was due to three factors -- significant growth in unit sales volumes; manufacturing efficiencies from the continuing ramp up of (indiscernible) Nancy, which accounted for 60 percent of our overall production in the quarter compared to 35 percent in the second quarter a year ago; and more favorable product mix. These positive factors were partially offset by the impact of lower selling prices and higher cotton costs, as well as increased SG&A expenses, although SG&A declined as a percentage of sales, and higher depreciation as a result of our continuing capital expenditure program.

Relative to our expectations for the quarter, as opposed to comparing with last year's results, our growth in EPS was in line. Unit sales volumes were higher than anticipated, and, together with additional manufacturing efficiencies and more favorable product mix, offset the impact of significantly higher promotional pricing activity. Promotional pricing included additional discounts resulting from the higher than projected unit sales growth. Pricing in the Canadian market was significantly impacted by the lower price of U.S. import competition due to the reduction in the relative value of the U.S. dollar.

Unit sales volumes were up 24.6 percent in the quarter compared with the second quarter of last year. This strong growth reflected continuing market share penetration across all segments of our target markets, combined with a strong recovery in overall industry growth and market demand. As indicated in our press release, the S.T.A.R.S. market statistics for sales by distributors to screen printers no longer include data for our largest distributor, with effect from January 1, 2004. Industry data for the March quarter of 2003 has been restated on a comparable basis, and shows that in all categories market demand has been strong. Gildan's growth has significantly exceeded the overall market growth due to our continuing market share penetration.

In the T-shirt category, the overall market grew by 11.6 percent and Gildan's unit shipments grew by 38.3 percent. In the sport shirt category we were pleased to see positive overall market growth of 1.1 percent due to a rebound in corporate promotional spending after approximately three years of successive declines. Gildan's shipments in this category increased by 34.7 percent. Industry growth in fleece was 13.8 percent, although the March quarter is a seasonally low quarter in the fleece category, and Gildan's shipments of fleece through the S.T.A.R.S. distributors grew by 39.2 percent.

Our shipments to our largest distributor grew at a comparable rate to our high rate of growth with the S.T.A.R.S. distributors. In terms of market share, our share in the T-shirt segment increased from 29.1 percent to the March quarter last year, including our largest distributor, to 31.2 percent this quarter without this distributor. In sport shirts our market share increased from 18.4 percent to 24.4 percent, and we became the number one brand in this category. Our share of the fleece category grew from 10.7 percent to 14.3 percent. We also achieved strong growth in Europe, where our unit shipments increased by 38.9 percent over the second quarter last year and our unit shipments in Canada increased by 10.2 percent.

Gross margins were 27.3 percent before the impact of the change in functional currency, compared with 29.6 percent in the second quarter of fiscal 2003. The negative effect of higher cotton costs and lower industry selling prices more than offset the positive gross margin impact of more favorable product mix, continuing manufacturing efficiencies and the non-recurrence of the prior year's special charge for the closure of our Montreal sewing plant.

Due to our higher than projected sales in the second quarter and resulting lower than anticipated quarter-end inventory, we expect to be capacity constrained in the third quarter. Therefore, achievement of our original EPS guidance for the full fiscal year will depend upon more favorable industry pricing.

Industry fundamentals, and we specifically mentioned the strong growth in overall industry demand, the reasonable balance of inventories within the distributor channel, and higher raw material costs for both cotton and polyester appear to support higher pricing in the second half of the year. We are projecting some gross margin improvement due to reduced promotional activity and the higher proportion of fleece in the balance of the year.

However, based on the continuation of aggressive industry price competition, together with our short-term capacity limitations in the third quarter, we believe that it is more realistic to revise our full year EPS guidance from U.S. 2.25 to 2.30 per share before the functional currency adjustments, to a range of U.S. $2.05 cents to 2.15 per share, which is still up by approximately 15 to 20 percent compared with fiscal 2003. The impact of the functional currency adjustments will be minor in the second half of the year, as they will be limited to the depreciation impact.

Before adjustments, EPS is now projected to be 80 to 85 cents U.S. in the third quarter, up approximately 10 to 16 percent from the third quarter last year, which included an extra week. In the fourth quarter, while we expect to be in a better capacity position, we now expect EPS of U.S. 55 to 60 cents before functional currency adjustments, up approximately 15 to 25 cents -- up approximately 15 to 25 percent from fiscal 2003.

