Gildan Activewear Inc (GIL) 2007 Q1 法說會逐字稿

Welcome to the Gildan Activewear first quarter fiscal 2007 results conference call. As a reminder, this call is being recorded. We are joined here today by Gildan's President and Chief Executive Officer, Mr. Glenn Chamandy. And Executive Vice-President, and Chief Financial and Administrative Officer, Mr. Laurence Sellyn. Mr Laurence Sellyn will by providing a brief formal review of the details of the first quarter results and update on the outlook for the remainder of the fiscal 2007. After which, Mr. Glenn Chamandy and Mr. Laurence Sellyn will open the call up to questions.

Before turning the meeting to management, please be advised that certain statements included in the conference call may substitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve unknown, and known risks and uncertainties than could cause actual results to differ materially for future results, expressed or implied by such forward-looking statements. We refer you to the company's filing with the U.S. security exchange commission and Canadian security commission regulatory authorities that may affect the company's future results.

I would like to turn the call over to Mr. Laurence Sellyn. Please go ahead, sir.

Good afternoon, and welcome to Gildan first quarter conference call. In our release after the markets closed this afternoon, we announced quarter earnings on the $0.01 head of our guidance, and same as the first call consensus of analysis estimates and we reiterated our full year sales and earnings estimate. The only change in our plans and assumptions in fiscal 2007 was that we have increased our capital expenditure budget to position the company to support faster sales growth in fiscal 2008 and beyond.

To start with the results for the quarter, our EPA of $0.28 U.S. per share before restructuring charges was $0.01 higher than last year and our guidance for the first quarter. Compared to the first quarter of fiscal 2006, 4% reduction in unit selling prices for active ware, the impact of higher cotton costs and higher SG&A and depreciation expenses were offset by a 15.2% increase in active wear unit sales volume, more favorable product mix, more favorable manufacturing efficiencies, and $0.01 EPS secretion impact from Kentucky Derby Hosiery. The growth in unit sales for active wear is still driven by core markets in the screen print channel, where overall industry growth in the quarter was 2.9% and where we achieved continuing market share penetration in all product categories. Our market share in T-shirts was 46%versus 41.7% a year ago. Our market share of fleece was 36% up from 27.7% a year ago, and our market share in sport shirts increased to 34.6% from 33.9%.

Inventories from the channel continue to be in good balance, and we're down slightly compared to a year ago. Unit shipments in Europe were also up by 35% compared with the first quarter of last year. Due in part to the addition ever major new distributors in UK. Product mix was very favorable compared to the first quarter of fiscal 2006 due to an increase of approximately 75% in unit volumes for fleece, and higher proportion of colors in the T-shirt category. Total sales revenues including socks grew in the quarter by over 50% compared with last year. Three of the national mass market retailers served by Kentucky Derby were included in the top ten customers in the quarter, ranked by sales revenue. Their largest customer accounted for 10% of our first quarter dollar sales revenue.

Gross margins declined to 29%, compared to 35.7% in the first quarter of fiscal 2006. Excluding lower margins from the sale of socks, which do not yet reflect the impact of rationalizing our silk manufacturing operations post acquisition of KD H, gross margins in the first quarter of the current fiscal year were 33.1%. Decrease in gross margins for active wear was due to lower selling prices that reduced margins by approximately 300 basis points, and higher cotton costs compared to the low point in the first quarter of last year, which negatively impacted margins by approximately 250 basis points . These factors were partially offset by the approximate 200 basis points favorable impact of more favorable product mix and the 100 basis point impact of continuing manufacturing efficiencies. The more favorable mix reflected a higher proportion of fleece and color T-shirts compared to the first quarter of last year .

SG&A expenses amounted to $26.1 million, or 14.1% of sales compared to $18.1 million or 15% of sales in the first quarter of last year. SG&A expenses included approximately $4.7 million of expenses from KD H, and a charge of $1.1 million for transitioning to a new leased aircraft, while last year's SG&A expenses included a special severance charge for approximately half a million dollars. The charge for the aircraft was composed of a loss on early termination of the previous lease and duplicate lease payments in the first quarter. The all-in lease and operational cost for the new plane are expected to be similar to the old plane so upgrading of the aircraft is no expected to negatively affect EPS -- Increase in depreciation costs of approximately $1.3 million it due to depreciation and amortization for KDH and the continuing capital investment by the company in our major capacity expansion project.

