Gildan Activewear Inc (GIL) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter fiscal 2008 Gildan Activewear earnings conference call. I will be your coordinator for today. At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session toward the end of this conference. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes. I would like to turn the presentation over to your host for today's call, Sophie Argiriou, Director of Investor Communications. Please proceed.

Thank you. Good morning, everyone, and thank you for joining us. Earlier this morning we issued our earnings release and our quarterly report for the third quarter of fiscal 2008. These documents can be found on our website at www.gildan.com and will be filed with the Canadian Securities Regulatory Authorities and the US Securities Commission. Joining me today are Glenn Chamandy, our President and Chief Executive Officer; and Laurence Sellyn, our Executive Vice President and Chief Financial and Administrative Officer.

Before we begin, I would like to remind everyone that certain statements included in this conference call may constitute forward-looking statements within the meaning of the US 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 and implied by such forward-looking statements. We refer you to the Company's filings with the US Securities and Exchange Commission and Canadian Securities Regulatory Authorities that may affect the Company's future results. I would like to turn the call over to Laurence Sellyn. Laurence.

Good morning, everyone. I will review our third-quarter results and full year fiscal 2008 update and then comment on the factors impacting our outlook for fiscal 2009. Reported EPS for the third quarter was $0.44 per share compared to $0.43 for the third quarter of fiscal 2007, which included a $0.05 per share income tax recovery. Excluding restructuring charges from both years, as well as income tax recovery recorded last year, third-quarter EPS was $0.46 versus $0.42, an increase of 9.5%. Results for the third quarter of this year, which included an extra week of production and shipments to maintain the alignment of our 52-week fiscal year with the calendar year were also impacted by a $0.02 charge to provide against our receivable from Steve & Barry's University stores which filed for Chapter 11 bankruptcy protection during the third quarter and also about $0.02 of other charges mainly to write off surplus fixed assets. EPS for the third quarter was $0.01 ahead of our internal forecast for the third quarter, which was the basis for our revised April 29, EPS guidance.

Compared with this forecast, the impact of higher unit sales volumes, higher selling prices, and more favorable product mix for activewear were largely offset by the special items totaling $0.04 per share and higher than forecast SG&A expenses mainly due to professional fees for special projects. Compared to the third quarter of last year, and excluding the income tax recovery from last year's results, the increase in EPS was due to higher activewear selling prices and increased activewear unit volumes, as well as favorable manufacturing variances. These favorable variances were partially offset by higher cotton and energy costs, higher selling general administrative expenses, higher depreciation expenses, and the $0.04 per share impact of the bad debt provision and the asset write-offs in the quarter.

Sales revenues in the quarter increased by 30.6% from last year. Excluding the impact of the Prewett acquisition, sales increased by 14.7% due to an approximate 6% increase in activewear unit selling prices and a 10.4% increase in unit sales volumes primarily for activewear. The growth in activewear unit sales volumes was due to increased market share in all product categories in the US, wholesale distributor channel. With our share in both the T-shirt and fleece categories exceeding 50% according to the S.TA.R.S. report.

Gildan's growth in activewear sales continues to be significantly constrained by lack of inventory. In spite of improved production in the Dominican Republic, our finished goods inventories of activewear at the end of the third quarter was approximately 1 million dozen lower than the end of the third quarter of last year. Distributor demand for Gildan products remained very strong and exceeded our product availability to service demand. Our open order position increased significantly during the third quarter and has remained high so far during the fourth quarter. Overall industry shipments in the third quarter declined by 3.5%, although preliminary S.TA.R.S. data for July shows flat overall industry demand compared with July of last year. We agree with (inaudible) response in their conference call on Friday that the decline in the third quarter was attributable to product shortages in the channel and selling price increases for price-sensitive white T-shirts.

During the third quarter, we began shipment of our first retail underwear program which started positively. Retailer sales of our sock programs were also strong in the third quarter. We have continued to rationalize our socks product mix to focus on profitable high volume basic products which leverage our core competency and large-scale vertically integrated manufacturing. Also we have continued to make good progress in developing our systems to service retailers. We have sustained good service levels and fill rates for our large basic replenishment sock programs which was recognized by a first supplier of the quarter award from our largest retail customer for its April quarter. Gross margins in the third quarter was 31.6% down from 32.4% in the third quarter of last year.

