Gildan Activewear Inc (GIL) 2005 Q4 法說會逐字稿

Good day, everyone, and welcome to today's Gildan Activewear fourth-quarter 2005 results conference call. As a reminder, this call is being recorded. Our speakers today are President and Chief Executive Officer, Mr. Glenn Chamandy, and Executive Vice President of Finance and Chief Financial Officer, Mr. Laurence Sellyn.

Before turning the meeting 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 unknown and known 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 filing with the U.S. Securities and Exchange Commission and Canadian Securities regulatory authorities that may affect the Company's future results.

I would now like to turn the call over to Mr. Glenn Chamandy. Please go ahead, sir.

Thank you. Good morning and welcome to our fourth-quarter conference call. Our fourth-quarter results released this morning continue our trend of strong sales and EPS growth. Before Laurence reviews our fourth-quarter and fiscal 2005 performance, I will make a few remarks about our positioning and outlook for 2006.

We have previously initiated EPS guidance for next year at approximately U.S. $1.85 per share, which represents an increase of approximately 20% over U.S. $1.55 per share in fiscal 2005. This guidance is based on two key assumptions. One, that our U.S. sales volume will increase by approximately 20%, and secondly, that our selling prices will decline by approximately 1.5% year-over-year in fiscal 2006. An industry price increase of approximately 3% was implemented in the first quarter of fiscal 2006. However, there continues to be significant promotional activity off a higher selling price, and it is difficult at this time to evaluate the pricing outlook for the balance of the year. Our unit sales growth will be a function of our production capacity. Our incremental capacity in fiscal 2006 will support our continuing market share penetration in the wholesale screen print market, where the Gildan brand continues to have strong momentum, as well as increase our retail sales to 1.5 million dozens next year, and our continuing international expansion, including approximately 500,000 dozens, which we plan to sell in the Mexican market.

Our sales of activewear and underwear in fiscal 2006 will be directed -- sorry our retail sales of underwear and activewear will be directed to regional retail chains, which fit better with our capacity expansion program, and this will pave the way for selling to major mass-market retailers in the future. We continue to be very excited about the opportunity for Gildan's entree into the stock market and to pursue our objective of building a leadership position in this industry. We are evaluating opportunities to accelerate our penetration of this market and to capitalize on our new state-of-the-art facility coming onstream.

Our sock facility and all of our major capacity expansion projects are progressing on schedule. The building for our Rio Nance sock facility will be complete by March and we expect to begin production in our third quarter of fiscal third quarter. Construction of our Rio Nance activewear facility is scheduled to be complete during the third quarter and begin production in our first quarter of 2007. The ramp-up of the Dominican Republic facility and the development of our country management team are progressing on schedule and we continue to expect overall end-year production of approximately 40 million dozens for fiscal 2006, and increasing to 50 million dozens for fiscal 2007.

And With that, Laurence will now present our fourth quarter and fiscal 2005 financial performance.

Good morning. This morning, we reported diluted EPS for our fourth quarter of $0.48 U.S. per share. Excluding a $0.01 per share gain from the sale of Canadian yarn spinning equipment, EPS for the fourth quarter is $0.47 per share, up by 42.4% from the fourth quarter last year, before last year's charge for the departure of Greg Chamandy. Our most recent guidance had assumed EPS of $0.42 U.S. for the fourth quarter. Compared with our guidance, the higher EPS in the quarter was due to continuing more favorable selling prices and product mix, partially offset by non-recurring items, which negatively impacted both gross margins and SG&A expenses, of which I will give more details later.

Compared with the fourth quarter last year, the growth in EPS was primarily due to continuing strong growth in unit sales volumes and lower costs of cotton, partially offset by higher selling, general and administrative expenses, including the non-recurring items, and slightly reduced selling prices from last year. Pricing was sequentially up a percent higher in the fourth quarter than the third quarter, but approximately half a percent lower than the fourth quarter of fiscal 2004.

Sales in the quarter, at 180.7 million U.S., were up 24.1% from the fourth quarter last year, due to a 25.2% increase in unit volume shipments. The growth in unit volumes primarily reflected continuing strong year-over-year market share penetration in all product categories in the U.S. wholesale distributor channel, together with unit sales increases in all our other geographical markets.

Gross margins were 32.3% compared with 30.9% in the fourth quarter of last year. The increase in margins was primarily due to lower cotton costs, partially offset by the slightly lower selling prices. Manufacturing costs were comparable to last year as ongoing efficiencies and non-recurrence of the prior-year charge for the closure of the El Progreso sewing plant were offset by higher energy and transportation costs, start-up inefficiencies for the Dominican Republic facility, and an increase in reserves for statutory benefits for our Honduran employees.