Our tax rates in the quarter were 6.5%, compared to 4.4% in the first quarter last year due to accruing full U.S. taxes for the soft business, Our higher tax rates in the legal entity because of the lower deduction for corporate interest expense as we continue to repay the installments in our senior note, and the unfavorable tax treatment of the restructuring charge under our tax structure. Our full year tax rate is projected to be approximately 5.5%. Our EPS guidance for fiscal 2007 has been left unchanged at $2.61 per share before restructuring charges, and will continue to be reevaluate as we get closer to the peak summer selling season. Underlying assumptions are the same as previously communicated.

Projected sales revenues of approximately $975 million, active wear unit volume growth of 15%, and total unit volume growth of close to 60%, including socks, selling price reduction, averaging slightly over 2.5% for activewear for the full year, and significant manufacturing efficiencies primarily attributable to the DR text office facility and the rationalization of our Canadian textile manufacturing . Cotton costs will continue to be significantly higher than last year in the second quarter. They are expected to be more comparable to last year and second half of fiscal 2007. We've initiated EPS guidance for the second quarter at approximately 20% higher than the second quarter of last year before restructuring charges. We are continuing to make steady progress in achieving programs in the retail channel, including new programs with other mass market retailers for the 2007 back to school season. And our focus is to continue to roll out more programs as we add production capacity. We are sufficiently confident in our retail opportunity as well as our continuing growth in the screen print market that we have decided to accelerate the installation of equipment and ramp up of our two major capacity expansion projects in Honduras.

Subsequently, we are increasing our capital expenditures plan for fiscal 2007 from $110 U.S. to $145 million U.S. Even with this increase, our fiscal 2007 capital expenditures will continue to be fully financed by our internally generated operating cash flow. We expect to generate approximately $20 million of free cash flow in fiscal 2007 after capital expenditures, and continue to have significant finances flexibility and [inaudible] to finance further capacity addition as well as possible future acquisition. EPS impact of incremental depreciation and interest expense is in fiscal 2007 resulting from additional capital expenditures is expected to be fully offset by increased manufacturing efficiencies in year from these investments.

Although the major cost reduction impact from the additional capital spending will be in fiscal 2008, management now expects cost synergies from the transition of self manufacturing due to the faster ramp up of rule 93, result in EPS accretion from the Kentucky Derby act acquisition running at an annualized rate of approximately $0.20 per share by the end of fiscal 2007. With our projected sales mix of T-shirts, fleece and underwear, which can all be produced in the same manufacturing facility, we project based on this mix that we will have in excess of 60 million dozens of combined active wear and underway capacity in play in offshore manufacturing facilities during the second quarter of fiscal 2008. And over 25 million dozens of dash sock manufacturers capacity in Honduras in addition to our North American capacity. Please note that capacity when expressed in dozens is significantly impacted by-product mix. During the course of this year, we will be carrying out detailed analysis of our needs for future capacity additions as well as evaluating the future of our remaining North American manufacturing operations. With that, Glenn and I are now available to answer questions.

[OPERATOR INSTRUCTIONS] Please stand by while we compile a list. And your first question comes from the line of Jessy Hayem with Desjardins Securities. Please proceed.

Thank you. Good afternoon. First question is on pricing, the 4% jewelry decline that we saw in the first quarter of 4% It seems like it was more substantial that we've seen in recent quarters. Of course, you had noted back in the fourth quarter that this was more likely going to be the case. I'm wondering, was there anything particular that happened in the quarter? It is usually promotional time of year, and of course, just wondering, seen that cotton costs were firmer, did anything particular happen in the quarter that caused the price decline?

Well I think it was a function of our product mix, and the products that we sold in the, in the quarter, and unit pricing was maybe marginally worse than what we reflected in the forecast, but it wasn't very different.