The Prewett acquisition diluted consolidated gross margins by 150 basis points, the 70 basis-point increase in gross margins excluding Prewett was due to the positive impact of higher activewear selling prices, which enhanced margins by almost 450 basis points and favorable manufacturing variances mainly arising from the consolidation of textile manufacturing in Honduras, which increased margins by approximately 300 basis points. These favorable margin variances were largely offset by higher cotton costs which negatively impacted margins by approximately 250 basis points. Higher energy and transportation costs which reduced margins by 250 basis points. The impact of production inefficiencies in the Dominican Republic which negatively impacted gross margins compared to last year by approximately 100 basis points, as higher cost inventories produced in the second quarter were consumed in cost of sales. A lower proportion of sports shirts where Gildan was impacted by the production issues in the Dominican Republic and which negatively affected margins by approximately 50 basis points and approximately 50 basis points for other adjustments.

Selling, general and administrative expenses increased by $15.5 million or 54.4% for last year. Due to the acquisition of Prewett, the bad debt provision, higher distribution and transportation expenses, higher Corporate infrastructure costs including the impact of the higher value Canadian dollar, a charge for disposal of surplus assets and professional fees for special projects. Excluding the impact of the bad debt provision and the charge for disposal of surplus assets, selling, general and administrative were 10.7% of sales compared with 9.7% of sales in the third quarter of last year. The increase of $5.1 million in depreciation and amortization expenses was primarily due to the ramp up of major capacity expansion projects and the acquisition of Prewett, including $1 million for the amortization of intangible assets, as well as a charge to write down surplus assets.

We continue to be comfortable with our full-year guidance of EPS of $1.45 to $1.50 for the full 2008 fiscal year. We are not yet in a position to feel comfortable providing EPS guidance to the market at this time for fiscal 2009 due to lack of visibility in cotton costs and other key assumptions which will significantly impact gross margins in EPS next year. Typically, we have committed to the majority of our cotton purchases for the upcoming fiscal year by this time, but have not done so for fiscal 2009 due to the volatility of cotton costs and high futures prices for cotton. A significant proportion of our cotton purchases for next year are still uncovered, although we have been taking advantage of opportunities to lock in cotton for the first half of the year.

We continue to feel confident in achieving our projected manufacturing efficiencies for the improvement and the performance of the Dominican Republic facility, in line with our original assumptions for fiscal 2008 as well as in achieving efficiencies from the successful ramp up of Rio Nance 2 and Rio Nance 3. Also, we are confident that the acquisition/integration issues which negatively impacted EPS this year will not reoccur in fiscal 2009. We also expect to benefit from a higher volume product mix in fiscal 2009 due to a higher proportion of fleece products, the development of our ring-spun products, and the continued rationalization of our sock product mix, including the elimination of unprofitable products and programs which do not fit with our business model. However, as we said in our release this morning, even with these positive factors, further increase -- further increases in selling prices will be required during fiscal 2009, in addition to the carry over impact of price increases previously implemented during the course of fiscal 2008, in order to maintain or enhance consolidated gross margins as a percentage of sales and offset the significant impact of projected increases in cotton and energy costs, as well as inflation and other cost input such as chemicals, dive starts and labor rates.

The cost structures for both our wholesale and retail products are significantly impacted by higher cotton and energy costs, and so in this environment, we will be seeking to obtain selling price increases in both the wholesale and retail channels in order to protect our margins. Production costs and unit production cost in the Dominican Republic facility are continuing to improve. And we continue to believe that excluding the impact of higher cotton cost and higher energy cost, the operating performance of the plant in fiscal 2009 will be in line with our original assumptions for fiscal 2008 before we revise our fiscal 2008 guidance in April. Average daily production in the Dominican Republic in the month of June was approximately 30% higher than the second quarter of fiscal 2008. And average unit costs were more than 20% lower before the impact of higher energy costs.

We are continuing to strengthen our management team and operating procedures at the plant with a goal over time of further raising our previous performance targets. We will update the market with more information on our outlook for fiscal 2009 as our visibility and major assumptions impacting our margins and EPS improves. At such time as we have sufficient visibility, hopefully when we report our Q4 in early December, we will be in a position to provide earnings guidance either for the fiscal -- for the full fiscal year or otherwise for successive upcoming fiscal quarters.

