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Gildan Activewear Inc. (NYSE:GIL)

F2Q09 Earnings Call

May 14, 2009 8:30 am ET

Executives

Sophie Argiriou – Director, Investor Communications

Laurence G. Sellyn - Chief Financial and Administrative Officer, Executive Vice President

Glenn J. Chamandy - President, Chief Executive Officer, Director

Analysts

Jessy Hayem – TD Securities

Sara O'Brien – RBC Capital Markets

Kenric Tyghe - CIBC

Martin Landry - Desjardins Securities

Spencer Hill - Credit Suisse

Anthony Zicha - Scotia Capital

David Glick – Buckingham Research Group

Doug Cooper - Paradigm Capital

Claude Proulx – BMO Capital Markets

Eric Tracy – BB&T Capital Markets

Sarah Hughes – Cormark

Candice Williams – Genuity Capital Markets

Randy Fullock - EOS Partners

Vishal Shreedhar - UBS

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2009 Gildan Activewear earnings conference call. My name is Shanelle and I will be your coordinator for today. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Miss [Sophie Argiriou]. Please proceed.

Sophie Argiriou

Thank you, Shanelle. Good morning, everyone and thank you for joining us. Earlier this morning we issued our press release announcing our earnings results for the second quarter of fiscal 2009 and our interim quarterly shareholder report containing management’s discussion and analysis of consolidated financial statements. These documents are available on our website at www.gildan.com and will be filed with the

Canadian securities regulatory authorities and the U.S. Securities Commission.

I am joined here today by 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 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 filings 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 Laurence Sellyn. Laurence.

Laurence G. Sellyn

Good morning. EPS for the second fiscal quarter was $0.06 per share, down significantly from $0.35 in the second quarter of last year. The decline in earnings was due to four factors -- weak demand for activewear in the screen print channel due to the overall economic conditions, further distributor destocking as a result of our decision to limit our credit exposure to our largest wholesale distributor, as it undertook a process of debt restructuring, a lower proportion of higher value activewear products in our activewear sales mix, and the consumption of previously manufactured high-cost inventories in our cost of goods sold in the quarter.

As a result of these factors, net sales in the second quarter declined to $245 million, down 17% from $294 million a year ago, and gross margins in the quarter were 15.8%, compared with 28.8% in the second quarter last year.

Unit shipments of activewear into the U.S. screen print channel declined by 14.8% or 1.6 million dozens. Approximately 1.2 million dozens of this decline was due to an 18% decline in overall industry shipments from U.S. distributors to U.S. screen printers as reported by Stars. A further 1.4 million dozens decline was attributable to distributor destocking, primarily as a result of our decision to limit inventory replenishment to [Broder], which significantly depleted its inventories during the quarter.

These negative factors were partially offset by increased market share in all product categories, which positively impacted our unit volumes by approximately 1 million dozens.

Our market share in t-shirts was up from 50.7% last year to 58.1%. Our share in fleece increased from 48.8% to 56%, and our share in the sports shirts category increased from 35.5% to 37.7%.

As a result of our higher market share, unit shipments of Gildan branded activewear from U.S. distributors to screen printers declined 5.5%, compared to 18% for the industry overall. The difference between the 5.5% decline in shipments of Gildan product to screen printers and the 14.9% decline in our unit shipments into the U.S. distributor channels reflects the impact of the destocking due to our lower shipments to Broder.

In addition to the impact of lower unit volumes, activewear sales in the quarter were negatively impacted by a lower proportion of high value fleece and long sleeve t-shirts, and a higher proportion of sales of second quality t-shirts. Irregular t-shirts are a normal part of the screen print business but our irregular sales in the second quarter were abnormally high, as we significantly reduced inventories of second quality product which had accumulated over time.

Sales in the Canadian market declined by 45.9% compared to the second quarter of last year, due to weak demand, distributor destocking, and the decline in the value of the Canadian dollar.

Sales in international markets were negatively impacted by the decline in the value of local currencies, compared to the U.S. dollar. Higher unit sales in Western Europe, the U.K., the Asia-Pacific region and Mexico were offset by the temporary suspension of distribution in Eastern Europe, which had been a growing market in fiscal 2008.