Okay. And as with regards to your fleece shipments, you've had pretty solid increase in the first quarter versus the industry, you obviously with the Dominican Republic coming on board, you must be taking share away. I was wondering if you could give us some color as to what happened in the first quarter to drive the strengths, and if it was retail and wholesale driven.

Well, our market shares has been progressively increasing throughout the year. Really, the bulk of the shipping season and fleece happens in the August through October/November, December period. That's why we see the spike as a product gets sold through the marketplace. And all these statistics in terms of share are a function of the wholesale market.

And your next question comes from the line of Candice Williams, with Raymond James. Please proceed.

Good afternoon. Quick question for the mass merchant roll out back to school '07, is that a full product line?

It's going to be a combination of different customers. Actually, we're currently negotiating with, some will be roll outs of major sock programs, and other full branded programs of socks and underwear and potentially fleece.

Thanks. And in terms of your Cap Ex, are you prepared to give us anymore color on where the incremental Cap Ex is going in terms of socks versus Activewear facility?

Cap Ex is basically -- You want?

I don't think we're, the bottom line is we're ramping both facilities up to their full capacity by the second quarter of next year.

Okay. Thanks. And just one last question on the current concerns regarding decreased cotton acreage. Being planted next year. If that is the case, what alternative sourcing arrangements are available to you on the cotton that lets you, I guess, sit within all the rules of the current trade legislation?

Just reference point that United States still plants 20 million bales of cotton and if they reduced somewhat, the cotton being produced, consumption is only about five or six million bales, so there's still a big export of cotton so there is no shortage of cotton, even with the reduction of planting, so it's a function of the world price, and whatever happens in the United States is reflective in the global environment, and it will affect everybody in the industry. What's important, in our segment in the wholesale market, we typically are able to pass pricing on as prices are increased to us in terms of raw material, so we would no not be effected.

That does not necessarily on a quarter per quarter basis, but long sustained periods? You would be able to pass through

We would be able to pass it through relatively quickly in the wholesale channel.

Thank you.

And your next question comes from the line of Anthony Zicha with Scotia Capital. Please proceed

Laurence could you please explain the KDH secretion, I didn't quite catch what you were saying in terms of $0.20 for fiscal '07.

What we said what we announced the acquisition Anthony was that when we had achieved all of this synergies and Rio Nance was fully ramped up, we would be targeting $0.30 EPS secretion, and we had previously said that of that $0.30, we would run at a rate of $0.15 at the end of fiscal 2007, with this faster ramp up of the facility, and progress we are making with the integration, we are now looking at more like running rate of $0.20 EPS accretion at the end of the year. Some of the high accretion will be used to affect higher depreciation and interest during the course of the year as a result of the increased capital expenditures.

Thank you. And Glenn, could you give us an update on Europe and progress and UK and maybe in the French markets?

Our progress in Europe is, we've increased our shipments by over 35% primarily due to new distributors in the UK, as well as our success of continued penetration within the European market, so we are very bullish in our European business, and its off to a great start.

Okay. Thank you very much.

Next question comes from the line of Claude Proulx with BMO Capital Markets. Please proceed.

Thank you. Good afternoon. Two questions. The first one is if I look at the top line of Kentucky Derby, it looks like it's greater. I understand there's some seasonality, but seems like it's greater than the amount you gave when the company was acquired, $16 million in just one quarter, seems like the run rate is greater than something like 120 on an annual basis?

It's a combination of seasonality, plus the fact that we are making good progress in our building on the sock business.

You could end up doing more than $0.30 on, getting more than $0.30 out of Kentucky Derby.

Sales weren't quite $6 million, they were more like closer to the 43 level.

The other thing is the restructuring of the operation, I doubt it wouldn't be segregated and it was segregated in your income statement. Why was it? I mean it implied it's temporary

That's right, we've always isolated the restructuring and accelerated depreciation costs and in our communications with the marketplace and in discussions with our auditors, the appropriate disclosure on the statement was to group these costs together in restructuring costs. So accelerated depreciation is in there [inaudible].

Thank you.

Your next question comes from the line of Richard [inaudible], CIBC World Markets. Please proceed.