Based on meeting our production targets for the Dominican Republic facility and the successful ramp up of Rio Nance 2 we expect to have approximately 51 million dozens of production capacity for activewear and underwear in fiscal 2009, down from our previous estimate of 52 million dozens due to a higher proportion of fleece and ring-spun products which, however, will result in a higher value product mix. A portion of our production in fiscal 2009 will be required to rebuild activewear inventories from current very low levels.

We are planning to invest approximately $160 million in capital expenditures in fiscal 2009, primarily for our Rio Nance 4 and Rio Nance 5 capacity expansion projects. This new capacity will be required to support our plans to achieve significant further penetration in the match retail channel. The majority of our increased production in fiscal 2009 is expected to be required to support our projected growth in wholesale channel.

The new Rio Nance 4 facility is running a little behind schedule but the major landfilling operations are now virtually complete. During our investor trip in October, we will review our overall plans for the Rio Nance complex including both new capacity expansions, the proposed project to reduce our energy costs in Honduras, and our proposed new distribution center. We are continuing to further strengthen our country management team in Honduras as we continue to expand our operations in the country.

Free cash flow for the first nine months of fiscal 2008 has amounted to $92 million after capital expenditures of $80 million. At the end of the third quarter, the Company continued to have a very strong balance sheet with significant unused financing capacity to be able to pursue our organic growth plans and implement selective acquisition opportunities. Finally, we would like to update you on the status of the Canada revenue agency audit. While the details of the audit process and discussions with the CRA need continue to be kept confidential, discussions in the third quarter have been very constructive. We will now turn the call over for questions.

Thank you, Laurence. Before moving to the Q&A, in order to allow everyone the opportunity to ask a questions, we ask that questions be limited to two per caller and time permitting we will circle back for a next round of questions. Thank you. Operator.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Sara O'Brien with RBC Capital Markets. Please proceed.

Hi, guys. Laurence, I guess just a question that is on top of mind of most investors right now is how confident -- or how comfortable is Gildan in terms of maybe the outlook for your unit volumes for 2009? I know you can't talk to margins because of input costs, but in terms of the demand for your product and given the state of the economy, are you still comfortable that unit volumes should grow pretty significantly in 2009?

Well, we are comfortable that we will sell the capacity that we have available less the proportion of the capacity that we will need to allocate to rebuilding our inventories to service the market from the current low inventory levels that we have today.

Okay. Is it possible just to give us like a percent growth year-over-year in terms of unit volumes then?

Well, this year, our activewear--.

I'd say about 10%.

Okay. But I guess you said product mix will favor positively into '09?

Definitely.

I mean our activewear unit volumes this year will be close 44 million dozen so that is really the number you need to use as base for what we will sell in 2009.

Okay. Okay. And just to follow-up on that. So in terms of -- you are confident you can sell what you produce. So in terms of the demand outlook out there both in retail and wholesale, you are not feeling nervous at this point that things are any different than they were last quarter?

We have -- we have a lot of momentum right now. Business is very strong. We've never had a larger open order position in the history of the Company leaving Q3. So we are very excited and optimistic about our volumes for next year. The things we don't know is what is going to happen to the economy obviously. That we can't foresee, but based on where we are today, business is very strong. We left a lot of open orders on the table at the end of Q3 and we are continuing to manufacture at 100% of our capacity levels.

Okay. Great. And maybe Glenn if you can talk a little bit about retail programs. We know you started shipping the boys underwear. Seems like socks are doing pretty well. What is the news on sort of the next retail program wins we can expect out of Gildan. Are you working on new products -- new products for the retail channels and something we could hear early F'08 or late F'08?

Well, first of all, our whole retail business is progressing very well. We have turned the corner really in terms of really building the infrastructure that is required to service the retailers. Our in stock levels for all of our major retailers in the high 90% range right now. And we have gone a long way from where we started a couple of years ago. I think one of the things you have to understand is that our overall retail volumes, specifically in the sock category have been slightly increased or maintained, but what we have been able to do over the last couple of years is actually reduce the amount of SKUs at the companies of which we required, were running and giving examples that our consolidated SKU base was probably close to 3,000 SKUs at this and KDH and today going forward we will be around the 300 range into fiscal 2009 with no lost volume. We have done is we've basically divested ourselves of unprofitable product lines and the programs in which we've obtained today are high-volume Gildan type star programs which is really of our core competency that also reflected the skill sets of our production facilities in Rio Nance.