Sales to mass market retailers were essentially the same as in the second quarter of last year. The impact of the rationalization of our sock product mix and the elimination of unprofitable soft product lines during fiscal 2008 was essentially offset by growth in our continuing soft programs, in spite of the weak overall retail market conditions.

Point of sale data for mass market retailers reflecting our sock sale strong retailers to consumers reflect strong growth during the second quarter.

Underwear sales in the mass market retail channel also increased significantly from a very small base a year ago.

Gross margins in the quarter declined significantly to 15.8% compared with 28.8% in the second quarter last year. The decline in gross margins was due to the more unfavorable activewear product mix, which negatively impacted gross margins by approximately 500 basis points, and higher commodity and manufacturing costs, which together reduced gross margins by approximately 800 basis points.

The increase in manufacturing costs was due to the consumption of the balance of inventories produced when energy costs were at their peak, with oil at $140 a barrel. And also reflected the cost of the transition in sock private label brands, which is now complete.

In spite of these transitional inefficiencies in sock manufacturing, gross margins for socks in the quarter were higher than margins for activewear products. The improvement in sock gross margins reflect the rationalization of sock product lines, the completion of the integration of our first sock acquisition, and the successful ramp-up of our sock manufacturing operations in Honduras.

We are planning for the second half of the fiscal year on the basis that the current weak overall macroeconomic conditions will continue, resulting in a continuation of very weak activewear sales demand in the screen print channel and severe selling price competition.

Preliminary stars data for the month of April, which is still to be confirmed, indicates a decline in overall industry unit sales of approximately 17%.

In spite of the continued weak industry conditions, gross margins in the second half of the year are expected to improve compared with the second quarter, due to lower energy and transportation costs, lower commodity and raw material costs, the non-recurrence of factors such as the transition to the new private label sock brands which impacted margins in the second quarter, and more favorable activewear product mix, in line with the normal seasonality of industry demand.

We have good visibility on the positive trends impacting our cost of goods sold, as we will be selling products already manufactured and currently in inventory.

In addition, all of our manufacturing operations in both Central America and the Caribbean Basin are operating very efficiently. The above factors are projected to positively impact gross margins in the balance of the year compared to the second quarter by in excess of 10% before the impact of possible further selling price discounting and production down time.

We utilized approximately $62 million of cash in the second quarter to finance the $78 million increase in receivables, mainly due to higher seasonal activewear sales in the second quarter compared to the first quarter, and approximately $13 million of capital expenditures.

Inventories at the end of the second quarter were slightly reduced compared to the end of the first quarter. The impact of increased unit quantities of activewear finished goods was more than offset by the reduction in activewear unit costs, which will benefit gross margins in the second half of the fiscal year, lower work in process inventories, and lower inventories of socks.

The company ended the quarter with net indebtedness of just under $100 million. While we continue to have a very strong balance sheet and significant un-utilized financing capacity under our revolving bank credit facility, we are planning to completely eliminate our bank debt in the second half of the fiscal year. In particular, we expect to significantly reduce activewear finished goods inventories during the peak summer selling season for t-shirts, in spite of the assumed weak industry demand, by scheduling further production downtime as required.

Net capital expenditures are now projected to be in the range of $60 million to $65 million. The planned incremental capacity expansion projects at existing textile facilities are now being deferred to fiscal 2010. We believe we will be able to quickly ramp up this additional capacity for activewear and underwear, as well as the new [inaudible] for sock facility to meet demand as required and support our business plans for next year.

Within the next 24 hours, we should know the outcome of Broder’s negotiations with its bond-holders. If Broder is not successful in achieving its minimum tender condition to convert its notes into new debt and equity instruments, Broder indicated in its most recent press release that it is taking the required steps to be able to proceed with a Chapter 11 filing. If Broder files under Chapter 11, we may be required to provide for all or part of our net accounts receivable from Broder, which currently amount to approximately $12 million, compared with approximately $18 million at the end of our first fiscal quarter.

However, at this stage, we continue to be optimistic that Broder will be successful in implementing its exchange offer to its bond holders.

Regardless of the ultimate outcome of the Broder restructuring process, inventories in the U.S. distributor channel are very low and we anticipate that industry shipments into the channel in fiscal 2010 will benefit significantly from non-recurrence of the distributor destocking, which has had a significant negative impact on industry sales in the current fiscal year.