In summary, we are currently forecasting full year sales units of approximately 26.5 million dozens, versus our original budget of 26 million, and up approximately 17.25 percent from sales of 22.6 million dozens last year. As the industry goes through the current phase of intense price competition, we continue to drive market share penetration in all segments of the market and to achieve EPS growth in excess of our objective of minimum 15 percent.

As we bring our new facility in the Dominican Republic on stream, we expect to be well-positioned to continue to achieve our objective of minimum 15 percent annual earnings growth in fiscal 2005. The construction of this facility is running ahead of schedule and we expect to have in excess of 5 million dozens of production available in fiscal 2005, as well as achieve further manufacturing cost reductions as a result of continuing to implement our offshore manufacturing expansion plan. We will also be taking advantage of our added capacity and low-cost structure to proceed with our plans to enter the retail channel in fiscal 2005.

The Company used cash in the second quarter for seasonal financing of trade receivables, which reflected days sales outstanding of 45 days, and to finance the capital expenditures for our major projects in Honduras, Flash (ph) Nicaragua, and the Dominican Republic and Haiti. Due to the accelerated schedule for the Dominican Republic facility, we are now projecting full year capital expenditures of approximately $65 million U.S., primarily for the above projects and also to begin the further expansion of our North Carolina distribution center to accommodate our forecasted sales growth.

We ended the second quarter with surplus cash of $21.4 million U.S., and intend to use this cash to satisfy our first scheduled repayment of our senior notes in June in the amount of U.S. $17.5 million. After meeting this debt repayment and our capital expenditure requirements, we expect to end the fiscal year with surplus cash of approximately $55 million U.S. and significant unutilized debt capacity in order to be able to take advantage of any strategic growth opportunities that may arise.

And now we will be happy to take questions.

(OPERATOR INSTRUCTIONS). Dennis Rosenberg, Credit Suisse First Boston.

Could you tell us what's driving the increased promotions, given the strength of the market, the good inventory position in the market and the fact that everyone is suffering from higher raw material costs?

The main factor is intense price competition from Fruit of the Loom.

What do you think is the reason for that?

I think you should pursue that line of questioning with them, Dennis; it's not appropriate for us to speculate on what their strategy and objectives are.

So why would you expect that to abate in the second half?

We don't plan for it to dissipate in the second half; we basically have less inventory to supply the market in our third quarter, and we forecasted basically the pricing analogy based on the amount of inventory we have to sell in the marketplace.

So what you are saying is you would sell above market because you are in a tight inventory position?

That is correct.

What do your customers think of that?

Our customers basically -- first of all, we're still within the market pricing amongst other peers in our industry. The rationalization in terms of Fruit's pricing is they're basically the only one of our competitors actually pricing at irrational type prices. The rest of the industry is pretty well in line together.

Is their pricing below the rest of you guys?

They're pricing below the rest of the industry, that is correct.

So if you're not meeting their prices and the rest of the industry is not meeting their prices, where is the price pressure?

The price pressure has been from them. There's a fine line between what price we can sell our products for and how much promotional activity we need to keep our momentum going and our market share, and that is the line that we are constantly monitoring and managing our bottom-line.

In the context of the overall supply dynamics as we see them for the balance of the year, we think the promotional and discount level that we have forecasted is realistic; it still continues to be at a historically high level.

But just to note that as we enter into the fourth quarter when our inventory comes back on line, we've also made projections that we're going to start to be more aggressive on pricing to maintain our share in the market, based on the inventory we have coming on line.

The inventory at the end of the quarter of 130 million, up about a third from the same quarter last year, and your sales growth is in the 20s. So why do you characterize that as being light on inventory?

First of all, part of that inventory is in terms of the cost of goods sold because the valued inventory is at a higher value because of raw materials, and also the quality of that inventory as we sell more added value products like fleece, golf shirts, etc. So part of that is in the actual dollar value of the per dozen mix within our inventory. Secondly, we have allocated more inventory on other markets in which we are pursuing now. Like Europe; we've increased significantly the amount of inventory on that market, as well as we increased and brought inventory into the Australian market. So basically, we have allocated more inventory in those areas, as well as we have increased the amount of SKUs in the Company this year by 600 SKUs from -- which is we went from 1700 to about 2400 SKUs. And we need the inventory to support all those additional SKUs, and those additional SKUs are also higher margin better SKUs for us.

Also, Dennis, if you're relating opening inventories to the anticipated sales during the upcoming quarter, you should remember that in the corresponding quarter of last year we had an extra week of sales.