Okay. Super and--?

And maybe just one last point is that this is -- for us right now is what we are going to leverage as we go forward basically, and we'll continue to use that to leverage future opportunities in underwear and other activewear products. And really, our big push right now is to bring new capacity support, potential new programs in the future and in retail it takes a little longer. It is something you have to plant seeds today for future sales. So really, we are look for the timing of bringing on new capacities to support originally bigger programs in the future. One thing I can also say is that -- as we consolidated our programs, the programs we do have today from a POS point of view up until the end of June have been selling very well and we have seen double-digit growth in each one of these programs. The value proposition that we have offered to customers in terms of our better value and better margin for our retailers basically is helping and the sell throughs are very strong. So far in our underwear we have seen the sell throughs a bit, being very successful and we are very optimistic about that program as well.

Okay. Great. Just to finish on that then. Production capacity that you need to address new retail programs. Is that something we should look for in 2010 at this point or would you have enough capacity some time in 2009 to deliver on those?

Well, we are going to continue to service the mid-sized retailers with the capacity obviously we have available in 2009. We are going to be capacity restrained. Our 51 million dozens of capacity. We need at least 1 million to 1.5 million dozens to replenish our inventories. Our inventory at the end of June is down over 1 million dozen on a much higher volume base year-over-year. So that's limiting our opportunity in terms of what we can sell in 2009. But more important I think is that with the momentum we have and the programs we have, the infrastructure we put in place, the service levels and where we are with the retailers, our objectives is to plant the seeds for 2010 for some major type programs?

Okay, super, thanks. I will circle back.

Your next question comes from the line of Jessy Hayem with TD Securities. Please proceed.

Thank you. I just wanted a clarification. You mentioned you had better than projected unit volume in the quarter. Is that mainly attributable to the Dominican Republic issues being resolved faster than you anticipated or was it a combination of factors if you can provide us some comment on that.

Well, it was very strong demand in the marketplace, which we were able to meet through the combination of effectively utilizing inventory we had available plus meeting our production targets for the Dominican Republic.

Okay. Just on the Dominican Republic, are you back at close to 100% efficiencies as you have projected or can you give us an idea of the run rate that you are at?

Well, right now our run rate is very close to our capacity for fiscal 2009.

Okay. Great. And just on the -- the goal for activewear unit sales for fiscal '08. Can you remind us what that is? Retail that is.

It was never segmented out of the sales like this, Jessy and we don't want to provide that information.

Okay. Fair enough. If I can give you one more. In regards to your cotton costs and oil price that is embedded in your guidance, is there anything you can provide us there in terms of, I guess, what's embedded in your guidance of oil price and what kind of sensitivity for moves related to that to your earnings?

You are talking about for '08?

Correct.

Yes, I mean, again, Jessy, for competitive reasons, we prefer not to give information about our cotton costs, which we prefer not to do for competitive reasons and we have never provided that information publicly.

Fair enough. What about on the oil price that's embedded in your guidance?

It's -- you know that -- it's a reflection of the oil prices in the market as they have changed during the year.

Okay. Great. I will circle back for more. Thank you.

Your next question comes from the line from Anthony Zicha with Scotia Capital. Please proceed.

Good morning, gentlemen. You stated that you are looking to seek a selling price increase in both retail and wholesale channel in '09. Can you quantify the magnitude and provide some clarity on the timing, and would this be above and beyond what your competitors have done already. Is this another round of increases?

Yes, I mean, we can go down that path, what we are saying, Anthony is that we are not in a position to provide guidance at this time, because we don't know what the magnitude of cotton and energy cost increases will be and what we will need to flow through into higher selling prices. We have confidence in all the aspects that are under our control as we mentioned in our formal comments. We are comfortable that we will meet our objectives for the improvement to the Dominican Republic performance. We are comfortable with what we've achieved in terms of the ramp-up of Rio Nance 2 and Rio Nance 3. We are expecting to have more favorable product mix, which will result from a higher performance of fleece and ring-spun products and from rationalizing our soft products and eliminating unprofitable soft product lines. We are comfortable we will not have any reoccurrence of retail acquisition integration issues impact our performance this year. So all of these elements that are internally controllable we are comfortable with. But the external macroeconomic items, we don't have visibility and that's why we can't provide guidance and I don't think it is useful for us to speculate on that at this point.