As we said, the positive EPS impact in the quarter of higher unit sales and higher gross margins was partially offset by increased SG&A expenses. Excluding the charge in the fourth quarter last year in relation to the departure of Greg Chamandy, SG&A expenses increased by 31.7% over the fourth quarter last year. The increase in SG&A expenses was due to severances, an adjustment to the reserve for doubtful accounts, to fully provide for potential exposures to two of our smaller distributors, higher distribution expenses and impact of the stronger Canadian dollar.

With our strong fourth-quarter results, we ended the 2005 fiscal year with EPS of $1.55 per share U.S. before the yarn spinning charge on 654 million U.S. of sales.

EPS was $0.05 higher than our most recent full-year guidance and up 38.4% from fiscal 2004 before the charge last year for Greg Chamandy's contract and the functional currency impact in cost of sales due to revaluation of opening inventories. Also with the $0.01 gain in the fourth quarter, the full-year special charge for the closure and relocation of the Canadian yarn spinning operations is reduced from $0.13 U.S. per share to $0.12 per share. As Glenn said, we have left our recently initiated fiscal 2006 guidance unchanged at this time, at U.S. $1.85 per share, up 19.4% for this year, with potential further upside to be better evaluated as we get clearer visibility on whether current more favorable than anticipated pricing will continue. We are comfortable in projecting a strong first quarter for the new fiscal year, with EPS at least 64% higher than the first quarter of fiscal 2005.

We generated 30.8 million of free cash flow in the fourth quarter, and free cash flow was 9.4 million U.S. for the full 2005 fiscal year. Free cash flow was after $86.1 million of capital expenditures for the year, including 100% of the joint venture investment of approximately 10 million during the year in our new spinning facility in Clarkton, North Carolina. We ended the year with cash and cash equivalents of 69.8 million U.S.

We expect to finance our previously announced capital expenditure program of approximately 105 million U.S. for fiscal 2005 out of our internally generated cash flow from operations and to continue to maintain a strong balance sheet with considerable financing flexibility.

And that concludes our comments and we are ready to take questions.

(Operator Instructions). Dennis Rosenberg, DSR Consulting.

Good morning and congratulations on another great performance.

Dennis, you're a little fainter than usual.

Good morning. Congratulations on another great performance. In the first-quarter guidance, you said that pricing so far is better than what you were budgeting. How much better budgeting is that pricing right now?

In our $0.23 guidance we've given for the first quarter, we include about $0.01 impact of more favorable than anticipated pricing because we had budgeted price decreases in the quarter and that's why we are saying that we expect our actual results to be at least $0.23. There is further upside from pricing that will potentially impact our first-quarter results.

Okay, so the $0.23 includes $0.01 --?

Includes about $0.01, but there is potential further upside, which is why we are saying at least $0.23.

And could you talk about the retell ramp-up beyond '06? I know what your 2010 projections are, but how does that progress in '07, and do you start hitting the mass merchants in '07?

Well, we're going to be hitting mass merchants actually in '06, I mean just more regional changes, not necessarily the Wal-Mart and Target, for example. And for next fiscal year, we're projecting to increase our retell shipments by to up to 3 million dozens in the underwear and activewear category, not excluding socks. And really going into 2000 -- towards 2007, end of 2007 into 2008, we believe we will able to penetrate by that time, the major, larger, mass-market retailers.

Okay. And you made a comment that you're looking at opportunities to accelerate penetration of retail. What specifically do you mean there?

Well, we're looking at, potentially, as we bring on this capacity online, we believe that there's a large opportunity in the sock industry, A, because it's highly fragmented, so there's more room for entry into the mass market we believe in a quicker amount of time because of the nature of the marketplace. And also, we're evaluating potential opportunities within the existing companies that are participating in the industry today.

You mean in terms of acquisitions?

Yes.

Okay, thank you.

Claude Proulx, BMO Nesbitt Burns.

Thank you, good morning. First question, you talk about some nonrecurring event in the quarter. I mean are those items included in the EPS that you're showing, the 1.55? And you talk about severance. You talk about taking additional provision for doubtful accounts with two smaller distributors and I think also your un-U.S. employees. Are those really -- can you expand on that and product price especially?