Glenn and I would like to end our formal comments by emphasizing that while the macroeconomic environment continues to have a negative impact on our industry, our management team at Gildan feel positive and confident about the operations and future potential for our business. In addition to further consolidating our leadership position and further increasing market share in our core business in the U.S. wholesale distributor channel, we believe that we are currently well-positioned to pursue our growth opportunities in the mass retail channel and other screen print markets over the next 12 months.

We have continued to make key additions to our sales organization to serve these markets and we are achieving excellent service in overall performance levels with our existing retail programs, including the introduction of our new private label sock brands.

The achievement of new retail programs is a major focus of the company’s energies at this time, although you will understand that at this time, we cannot comment on specific programs we are pursuing and discussing.

Sophie Argiriou

Thank you, Laurence. Before moving to the Q&A, as always, I would ask that everyone try and limit their questions to two or three in order to give everyone the opportunity to ask a question and time permitting, we’ll circle back for an extra round of questions. Thanks. Operator, we’re ready for the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Jessy Hayem of TD Securities.

Jessy Hayem – TD Securities

Thank you. Good morning. First question is on the manufacturing down-time that [you have] taken in the second quarter. How many weeks was that? And was the impact as expected, about $0.03 to $0.035 to earnings?

Glenn J. Chamandy

We took about five extra days against our original plan in the quarter and we’ve taken a little extra time during the shut-down in April, which is a planned shut-down during Easter, so we took another six days in the April, which is Q3, basically, so far. And the weekly cost to us after closer analyzing the situation now that it’s become a reality, is closer to $0.025 to $0.03 per week of shut-down.

Jessy Hayem – TD Securities

Okay, sorry, just to make sure I am clear, Glenn, you said five days in total in the second quarter, right?

Glenn J. Chamandy

Second quarter, yeah, and then other than the normal Easter shut-down, we took an extra six days so far in April.

Jessy Hayem – TD Securities

Okay, great. And then -- and I suppose I guess the $0.025 sensitivity would hold for the coming weeks or --

Glenn J. Chamandy

$0.03 is a good working number in terms of weekly shutdown costs.

Jessy Hayem – TD Securities

Okay, great. My second question is on -- I’m just a little surprised to see still $12.5 million in accounts receivable outstanding with Broder, seeing that you had -- you mentioned tightening shipments in the quarter. How many days were these particular receivables outstanding? And can you also comment on the health of the total outstanding receivables? How much of that $176 million you have is over 60 days?

Laurence G. Sellyn

Broder’s current with its receivables at the end of the quarter, so the receivables that are on our balance sheet at the end of the quarter reflect new sales as the previous receivables were fulfilled.

Glenn J. Chamandy

Yeah, and then the receivable number is -- the days outstanding is a little bit higher due to a small dating program of basic t-shirts in the quarter to support the inventory we thought we needed in the channel, and that number should work itself out and be back to normal at the end of this quarter.

Jessy Hayem – TD Securities

Okay, and then does that mean that you have resumed shipping at somewhat normalized rates to Broder so far in the current quarter?

Laurence G. Sellyn

Well, we are waiting to see what they announce within the next 24 hours.

Jessy Hayem – TD Securities

Okay, great. And the final question is can you remind us how early do you guys typically start to cover your [cotton] requirements for the upcoming fiscal year and have you started covering for fiscal year ’10? If so, what percentage is covered and if possible, a price indication on that as well.

Laurence G. Sellyn

Well, we manage that in the context of the market and the circumstances at the time. We will clearly have a significant carry-over of ’09 cotton into ‘010 because of lower volumes this year. We have covered a little bit of cotton for 2010 and even with the carryover from ’09 into ‘010, we would expect our cotton costs in the first half of ‘010 to be significantly below the first half of this year.

Jessy Hayem – TD Securities

Okay, great. Thank you. I’ll circle back for more.

Operator

Your next question comes from the line of Sara O'Brien of RBC Capital Markets.

Sara O'Brien – RBC Capital Markets

Can you talk, Glenn, about your production levels now, I guess sort of expected as a percentage of your total capacity? Just remind us exactly where you are on total capacity potential right now?