Could you give us the sales estimates for the third and fourth quarters to support the earnings estimates?

Let's say for sales for the third quarter we're looking at in the order of $165 million, and in the fourth quarter in the order of $140 million.

(OPERATOR INSTRUCTIONS). Andrea McReynolds, Sprott Securities.

What is your capacity at right now? What were you running at in the quarter?

What we're going to end up for this fiscal year is producing around 27.5 million dozens, and by the end of September we will be roughly around 29 million dozens on annual run rate. And we're currently around just under the 28 million dozen level today. We're building up to about 29 million on an annualized basis by September 30, but 27.5 will be our actual production for the fiscal year.

And you said that was up from an original budget of 26?

Our sales forecast for the year was for 26, and our actual shipments based on our revised forecast will be 26.5 million.

Okay. I'm a little confused. It looks to me that you're actually -- you've increased capacity I think you said faster than expected; it looks to me that this is fully a pricing issue, that the 5 percent increase is just not coming through as you had expected. And that if your capacity -- I'm just confused about the capacity constraint in Q3. Are you actually having lower capacity than what he thought you would have had in Q3?

No (indiscernible) two questions. Your first part of your question is basically -- we definitely did not -- be able to keep our price increase; that money also (indiscernible) into lower prices through promotional activity. And the second part of your question is -- we exceeded the first two forecasts. For Q1 we exceeded our plan by about 2, 300,000 dozens, and Q2 we exceeded it by 600,000. So we significantly exceeded the amount of dozens shipped in our first two quarters which has reduced the amount of inventory we have available for Q3. And as Q4 comes in we'll be actually having more inventory coming online to support the sales for that quarter.

So you basically just pulled through (technical difficulty)

And the extra volume offset the lower selling prices.

Claude Proulx, BMO Nesbitt Burns.

First question is just to clarify. Your pricing assumption for the second half of the year -- you're assuming the pricing will remain stable relative to where it is today?

We are assuming no increase in list selling prices, but a slight reduction in the level of promotional discount.

The price -- I think the -- from what I hear I think the irrational pricing is mainly in one category; I think it's in T-shirt, and I think more specifically it's like 100 percent cotton white T-shirts. Is that true?

The irrational pricing that is in the T-shirt category, I would say in all three categories -- which is 50-50, white premium quality, and the lower-end quality cotton shirts, as well as it's in colors as well from other manufacturers. It's all across the board.

The Dominican Republic -- when is it going to start producing the first dozen? When is it going to become available?

The plant is going to start production in October of 2004.

And if I look at next year, we should probably be assuming that you'll be producing more than we had initially assumed. Like -- I think -- I don't know; I don't remember seeing numbers like 28.5 million dozen produced (inaudible)

We're going to start the year producing an annual run rate around 29 million dozen and we will finish the year in the neighborhood of 34 million dozens, for an actual production just over 32 million, which will probably be our actual production for fiscal 2005.

But can we assume that you can sell 32 million, or that would be much -- you need to rebuild inventories?

Part of this don't forget is going to be going into -- yes, a small part of this will be going into building inventory, but this will also help our retail initiative as well as help us to penetrate the existing wholesale market where we lost lots of sales this year. We create a lot more demand for our product than we've been able to supply. Even last quarter, we left orders on the table despite the huge success we had, and despite the fact that we worked the lowest priced white T-shirt in the market. So we feel that with this extra capacity we have the momentum right now to be able to sell more dozens in our existing market, capture more share, and also allocate a portion of this production to make our entree into the retail market.

But if we include retail and wholesale, can we assume that next year you could sell 31 or 31.5 million dozens?

We're going to provide guidance as we go forward into our next call.

Lastly, regarding the move that you've made to the Dominican Republic, and before that you went to Honduras; and we know that one of your competitors has already announced that they're going to build a plant in Honduras, or they are building a plant in Honduras -- are you aware if other competitors are doing the same thing or following your lead?

We haven't heard of any.

Martin Goulet, National Bank Financial.

Back to the inventories. Can you break down the 130 between raw material work in process and finished goods, to see where the biggest increase has been year-over-year?

I'm breaking down the 130 between raw materials, work in process and finished goods; right?

Yes.

6 percent is raw materials, 17 percent WIP, and 77 finished goods.

How would that compare with last year, Laurence?

With last year, raw materials was about 9, say 10 percent, 13 percent work in process and 77 finished goods.

Okay. Regarding your inventories at wholesale, is there also -- is that really where the problem is, given you say your capacity constraint is -- how are your inventory levels at wholesale as we speak?