Okay. And, Glenn, with regard to smaller regional retail players, are you seeing any softness? We saw Bosco's go under Chapter 11.

Well, we are still -- the back-to-school I would say in general in retail is off to a slow start. That is what we are hearing. But as far as we are concerned, we are progressing quite as well. We are continuing to add product in each one of the different segments. So we are seeing increases with all these regional customers because we are continuing to enhance our portfolio in the amount of escrow use in carrying our brand. So we will continue to have sales increases as we go forward.

Okay. And last with reference to the DR facility. What is the capacity currently running at?

We are running over 90% of the capacity in the facility. And, you know, we should be in Q4, this quarter, running at 100% of our objective.

Okay. Thank you very much.

Your next question is from the lane of Eric Tracy with BB&T Capital Markets. Please proceed.

Good morning. Yes, if I could just follow-up on the capacity. Just a clarification. Laurence, I believe you said at the end of '08, activewear and underwear will stand up 44 million dozens and the implied guidance for '09 is 51 million now? Is that correct?

Yes, we said our capacity next year will be 51.

Okay. And I am just trying to reconcile that. It looks like about a rough 18% year-over-year.

Of the 51, 1 to 1.5 million dozens need to be put in inventory to rebuild our inventories in the wholesale channel.

Is that the whole variance between that and the 10% unit volume growth that you mentioned?

There would be nothing else -- yes, I mean you got the '08 number and you've got the '09 capacity available.

Okay. Are you able to talk about just overall capacity, kind of where you expect to end '08 relative to '09?

51 million dozen by then.

Yes.

Okay. Okay. And then maybe just turning to G&A. Looks like it is certainly higher. Had some various puts and takes in the quarter. Laurence as we look to Q4, any kind of sequentially how we should think about at that? Seems like there was some one-time items. I am trying to figure out if that flows through at all or how we should think about that year-over-year relative to Q3?

Yes. I would say that as a percentage of sales, we would expect -- because of the one-time items we would expect SG&A to be lower as a percentage of sales by probably something like 50 basis points than it was in Q3.

Okay, that's fair. Then maybe just lastly, the extra week in Q3. Are you able to quantify the impact for either sales or EPS perspective?

Sorry, say that again, Eric.

The extra week in Q3, are you able to quantify the impact either from a sales or EPS perspective?

Well, what it did is it gave us an extra week of production and shipments to -- to satisfy, to service our open order position. And the value of an extra week would be about $0.03. However, if you look at it from the perspective of if we had had inventory available even with a week less, our sales in the quarter would have been significantly higher than they were with the extra week this year because, where the extra week from a sales perspective really ended up with was in our open order position which was around $90 million by the end of the quarter.

Okay. Great, thanks, guys.

Your next question is from the line of Candice Williams with Genuity Capital Markets.

Just a quick follow-up to Jessy's question, actually. You had said in the first-quarter conference call that a $0.04 increase in comp could be offset with a 1%increase in pricing. Do those sensitivities still hold?

Yes. The impact of every $0.01 increase in cotton, Candice, is about $0.035 per share. And in -- the impact of every 1% in pricing in wholesale is about $0.09 per share. And in retail, it's about, $0.02 to $0.03 per share.

Great. If I recall correctly, the Dominican Republic and the lost inventories were supposed to hit you by about 3 million dozens this year. How much of that was made up in the third quarter? And how much overall now that you have visibility at the end of the year are you just not going to be able to make up?

Well, we are still in the same place. We are still 1 million dozens lower than we were at the same time last year in finished goods of inventory because although we have improved the production, we have been selling every dozen that we can produce and using that plus our existing inventories to support the very strong demand in the marketplace, and the very large open order position that we have.

Great, thank you.

Your next question is from the line of Sarah Hughes with Cormark Securities. Please proceed.

Hi, guys. Following on the DR facility. You said that capacity would be at 100%--.

Can you talk a little louder Sarah, we can't hear you very well.