Glenn J. Chamandy

Well, we are still running at our capacity level, which hasn’t changed. It’s between $51 million and $52 million if you ran on 49 weeks of the year. That’s our existing capacity and what we are doing is we are managing our inventory based on market conditions and we will take weeks out appropriately as we see fit, and taking a week out at a time basically to -- based on the outcome in the marketplace. So we haven’t changed really our overall capacity at this point in time.

Sara O'Brien – RBC Capital Markets

Can you talk about like what is your expectation at this point in terms of number of weeks, production shut-down for the back-end? And maybe just to comment on a number -- I know your inventory is stable but in units, it’s up. How many weeks of units do you have on hand versus last year?

Glenn J. Chamandy

Well, I mean it’s -- I really don’t want to get into that but I would say this --

Laurence G. Sellyn

Both of these questions, Sara, are obviously a function of our sales projection for the second half of the year and we don’t to guide on sales. We don’t have the visibility.

Glenn J. Chamandy

The only thing I would say is that in unit ship -- unit volumes, we needed more inventory at the end of fiscal 2008, our inventories were excessively low, so we needed more unit volume to support our ongoing business based on the share we have in the market today. But I would say in pure dollar value, our objective is to get pretty close to the end of 2008 inventory numbers is a good target for us.

Sara O'Brien – RBC Capital Markets

Okay. And can you just talk, Glenn, I mean, if Broder does get its exchange offer today and you continue and you see restocking next year, do you think under normalized conditions, excluding any new retail programs, you would be able to fill the 51 million to 52 million dozen capacity? Or would you expect to have to take some shut-down next year?

Glenn J. Chamandy

Well, the way we look at is this -- we feel that to now, we destocked in Q1 significantly. We’ve now destocked again in Q2, so the total destocking so far is roughly about 3 million dozens, which year over year, we believe will come back next year.

Laurence G. Sellyn

Three million dozens for Gildan, not for --

Glenn J. Chamandy

Yeah, 3 million dozens just for us, let’s say, on a year-over-year basis, which has been destocked. Because if you remember, our sales to the distributors is much lower than the actual sales to the end user because we destocked the channel by 3 million dozen.

Sara O'Brien – RBC Capital Markets

Right.

Glenn J. Chamandy

And then if you look at the market, let’s say, for example, which we are conservative and you say look at the market could grow, let’s say for example, by 5%, come back by 5%, that would add another about 1.5 million of opportunity for us next year. And if we were to pick up another couple points of market share, that could add just over 700,000 dozen. And we have put a big emphasis right now on going after direct business, which is those big private label companies, and that should conservatively -- we’ve just hired two sales people this year. That’s a growing part of our business and that we believe could add another million dozen for next year.

And then if you looked at our international growth in all the different markets, that probably conservatively would be a million dozens on a year-over-year basis, so if you look at just go forward and not really a big rebound in the market, we believe that adding 7 million dozens to the base of this year is probably a realistic target for us, and that’s without any type of retail windfall that we are really pushing hard right now. We’ve put in additional sales people to support and build our sales team and we are working very diligently today with all the major retailers to get placement.

So if you take all this into account, I mean, we are pretty optimistic that we could fill our capacity out next year. And also, just refreshing your memory, is that we also made plans to make incremental capacity expansions on our existing facilities, if we wanted to expand our capacity from 52 million to the 58 million to 60 million level with a very insignificant capital investment of just about $7 million to $8 million, and also with a lead time probably about four months to be able to do that.

So we have lots of time to actually increase our capacity past the 52 million, but at this point in time, we feel comfortable with our existing capacity level, and also we are going to have enough inventory at the end of this year in unit volumes to support the ongoing business, basically, so we also feel very comfortable with that as well.

So we’ve got a lot of flexibility, we are very optimistic. We are navigating through these times right now and we are really looking forward to the future and next year.

And the other thing is, is that I think you have to add on to that is that we are also working hard on the margin front, although we were disappointed with the margins now for this quarter. We have a lot of cost initiatives that are happening. We are going to have margin expansion as we go into the back of the year. But going on a year-over-year basis, especially in the first half of next year, we are going to have much lower cotton and energy costs, and as well we are in the process of moving all of our sock finishing off shore, which will be complete by the end of the third quarter. And that also will help our margins as we go into next year and our objective is that in retail, especially in socks, we are going to have our margins equal to or better as we go forward into the wholesale market.