Overall inventories in the channel are in balance and our inventories are in line with the overall industry and with our market share position.

Okay. But still you feel that there's some constraint because you're -- but how much sales have you the left on the table, as, Glenn, you mentioned?

We left at least from last quarter I would say about 500,000 dozens on the table.

Okay. Can you break down the fluctuation in gross margin and with our cotton costs, so on and so forth?

Sure, yes. Before the functional currency adjustment, margins were down from last year by about 2 percent. And the big items were that the impact of higher cotton costs and lower selling prices each impacted margins by about 4.5 percent for that line in total, and more favorable manufacturing efficiencies and more favorable product mix were each about 3.5 percent for a total of 7. So 9 minus 7 gets you your differential of two.

Okay. You have made some initial sales to Australia, if I'm correct, this quarter. Can you comment on that?

We sold about $1 million U.S. into Australia (indiscernible) in our first quarter in that market.

(OPERATOR INSTRUCTIONS). Cynthia Rose-Martel, Jennings Capital.

Just two questions. Just overall on the pricing, how much was it down quarter-to-quarter? I'm not asking by product but just in general, the overall basket of goods?

I would say the overall price was down on roughly 5 percent.

So about the same as it was in the first quarter year to year?

Right.

Vis-à-vis the Dominican facilities you were planning to build two sewing facilities in Haiti; are you still planning to do that?

We have one sewing facility that's up and running today, and we're in the process of evaluating our second facility.

Al Elena (ph), Seneca Capital.

I was wondering why did the distributor stop contributing to the S.T.A.R.S. report? And I'm also what impact positive or negative will that have on your business?

First of all we can't respond to that because we would have to ask that particular distributor. And as far as the impact on our business, the information that we use from S.T.A.R.S. provides us with information on different products and colors and sizes, and helps us understand the dynamics of our industry. The sample just got smaller; we still provide the same exact same information.

I'm just wondering if it would enable people with less transparency, less information at both your customer level as well as the manufacturing competitors -- with less information than pricing, will that help you boost pricing?

I don't think there's a correlation between the S.T.A.R.S. and pricing. I think that the information will definitely be not as good with having less people supplying the data. However, it's still used as a sample and gives us trends within the industry. And I think we still can get that information out of S.T.A.R.S. As far as pricing is concerned, that is really relevant I think of the situation in the informations being provided.

As far as your business in terms of going into the retail channel, when you talk about retail are you talking about going around your wholesale distributors to their customer, or is this retail, meaning like a Wal-Mart or something like that?

This is retail with a Wal-Mart, and it's a different channel that's not conflicting with their existing marketplace.

Would you ever compete and try and go around your wholesalers to go sell direct to their customers, or are you committed to staying with that, the way you distribute your product to the wholesale channel as is.

We do sell large screen printers to a selective group of customers. But most often all of our sales are through our existing network of wholesalers.

As far as the sport shirt market, it sounds like there has been a three-year decline that you're saying is probably bottomed out. Are you seeing continued improved demand in this current quarter? Do you expect an upturn in that business with a stronger economy in the U.S.?

It's too early for us to be able to comment on that.

We're projecting it to be still flat for -- flat to slightly down, and that's what's built into our projections.

Okay. Thank you.

Ron Schwartz, CIBC World Markets.

Thank you. Laurence, I'm just trying to do the math on the, I guess the capacity in volumes delivered. And if I strip out what you would have sold would say in the first two quarters, they would have come out of inventory, call it 900,000 dozen. And then you kind of take a look at second half math to get to the 26.5 half million dozen, it looks like we're talking ten-ish maybe 12 percent volume growth in the second half of the year. But stripping out that inventory in the first half, volumes would have been up about 15 percent. So I'm just trying to get a handle as capacity is continuing to ramp up quarter-to-quarter, it would appear like the math is showing the capacity might actually be coming down. Am I doing something wrong here? I'm just trying to understand the shift?

I think I probably better try and follow you through your calculation separately, Ron. Certainly our capacity is not coming down, it's increasing. But I would have to work through the mechanics (technical difficulty) with you and see where it's going wrong.

And the other question is, on the 65 million in CapEx, I think it was always planned that H2 '04 would be the big quarters for the big ramp up in spending, right? So nothing's more or less changed there?

Nothing's more or less changed there, no.