I just wanted to first follow up on Claude's question for the Kentucky Derby sales. I just wanted to confirm that your comments last quarter still remained intact. That the new sock shipments in the mass channel isn't starting until basically this quarter 2007 so we didn't see that in the Q1 numbers, is that still a fair statement for that branded sock business?

That's correct. The shipments will be later this month.

Okay. In the -- I think I milled the two Rio Nance facilities that are getting this incremental Cap Ex investment. Which two Rio Nance were these?

the two that are under construction. We have one, we have our Rio Nance one T-shirt facility that's fully ramped up and fully mature at this point, and we're constructing two new facilities there, one that will be predominantly for fleece and one for socks. These are the two that we're ramping up faster than we previously anticipated.

So I realized that part, but you are actually adding more capacity than you previously expected at Rio Nance 2 and 3, correct?

Running slightly more capacity, and accelerating the rate of when which the capacity will be brought on. And equipment will be ordered.

and [inaudible], my understanding you still have the ability to add in incremental capacity at this facility relative to the current run rate, is that correct?

We're ramping the DR up as well, and there is some room to additional capacity in that plant.

Would that be about 15 million, Glenn?

Well, it's hard to say bases on mix again, but we would rather not specifically say one plant in general but I think that we're comfortable with Laurence's comments were in the overall capacity, how's that?

That's good. And one final question, could you give the unit volume in the wholesale business this quarter?

Okay. Our total unit volumes were just over 14 million and socks was just over half of that, and I think that's as many segmentation and detail of your unit volumes as we are comfortable to provide.

Great, thanks a lot Laurence.

Your next question come from the line of Cary Coffman with Sterne Agee. Please proceed.

Great quarter. The back to school orders where you bring machinery in, you are accelerating Cap Ex bringing the machinery in. Can you give us some color on that business, either by-product category or customer?

First of all, the equipment that we are bringing in, it's going to be installed in the plants over this fiscal year, so major capacity expansion is really going to be for 2008. Our existing focus on -- We have capacity in place for this year to service additional business and as we bring on capacity, we are planning to sell new programs to retailers for back to school period. We would rather not say who they are, but for confidentiality, but we are confident in our ability.

All right. And on that same note, Gildan branded product that is going to the first major retail customers is that due in the stores this month?

You'll see it in the stores in February. It will be in the stores sometime in early March.

Okay that's it guys. Thanks.

And your next question comes from the line of Philippe Habeichi With Genuity Capital Market. Please proceed.

Thanks, just going back to Kentucky Derby quickly. Could you please let us know what the sales were at this time last year for Kentucky Derby?

At that time, Kentucky Derby was a private company Philippe, you know, I think we were up from the first quarter of last year, and I'm not in a position to give you the breakdown of their sales before we acquired them.

Okay. Fair enough. I appreciate that. Okay. Just looking for a general update on your retail penetration. How many doors, because I think that's how you comment on your penetration, how many doors are you into now with retail, and what was it at the end of last quarter?

I'd rather not say now because it's, reflected we are shipping the products to, I'd rather just defer to that until March when [inaudible]

You guys are making it hard on me though. Can you comment just on the underwear? Any underwear sales in the quarter?

Yes, we had some.

Sub 2 million? Is that fair?

We're not providing segmentation between activewear and underwear. [inaudible].

Alright fair. Let me ask something completely different then. You mentioned in your comments earlier that you expected to generate good [inaudible]. And one of the, which would put you in a strong financial position to consider a bunch of alternatives, including acquisitions. I was curious if you could comment on that, what do you have in mind in that sense?

What we are saying is that for the present time, we are focused on managing integration of Kentucky Derby and the huge opportunities we have for organic growth in retail, but down the road, we think there are going to be a lot of opportunities resulting from industry, consolidation in North America and internationally, and we see that as part of our growth strategy over time.

In the same product lines or complimentary lines?

We will develop and refine acquisition criteria as we go forward and provide some communication of that, but the point is, that we are going to generate more cash than we can re deploy to, in our organic capacity expansion, and we've talked about the issue of cash flow, cash accumulating in our balance sheet and what we have said is our first priority to continue to re deploy that cash and further growth opportunities over and above our base case plan, both organic opportunities and potential acquisition.

Okay, I'll leave you there, thank you.