Okay, these items negatively in total impacted our EPS in the quarter by about $0.06. So the $0.47 without these items would have been $0.53 and the $1.55 would have been $1.60. And what the items are, as far as the Honduran adjustment, we have a provision for accumulated post-employment benefits in Honduras, which we have extended to include employees who are not strictly required to receive these benefits under Honduran labor laws. So we've increased our accumulated provision. This will not have a meaningful impact in ongoing cost structure. It's a onetime adjustment. We have had some -- we made an adjustment to our bad debt reserve, which fully covers potential exposure to two smaller distributors that are experiencing financial difficulties. You know, we are optimistic that they will work their way through these issues but we have conservatively provided for any potential exposure to the Company. And then we have also reflected some severance costs in the quarter.

Okay. And that's for people at your office, people in the plants, in Canada or --?

This is all is related to the corporate office.

Okay, corporate office. Okay, second question, you just mentioned you opened the door to a potential acquisition. From a size standpoint, when we look at your cash flow, could it have a significant impact, or you are looking more at a small strategic move?

Anything along the lines that Glenn was referring to in the sock industry would be easily accommodated within our bank lines and our current cash position at the end of the year.

Yes, but you have like almost 70 million of cash and --

Yes. So the 70 million would be enough to cover anything that we would be contemplating.

Okay, thank you.

Ron Schwarz, CIBC.

Thank you. You guys mentioned that capacity is coming along as planned and 20% unit growth this year, yet we end production at about 40 million at the end of '06, 50 million in '07. It looks like if we ramp through 20% type of volume growth in 2007, you would have kind of an inventory cushion of maybe 3, 3.5 million dozen; that would be higher than you normally had. Could that mean -- could fiscal '07 -- I guess the question is, could fiscal '07 be the year that you finally kind of get ahead of the curve a little bit in terms of incremental capacity versus always being running full out?

We're going to actually bring up our inventories a little bit this year. I mean our projection of 40 million dozens is actually what we're going to produce within the fiscal year, and our sales of 20% increase will be between 37.5 to 38 million, so we're going to add some inventory. And a lot of that extra capacity as we ramp up is coming towards the end of the season, and a lot of it is actually going in to build inventory for some of our retail products, as well as to bring up the inventory levels of our activewear garments. If you look at our inventory at the end of September, it was relatively lower in this fiscal year, so we would like to have a little bit more inventory. And we will able to accomplish that in 2006. And truthfully, as we ramp up our capacity now in 2007, we believe we are going to work hard potentially in additional sales growth to try and capitalize on all this capacity coming on. And that's really where the opportunity will start kicking in in terms of potential sales growth.

Okay. So technically, theoretically, you would still be running at all out capacity for the next two years, given the business plan?

Correct.

Okay. And then just second question also on the acquisition, you are going to have a state-of-the-art facility down in Honduras. Would the acquisition just be really more along the lines of buying a customer list and the proper selling infrastructure? And if that's the case, could you not leverage the infrastructure you have now, that's destined for retail anyways?

Well, the combination of both, I would say. We have got a capacity coming on in this facility, which is 20 million dozens. If we can accelerate its ramp-up, then that would be the main reason for the acquisition, is to accelerate our buildup into the industry and start soliciting the major mass-market retailers the minute that we would acquire a company that already has the distribution in place. So we combine the distribution with our low-cost model that we're setting up in Honduras, we believe that that will be a win-win situation and accelerate our overall retail opportunity.

And just sorry for the last question, just following that, but if you are buying capacity, would this be other offshore capacity as well, or would the --?

We're buying the distribution basically and that's (multiple speakers)

Okay, that's perfect. Thank you.

Jessy Hayem, Desjardins Securities.

Thank you. Just wondering if you guys can give us an update on I guess the Dominican Republic. I think you had alluded to (indiscernible) capacity at the time of about 8 million this year in fiscal '06. Is this where you ended up? And maybe going forward, if you can just break down the different facilities, where you expect them to be in terms of capacity at the end of '06. I probably missed some of the comments you made, Glenn, at the beginning, so I apologize on that.

No problem. What we said is that we are going to produce end year this year 40 million dozens and we're going to produce next year 50 million dozens. We'd rather not break it down by plant because right now we're in the process of changing products and mix, and that changes the amount of dozens in each one of the facilities. So what we're saying is that we produced -- we will produce this year in-house 40 million dozens with the DR and Honduras and reduction in our Canadian textile facilities. That's basically the general plan for this year, and for next year, 50 million.