Do you see anything else transpiring, I guess on the overall industry front. You have a competitor out there that's not even meeting interest costs with cash flow. They are obviously getting crushed in this environment as well. At some point, do you think someone has got to start blinking and the rest of the industry kind of holds up against Fruit here?

I think the reality for us is that we can't speak for our competitors and their financial situation right now. But I think what's important is that despite the fact that there's such aggressive pricing in the marketplace, we are still able to increase our market share, have sufficient returns based on our performance. And we think that ultimately what will end up happening is that we're going to have rationalization within the marketplace. And we feel comfortable even at today's pricing levels. We can have sufficient returns and maintain the 15 percent EPS growth year after year. And as we bring on our Dominican Republic facility, that will allow us even to lower our costs, which will in turn lower our prices and continue to drive our market share and rationalize the market as we go forward. And I think that's really how we positioned ourselves, and we can't really speak for anybody else.

Last question. Has anything changed on the hedging front for cotton? Have you started doing anything for fiscal '05 yet?

Like we said earlier, we've covered all of our fiscal 2004. And for strategic reasons we don't feel comfortable at this point in time talking about our strategy for 2005.

(OPERATOR INSTRUCTIONS). Ethan Schwartz, CRT Capital Group.

A couple of questions. First, can you review the capacity additions in the hemisphere generally? You'll be up, I guess (indiscernible) it looks like 5 million dozens next year. Can you sort of give us a sense of what Russell is doing, what Fruit and Hanes are doing, and anything else you know about?

I don't think we can respond based on what they're doing because they've got a lot of facilities and plants, and I think you have to ask them that question. As far as we're concerned, we're going to continue to add our capacity based on what we think is the ability for us to sell that capacity, obviously. And we're not adding capacity and later not be able to sell. So we're focusing on our own market shares and the opportunities that we have based on the demand for our products, and again, focusing also on entering the retail category where we think there is a significant opportunity for us going forward.

On your manufacturing posture, once your Dominican plant is up and running, where will most of your knitting be concentrated? Is it going to be in Canada or in the region? And the sort of related question to that is, can you talk a little bit about how well you can compete with -- I guess I'm trying to figure out whether the U.S., Caribbean and Central American tariff preferences for U.S. yarn and U.S. fabric forward represent a significant disadvantage to knitting in the region, or whether all in, including transport cost and labor, knitting in the region is still significantly cheaper than North America yarn or North American fabric.

As far as our plan over the next three to five years, we basically by fiscal 2005 all of our basic T-shirts will be produced offshore, which, we believe, in the lowest possible cost structure available, not only in our hemisphere but globally. We think that we have a strategic cost advantage against any of our global competition, based on the way we're setting up our manufacturing. As far as our Canadian textile is concerned, we have been reducing our kilos or our pounds of fabric, let's say for example, being produced, and focusing on more added value specialty products in Canada where we are not under any severe margin pressure. And those quantities have reduced the amount of dozens output in our Canadian facilities significantly over the last 24 months.

Can you quantify the cost advantage a little bit? In other words, if I compare your producing fabric in region as opposed to one of your United States competitors using U.S. yarn and U.S. knitting forward to get the tariff advantage, what is the value and what is the tariff advantage that they have? And what do you see as the cost advantage that you have by being in the region, labor lower and transport cost?

I don't think we want to talk about our cost differential versus our U.S. competitors, but we can -- what we have said is that our offshore manufacturing model has about 1/3 lower conversion costs than our manufacturing in Canada.

And that's all in, labor, transport, everything I assume?

Correct.

Andrea McReynolds, Sprott Securities.

Can you just talk about the gross margin decline sequentially from Q1, and how much of that came from increased price discounting?

You know what? I have not analyzed that sequentially. I would like to get back to you on that question, Andrea.

Sure. Just a follow-up on Fruit's pricing. Glenn, you said that they were below the rest of the industry; can you give on average a sort of percentage how much below they're coming in at?

It's hard to tell exactly because of the different deals that they might have structured within the marketplace. But basically the rest of the industry raised prices on January 1; Fruit never raised their prices. So I would say minimum 5 percent lower, I would say.

Laurence, I had a similar question to you on the math that Ron did with the volume, so if we can talk about that later, too.

Sure.

(OPERATOR INSTRUCTIONS). Gentlemen, there appear to be no further questions. I'll hand the conference back to management.

Thank you very much, and thank you for attending our conference call, and looking forward to our third quarter. Thank you.

That does conclude our conference. Again, thank you for your participation. Everyone have a great day. You may now disconnect.