And your next question comes from the line of Dave Pupo with Orion Securities.

Good afternoon. Can you please educate a little bit on cotton pricing? I'm looking at cotton pricing last year, you're making, you have made some indications which regards to significant price decreases last year. I'm wondering when you buy cotton, how far forward are you buying? Because I'm not understanding the mass on how cotton was so low last year relative to this year in Q1.

What do you mean, not understanding the math?

What I'm looking at spot prices on cotton, they are looking fairly level year over year, so is this a hedging issue where, you are upside down on some hedges? Et cetera.

I'm not sure what data you are looking at, but we had an increase, significant increase based in both the first and second quarter from what were low points in the first half of last year, and like was said in the second half of -- Cotton prices will be more comparable, we are looking at about a $0.08 increase.

and so -- If you are buying cotton now, when does that cotton show up on [inaudible]?

[inaudible]

Are you buying a quarter in advance? Three quarters in advance?

To put it in perspective, I think first of all, when you look at our first quarter, typically, you know, we carry three to four months of inventory, so whatever we are selling through the first quarter was produced in our fourth quarter.

Okay.

That's really where the difference was in the cost, so you can't compare today's price against what was both through the P&L.

I understand. Okay. I was looking only through three months in advance of so of the, what is that, if you take out the acquisition, it looks like 255 basis points decrease in gross margin would be a normalized type of business, how much of that was cotton?

I'm not sure what, I'm not sure if I'm understanding your question, Dave, at all.

Normalized gross margin is 33.1% was indicated. Year over year, that would be about 255 basis point decrease in the quarter.

Right.

How much of the decrease would have been cotton pricing

About 250 basis points.

Okay. Perfect. Thank you very much.

Thank you.

And your next question comes from the line of Doug Cooper with Paradigm Capital. Please proceed.

Just quickly, if you could answer, the 975 guidance revenue guidance for the year, what is the assumption on retail?

Well, again, we are not segmenting out the retail and the activewear in there. The only guidance we were prepared to provide was segmentation between activewear and socks, which was about 42 million dozens of activewear and about 20 [inaudible].

Okay. And all the socks are retail? Just of the guidance for Q2 in earnings, 20% increase, I assume that's about $0.60 a share, I think you did 50 last year. Operating margin, what's the assumption for the quarter?

Operating margin, I'm only going to talk about that directionally, but it will be higher than the first quarter. We are projecting that it will be higher than the first quarter of this year.

Okay.

Also for, not including the impact of socks.

Not including the impact of socks. And just, you know, just if you are increasing your Cap Ex pretty material, and I guess you were having, I guess guidance of $2.61 a share by back it up 20% increase in Q2 you're looking for an over 30% increase in earns year other year in the back half of the year. Obviously as a retail program, presumably rolls out, the increased Cap Ex, you know, it's a pretty big increase between from 110 to 145, is this because a major retailer has come to you and said we want to place a big order, but you want to have it sooner than we may have thought so that's why you are ramping it up?

You know, we feel pretty optimistic about our ability to penetrate the retail market. We've been building our capacity up and selling every possible garment we can produce over last 15 years. And with the accelerated market opportunity in retail, as well as our combined momentum we have in the wholesale market, this capacity is required to support those missions.

Right. I guess my mount is it is demand driven, your clients coming to you saying we wants you to ramp it up faster?

Demand driven, yeah.

And can you comment about, you are in there taking share. Can you say who you would be taking share against?

Nope.

Okay. Thank you.

Thank you.

Your next question comes from the line of Charles Vincent with JP Morgan. Please proceed. Mr. Vincent, your line is open.

Next question, operator?

Your next question comes from the line of Monica Logani with Wall Street Access. Please proceed.

Hi, it's Monica Logani. Just a few questions on just in terms of Kentucky Derby. What kind of gross margin did that contribute? I know last quarter you said it was in the mid to high teens. And I presume it's gone up from then, could you just tell us where that came out?