Okay, and I guess that leads me to my next question in the fact that you are maybe (technical difficulty) more flexibility in each of the plants to produce different products. Is the strategy going forward still the push into retail? Or are you giving yourself flexibility and maybe as you've heard, some of your large accounts aligning themselves with some key suppliers as yourselves, maybe to be able to penetrate even more the wholesale distributors? And I'm just trying to get a sense I guess of the strategic priorities going forward.

Our priority always has been is to maintain our market share and penetrate as much market share as we possibly can in the wholesale market. And we never took our site off the ball. That's why we're taking our time in developing our retail strategy because we have so much momentum and opportunity in wholesale right now, it's utilizing a large quantity of our capacity that's coming online. And at the same time, it's giving us the ability to start off with the more regional retailers in retail to build our brand and our platform and then eventually as we continue to go to the 50 million level, we will have sufficient capacity to what we believe bring our market share up in the wholesale market to the 50% share that we're looking to obtain over the course of the next couple years, and as well, make a significant penetration in retail.

Right, okay, thank you, that makes sense. And just finally, Laurence, if you could on the gross margin components that you usually break down in terms of the positives and negatives or the pluses and minuses?

Sure. So our margins improved from 30.9% to 32.2%. The benefit of lowered cotton costs was let's say just under a 2% positive impact to gross margins and the negative impact of lower selling prices was about 0.5%. And as we said, manufacturing efficiencies zeroed, netted out to zero. Ongoing operating efficiencies positively impacted gross margins by about 1.5%, plus we also had another 1% favorable impact from the non-recurrence of the prior-year charge for the El Progreso closure. So that was 2.5% total positive variances, which were offset by higher energy and transportation costs, the start-up efficiencies from DR, and the adjustment we made to the Honduran reserve for post-employment benefits.

Okay great. Thank you. That's it for me.

Thank you.

Philippe Habeichi, Genuity Capital.

Just back on the issue of gross margin, I wanted to know, so, on a year-over-year basis, how much lower were cotton costs in the quarter?

We don't give out specific information on our cotton costs. But you can kind of extrapolate from the fact that I'm saying that the positive benefit was close to 2% in gross margin, so you can do the math on that.

Sure. Second issue is just, could you give us an idea of what hedging looks like for '06?

We're pretty well fully hedged as far as our cotton costs for '06, which will be below our cotton costs for '05.

Okay, excellent. And then the last point was on the Mexican market expansion, I think that you were setting up a warehousing facility to be completed in January. I'm just wondering how that's coming along?

We signed up a full network of distributors. We have our distribution in place, and we have begun to sell product. And for next year, we will sell roughly about 500,000 dozens into the marketplace.

Okay, now is the number of distributors a sensitive issue or can I have a rough idea as to how many that is?

It's approximately four right now.

Okay, thank you very much.

Cynthia Rose, Jennings Capital.

Very nice quarter. Well done, as always. Just two picky questions. When you spoke of the ramp-up of the Rio Nance activewear, were you referring to the building complete in calendar or the fiscal quarter?

The building will be complete in our fiscal quarter, fiscal year 2006, and we will begin production in our first quarter of fiscal 2007.

Okay, thank you. And could you just give me the actual unit shipments for the year in the fourth quarter if you can?

The actual unit shipments in the fourth quarter were 8.7 million dozens.

Thank you very much.

Martin Goulet, National Bank Financial.

You alluded to some inefficiencies in the DR. Obviously, that's normal when you start up, but can you elaborate a little bit more if there were some unforeseen events there? And let's say that on a 1 to 10 scale, how would you qualify the progression in the DR?

Well, the progression in the DR is very similar to what occurred in our Honduras buildup. So we're online with our past experience. Right now, we're in the point where as we speak, those efficiencies basically have been eliminated and we're running on an original standard. And the efficiencies were primarily due to higher electricity costs because we had some delays in hooking up to our cogeneration facility. So that's delayed us a little bit, so we had higher utility costs and now that we are online, we're back on track.

Okay. Usually at the beginning of the year, you always entertain discussions with your key customers at wholesale. Are they more cautious regarding -- given the state of the economy, might be weaker in '06? Are they cautious, vis-a-vis corporate promotions, or event the tourism market? And how that translates into your approach to market?

Well, typically, we are somewhat I would say, not completely, but somewhat recession proof in the sense where a lot of our products are going to annualize type events, where little league, restaurants, runs, for example, hockey games. And also, when the economy is not performing, garments like T-shirts are somewhat disposable items and they are make-you-feel-good type products, so you might not go buy your car but you might want to go out and buy your printed T-shirt because somebody just won the football game or whatever, you're just on holiday.