Sorry, is that better.

Much better.

On the DR facilities, you said capacity is going to be about 100% this quarter. I am wondering what the margins are like in the facility versus say Honduras and how much more improvement you need to do on that end.

Well, we said we would achieve 100% during the course of the quarter, not for the whole quarter.

Okay.

And in terms of the costs for the DR, what -- I think what we are prepared to say is that we will be back to where we projected we would be in 2008, taking account the impact of higher energy costs and higher cotton costs.

Okay. And then -- the -- have you implemented any price increases in the retail market yet. I know you did the wholesale.

No, we haven't as yet.

Okay. I was just wondering, has there been any price increases implemented in the retail market from your competitors? I am just trying to give you an idea of your confidence in being able to implement them going into 2009?

We would rather not talk about our competitors because we really don't know where they stand today. It is hard for us to evaluate, but as far as we are concerned, we will pursue price increases where we can within the retail channels for sure.

Okay. And then sorry, just lastly, Rio Nance 4, what is the delay, what is the expected timing of the opening and ramp now?

Well, originally we were going to start production in 2Q of '09 and it going to be in Q3 at this point. So probably about a couple months behind our growth projection.

Okay. Thanks.

Your next question is from the line of Jim Chartier with Monness, Crespi & Hardt. Please proceed. Sir, your line is open. Mr. Chartier, your line is open, sir.

We may have last him.

I am sorry, can you hear me?

Yes.

Okay. Can you update us on the completion timeline for the chemical and energy reduction projects?

Well, those projects will be complete in the first quarter of next year and start production -- are you talking about chemicals?

Chemicals.

And will start in our Q2 I would say next year at the latest.

Okay are you still expecting--?

The energy piece won't be effective probably until 2010.

Okay.

By the time it generates savings.

By the time it gets a start and generated, the savings are generated and flow through our P&L.

Okay. And then where are you on production levels in Rio Nance 3? Are you at $35 million yet?

Production levels at Rio Nance--.

A bit of function of mix as well, Jim, but we are north of 30.

Have you completed the expansion project there?

We have the last group of equipment actually being installed and being -- being worked on right now, and toward the end of September, we will be at our full capacity based on the mix that is running through the plant.

And based on the current production levels, the cost structure of the facility is fully meeting our targets and resulting in very good margins for the products that are being produced at Rio Nance 3.

What percentage of your sock unit sales will be through that facility in 2009?

Well, I think we will provide all the details of our '09 guidance at one time, but, you can say north of 30 and our sock fills, are north of 60. So, that gives you the information you need.

Okay, thank you.

The next question from David Glick from Buckingham Research Group.

Yes, good morning. Laurence, I just want to make sure I understand what you are saying about 2009. Is it fair to say given, since you are anticipating the recovery of these one-time DR and acquisition related costs that your pro forma earnings base is still -- for '09 is similar to your original guidance in that your ability to achieve your long-term growth objectives in EPS growth which I believe historically you said 20% is your long-term growth objective that that is primarily a function of your ability to pass on price increases to offset higher energy and cotton costs. Is that the best way to think about it?

I think that is a very good summary, David. I mean, nothing has changed in our world from when we have been talking to investors during the quarter. We are still comfortable with all the things I said. And I won't go through and enumerate them all again but the things that caused the downward revision in our guidance which we said wouldn't impact our performance in '09. We continue to believe they will not impact our performance in '09. And what will determine our growth in '09 will be what increases in cotton and energy costs are and to what degree we are able to flow them through into higher price saves both in wholesale and retail.

Okay, great. Thanks for the clarification. Good luck.

Thank you.

Your next question from the line of Susan Sansbury with Miller Tabak. Please proceed.

Hi, thanks very much. Sort of a side to raise from what David asked, could you summarize for me the sales and earning percent, EPS impact of the DR facility -- I don't know what you want to call it -- glitch production issue.

In what period?

2008, the third quarter, it is going to impact you -- whatever has happened--?

When we reduced our guidance we said that the impact on our guidance in the second half of the year was going to be approximately $0.30 due to the fact that we wouldn't have the production to support our sales projections and sales potential which is the reason that we have this huge open order position combined with manufacturing efficiencies that would result in higher production costs in the second half of the year as we consumed higher costs of inventory produced during the second quarter and third quarter as we completed the turn around of the facility.