I would say the margins are comparable.

to last quarter? Okay. And if you could, I know you talked about this in your open remarks about capacity, could you repeat those numbers? I want to make sure I understand what your new capacity numbers are versus what they were a quarter ago, now that you are increasing your Cap Ex plans.

the thrust of what we are seeing is the capacity that we had previously projected we have exiting 2008, we will now have in place in the second quarter of the year, so we are accelerating reaching those capacity targets and a full ramp up of the two new facilities in Honduras.

and what would it be for the end of '07?

Well, I think, you know, what we are prepared to say is that capacity will be the numbers I gave in the excess of 60 million dozen In the second quarter of fiscal 2008 of activewear, and over 25 million dozens of socks and in a year it will be less than that.

Okay. And last quarter, you had mentioned that there would be two to three million of extra available capacity for retail in '07. Is that, is that the same or is that, has that gone up in terms of excess capacity?

These, this acceleration of capacity will more benefit '08 than '07. From won't be a significant impact in '07, although there will be some more cost efficiency in '07.

Okay. And just in terms of just looking at industry growth in golf shirts, I know that's not a huge business, but just curious, what was going on, down 10%.

It's, market is changing and a lot of the fashion products are no longer being represented from the people that are being surveyed in stars, so basically, the product category is basically more of an uniform basic sport shirts wear, and that's one reason why it's declined of there are product things sold in channel that are not being reported, stars are in this category.

What's not being reported? Is that the uniform section or --

the fashion side, uniform side is being reported which is basically the products being sold by our sales and major competitors, some of the distributors are providing their own products that are more fashion forward they're no longer being provided.

Okay.

I don't think the market is down, I think it's just what is being provided.

Okay. And just one last question. I'm sorry to skip back to the same cotton question, I want to make sure I understand it. In this quarter, how many months ahead should we look at cotton in terms of understanding what the cotton prices are affecting? Your gross margins in the current quarter? Is it two quarters ahead?

We buy this quarter, we'll [inaudible] let's say next quarter.

So just one quarter lag?

In this time of the year, and depending on the seasonality when we build inventory. Typically it will go through next quarter because third quarter is our biggest quarter and that's when our inventory will hit the lowest point in time.

Okay. All right. That's it. Thanks.

[OPERATOR INSTRUCTIONS] And your next question comes from the line of Carey Coffman with Sterne Agee. Please Proceed.

Hi It's actually Randy [inaudible] sitting with Carey Coffman. Quick question question for you, it sounds like and looks like you are making significant investment now for the future. Can I ask you what percentage increase you anticipate in your capacity as a result of the investments that you are making, and whether or not you anticipate that such capacity will be filled on the next few quarters? Thank you.

We are going from 17 million dozens of capacity approximately in year in '07 to over approximately 95 million dozens of capacity and that is based on what we feel we need to support our sales projection.

I'm sorry, I didn't quite get that.

We are going from about 17 million dozens of capacity on in underwear to close to 95 million dozens of capacity by the time these facilities are completely ramped up from our offshore facility and we are putting that capacity in place to support our sales growth objective.

That's a huge increase when do you anticipate that you will be filling that capacity?

Well it gives us the opportunity to-- we feel that we will potentially need to have additional capacity in place before 2009.

I see. That sounds interesting. That's a quantum step up in capacity, so hopefully you'll be able to fill it.

Always have being able to fill our capacity as fast as we've invested in capacity expansion offer year.

What kind of returns are you looking for on your investment dollars.

Well, we have generated close to a 30% return on equity since we became a public company during a period when we've been in investing significantly in new capacity expansion year end year out. And you don't anticipate that you [inaudible] rate is lowered. We haven't -- To achieve the kind of returns we've done historically.

that sound good to me. Thanks.

Your next question comes from with a follow up question from the line of Richard [inaudible] with CIBC World Markets. Please proceed.

Just really quick technical yell, the 20% guidance that you are looking for in Q2, I want to verify that includes the unusual gain that you reported in Q2 last year; is that correct? That is comparing-- that's off the base of $0.51 in second quarter of last year. Precisely, that's great thanks.

There are no further questions in queue at this time. I would like to turn the call over to Mr. Glenn again for closing remarks.

Thanks for attending our first quarter conference call. And we will speak to you in May in our second quarter. Thank you very much.

Thank you for your attendance. This conclude the presentation you may now disconnect. Good day.