So we feel that right now, there's still strong momentum. The market for last year was very strong, and we believe right now currently, it's still very strong. The months of October and November were both good months. We've only forecasted in our growth strategy for next year a 2% market share increase. In fact, that's what we've only forecasted in our overall five-year plan. So typically, anything above and beyond that growth could be upside in terms of the market. And that's 2% market growth, not market share. So anyways, we feel very comfortable. But that's our feeling right now. The other thing I think is that we have got pretty good momentum right now, and we feel very comfortable with at least our forecast going forward.

And finally, regarding the two smaller accounts, Laurence, that you mentioned that are experiencing trouble. What kind of volume would that represent, if you can give a rough indication? And are you confident let's say these two go belly up, how confident are you to replace it with either the actual wholesalers or new ones in these markets?

Well, first of all, we're pretty confident that hopefully at this point in time that they're going to come through, but typically, our strength has always been the great product for the Gildan through the screen printers. So typically, when we have had distribution, we've had a couple of times in the past where customers have gone out of business. The other wholesalers were very easily being able to obtain that market share. So we're not concerned because what our focus is is to create the demand for the Gildan brand, regardless of which wholesaler sells it.

Okay, thank you, Glenn. That's all.

(Operator Instructions). Sara O'Brien, RBC Capital Markets.

Hi, guys. Just following on that two accounts that you may be having some issues with, just wondered -- are you concerned with further consolidation in the distribution network, given that Broder already controls such a huge portion of your business, are you seeing further consolidation? Is that sort of what's on the outlook?

Well, there's consolidation almost in every industry today, so this is just the natural progression, we believe, and there will definitely be consolidation. There's been a lot up until now, so a lot of the smaller distributors have either consolidated and some have gone out of business. But we feel that at this point in time, the market is pretty I would say stagnant in terms of its consolidation process. And from this point on, there might be some smaller guys. But overall, I would say that it's pretty -- it's already consolidated at this point.

Okay, so all the large moves have been done pretty much?

I would say yes.

Okay, and then just going back to the sock acquisition potential. If you were to make an acquisition, would this be of U.S. capacity that you would use, and with a brand name that's already there? Is that sort of the -- part of the strategy?

Well the thing is that I'd rather not specify what exactly it is, but I would just tell you that what our objective is is to buy distribution that we can run through our low-cost state-of-the-art sock facility that's being ramped up as we speak and being built. And it's going to come online relatively fast. So if we could accelerate our possible entree into socks by having immediate distribution and run it through our low-cost model, we believe that this would be a significant opportunity for our Company and that's really what we're trying to evaluate right now.

And I just want to emphasize what Glenn just said, that this is just scenarios that we are evaluating. You shouldn't take away from this that we have a transaction that we're about to announce. We are just evaluating different options as we build our state-of-the-art facility and look at the best way of quickly taking advantage of that capacity and ramping it up quickly.

Okay, but in terms of brand, I mean is this something that you're looking to put a Gildan brand on the socks, or is this private-label?

Our ultimate goal is going to be to build the Gildan brand.

Okay.

We can't be -- the point is, Sara, we can't be specific because we may or may not do anything.

Okay, fair enough. And just a question on gross margins. Given that you're fully hedged for next year, I'm just wondering if you're hedging -- should we see sort of choppy hedging throughout the year? Or is this something that it's going to look stable through the gross margin with improved cotton costs year-over-year?

I would not expect significant fluctuations quarter by quarter in our gross margins, if that's what you're asking.

That's right. Okay. And just in terms of SG&A, you did break down through the $0.06 impact from gross margin and SG&A. But just, if we look at SG&A going forward, is there like a basis point sort of guidance you can give in terms of what affected the cost in this quarter?

I would say that if you -- we would expect our SG&A as a percentage of our sales in '06 to be lower than 11%, if that sort of steers you in the right direction.

Fair enough, thanks a lot.

Hillary Lawson, Sprott Securities.

Hi, guys. Congrats on the quarter. Just starting out, you're fully hedged in terms of your cotton for next year. Do you have anything in place for '07 yet?

No, not yet.

So that's something you will roll on this year, assuming?

Yes.

Okay. And you may have mentioned this, how many dozens did you sell in fiscal 2005?

How many dozens did we sell for the whole --?

The whole year.

Was just under 32 million.

Thirty-two. And what was your capacity exiting the year?

It was roughly around 37, on an annualized basis run rate.

Okay, great. That's all for me, thanks.

(Operator Instructions).

If there are no further questions, that will conclude our conference call and thank everybody for attending.

Once again, Ladies and gentlemen, we thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.