Are you verifying that number or confirming that number at the end -- end of the quarter you just--?

Yes, there is no change in -- in anything that was said before.

And the lost sales?

Yes. I mean the reason that we have the high open order position, and you can see the demand in the marketplace for Gildan products is exceptionally strong and we ended the quarter with an open-order position of $90 million approximately and that unfulfilled sales demand is because we didn't have the production available from the Dominican Republic facility.

All right. Not to ask a stupid question, but, I mean, so the top line shortfall was $90 million? Or was it less than that?

Well, what we said is that the way we arrived at the shortfall -- the impact of the DR was we said we had lost -- about 2 million of dozen production will flow through to higher sales and it is possible we would have achieved -- we were assuming some of that production would go to maintain inventory levels because we -- of the production shortfall of 3 million would be required to support inventory levels would be continuing to run down inventories to support the strong sales demand.

Okay. A nice segue into my next question which is inventory at the end of the period was up I believe 26%. How much of that reflects -- how much of that will be shipped in the fourth quarter and how much of it reflects inventory rebuild?

Okay. The overall increase in inventories include the inventories from Prewett and higher sock inventories. If you exclude socks and underwear where we've build up inventories to support, our new program, inventories are essentially flat for activewear and we have, as I said, a million dozens lower finished goods volumes which are offset by higher cotton costs that resulted in an increase in the value off the inventories.

Okay. My final question going back to what -- a question that Sara lobbed in. I got confused about when you are going to have sufficient capacity to service more retail programs -- was this 2010 or 2011. Or when is it?

In 2010 for sure. We are building production capacity to support our -- our main strategic -- our main strategic focus for the Company is to leverage our business model into our retail and we are building Rio Nance 4 and Rio Nance 5 as new capacity to support our retail initiative.

Okay. And -- is there a number for what that dozens of capacities will be for retail? What that objective.

Rio Nance 4 will be a similar-sized facility to Rio Nance 3 and Rio Nance 5 will be similar sized facility to Rio Nance 1 and Rio Nance 2, if not maybe a little bit bigger.

Okay. But I don't remember what those capacities are. Laurence, can you just tell me?

Rio Nance 3 is close to 35 million dozens depending on the product mix. And Rio Nance 1 and 2 are about 20 million dozens of annual capacity because it was all T-shirts. And then what the actual capacity is will be a function of product mix because, for example, Fleece consumes more fabric so you get less dozens. And underwear consumes less fabric and you get more dozens so it would be a function of the product mix and Rio Nance 5 would be a facility that likely will be dedicated to high volume basic products.

Okay, great. Thanks very much.

Your next question is from the line of Doug Cooper with Paradigm Capital. Please proceed.

Good morning, Laurence. I understand that you don't want to give specifics. 2008, just the front end futures contract for cotton is about $0.67 today if your cotton price for fiscal '08 would be lower or higher than that?

Our average price of cotton will be higher or lower than $0.67?

For '08.

Is that what you are asking?

Yes.

Well, we have been buying cotton at market prices during 2008, and if you go back and look at what the market prices for cotton were during 2008, they would be well below that level. So our average would clearly be -- will be well below that?

Okay. So you're just buying on a per needed basis right now. You are not -- you said for 2009, you are essentially -- you haven't bought any or you bought 10% or what?

I didn't give a percentage and I am not going to give a percentage. But, we have always said that we would take advantage of windows of opportunities when cotton was at attractive prices and we have been certainly building up our cotton for the first half of the year and taking advantage of buying opportunities.

Okay. Thanks very much.

You are welcome.

Your next question is from the line of Sara O'Brien with RBC Capital Markets. Please proceed.

Hi. Glenn, in terms of the socks, we talked about 60 million dozen this is year. What is your outlook for those programs going forward? Is that somewhere you can see unit volumes growing another 10% or so next year? What is the demand like in your sort of forecast for that?

Well, we believe we are going to have some -- some growth next year, but it is also going to come through -- we are going to have some growth, but at the same time, we are also going to have a lot of replacement type programs as we divest ourselves of these SKUs. We are going to have bigger and better programs that will equalize slightly higher volume let's say for example in 2009. And, be more Gildan oriented type business. So we are giving up some business, to answer your question, but the business we are attaining will be much more substantial in terms of the size of the programs and the volumes.

And the economics.

And the economics.

Once we get past the tariffs from Honduras, we can expect that margins could see some pretty significant improvement next year?

That will depend on the--.

Cotton costs.

The $1 million question but more the $1 million question of what the impact of higher cotton and energy costs are and to what degree we recover these cost increases and prices. What is absolutely for sure is that we will achieve significant manufacturing cost efficiencies in socks in fiscal 2009. And the question is what degree we will be able to obtain all of these deficiencies in terms of passing through higher energy and cotton costs into higher prices.

Okay. Just a question. You referred to professional fees for special projects a couple of times. What kind of special projects are you looking at? Is this something, acquisition-type targets? What can you give us on that?

Mainly fees for legal and tax consulting.

Okay. Far less exciting. Thanks, though.

Your next question is from the line of Claude Proulx with BMO Capital Markets.

Thank you. Good morning. First question, in the past you gave the gross margin in your socks business. Can you give an update as to where it was in the third quarter?

It was on a -- it was north of 20% on average.

You mean -- was it significantly higher than 20% or just?

I am not going to give more information than that, Claude.

Okay. You talked about the $0.30 impact in the second half of the year from the problem in the Dominican Republic, but you didn't quantify how much of it was reflected in the third quarter. Can you quantify how much was reflected in the third quarter?

Not really. Because it is an opportunity cost in terms of sales is the biggest factor, Claude. What I can tell as that we went through the quarter and ended the quarter with huge unfulfilled sales demand because of shortfall in production.

But that -- that $90 million, how does it compare to historical level? I mean it is difficult to -- can you put that into perspective?

Historically, we don't have more -- we ship everything out once and historically we don't have more than $15 million of open orders at any time.

Okay. And last one. I mean your non North American sales are up marginally -- well, marginally -- maybe that's -- that's an exaggeration. Well, they are up nicely but they are not up as much as one would expect considering all the efforts that are put at growing into Europe, China, Australia. Is it just because you don't have the capacity and you are just focusing on your core North American wholesale market?

It is absolutely a function of capacity, availability of capacity and inventory and what we need to do to support our customer base in North America. Plus, also, Europe was impacted by the delay in introducing the ring-spun products which is a core product in Europe.

So should we expect a faster growth next year or, again you'll be capacity constrained?

Well, the -- we have already been shipping ring-spun products to Europe to support our growth in the European market.

Okay. Thank you.

Your next question is a follow-up from the line of Jessy Hayem with TD Securities. Please proceed.

Thank you. Actually my question was related to ring-spun garments and I guess the product that you have made on the production there and where are there are going to be manufacturers going forward?

Well, right now the progress is that we are fulfilling and we are delivering the product to market, and as far as our manufacturing strategy, we will defer that to maybe when you come and meet in Honduras in October. How is that.

Sounds good, Glenn. One more question just related to a question that Claude just asked on the components of the -- I guess the leftover guidance restriction in terms of particularly you had mentioned some of that guidance revision included a portion of IT glitches with the integration of the KDH system. Can you just give us an update. Is that pretty much behind us? Is the system fully integrated or are there any small fixes left to be done?

I think I mentioned in my comments, Jessy, that we feel we have made very good progress in developing our systems to service our retail. We feel we've turned a corner with serviced retail for our basic replenishment programs we manufacture very well, and we haven't incurred any more issues as we projected we wouldn't. So we are very confident that -- that's not going to be an issue that will impact our EPS in '09.

Perfect. And then as far as the percentage of socks that you currently sell out of -- I guess what is the breakdown of what you sell in socks that are manufactured in North America versus offshore. Is that something you can provide?

In North America versus offshore. Well, we went through earlier I think that we have total sock sales of north of 60 million at the moment, say 65. And we have over 30 million dozens of production coming out of Rio Nance 3 at the moment. So about 50%.

Thank you.

There are no other questions in queue at this time. I would like to turn the call over to Sophie Argiriou for closing remarks.

I would like to thank everyone for joining us here today, and we look forward to speaking to you at our next quarterly conference call. Thank you and have a good day.

Thank you all for your participation in today's conference. This concludes the presentation. You may now disconnect and have a good day.