So all those things combined, we are pretty optimistic and -- I don’t know if that answers your question.

Sara O'Brien – RBC Capital Markets

Yes, pretty complete. Thank you. And then maybe just a last question -- you talk about severe selling price pressure. How bad is it going to get and are you the leader on this, and is it to stimulate demand or is it to eliminate competition?

Glenn J. Chamandy

Well, right now I think it’s partly because there’s nowhere to hide in the industry. I mean, I guess, just like we’ve continued to manage our credit exposure with Broder, I think the whole industry is in the same position so people are, I would say, desperate in certain cases to move inventory, so that’s probably created a lot of price pressure, and I think in the event that Broder is successful with their bond offering, I think that will alleviate a little bit of the price pressure because I think that will just help the dynamics in the industry.

We feel that our market share is going to grow and hit our objectives and without massacring the pricing in the market, so we are trying to manage as best possible the -- obviously our pricing in the marketplace. We don’t think that there’s more units being sold because of this aggressive pricing. It’s somewhat a futile exercise and hopefully we will get some stability but because the market is down so significantly, it’s obviously -- and as well as the largest distributor, you know, in his situation, I think that this has compounded the issue so we will see what happens as we go forward. But obviously we will plan for the worst.

Sara O'Brien – RBC Capital Markets

So when you talk the worst, are we talking like another 8% decline or are we talking more like half that?

Glenn J. Chamandy

I think that the pricing is pretty well at a floor today. I mean, things are being sold pretty cheap so I think where we are now, maybe a little bit -- I think my gut feeling is that I think we are sort of at where pricing needs to be today.

Sara O'Brien – RBC Capital Markets

Can you tell me where that is, just relative to last year? Because I thought in your press release you said pricing was pretty flat.

Laurence G. Sellyn

Yeah, that’s what we said and you know -- I mean, I don’t think we can really -- we have visibility or can guide in pricing, and it may be --

Glenn J. Chamandy

There could be a couple of more percentage points to come out of it but that’s -- I think that’s where it’s at.

Sara O'Brien – RBC Capital Markets

Okay. Thanks a lot. I’ll just go back.

Operator

Your next question comes from the line of Kenric Tyghe of CIBC.

Kenric Tyghe - CIBC

Good morning. I just wanted to follow-up -- you mentioned the 1.4 million dozen units distributed destocking impact in the quarter. Appreciating that the majority of that would have been Broder, I wonder if you can just give some color around the order of magnitude that was attributable specifically to Broder versus the number sort of two, three, and four in the market?

Laurence G. Sellyn

By far the majority of it was Broder.

Glenn J. Chamandy

And a small portion in the Canadian market as well.

Laurence G. Sellyn

No, that was just the U.S. number, so Broder was by far the majority of that number.

Kenric Tyghe - CIBC

Thank you.

Operator

Your next question comes from the line of Martin Landry of Desjardins Securities.

Martin Landry - Desjardins Securities

Good morning. Can you give us a bit of color on prices of activewear during the quarter? Were they down year over year?

Laurence G. Sellyn

No, the selling prices were a little bit more favorable than the second quarter of last year -- in other words, the increase in gross selling prices were offset by higher promotional discounting but the net effect was slightly more favorable. Then, on top of that, we had lower realizations in our international sales because of currency. When you factor that into overall pricing, including the international side, was flat compared with last year.

Martin Landry - Desjardins Securities

Okay. And going on the international front, can you tell us how was your sales performance in local currency?

Laurence G. Sellyn

Well, we were up significantly as we say in the press release from a small base in Mexico and Asia-Pacific. We also grew even in weak markets in the U.K. and Western Europe and the only area where we were down is that we didn’t continue sales in Eastern Europe, which was a very growing market in the first half of last year and where there are significant economic issues.

Martin Landry - Desjardins Securities

Okay. And lastly, you’ve taken a provision of $2 million for severance costs in Central America. Can you give us a bit more detail on that?

Laurence G. Sellyn

Sorry?

Martin Landry - Desjardins Securities

I’ve read in your notes that you’ve taken a provision of $2 million for severance costs during the quarter. Can you give us a little bit more detail on that?

Laurence G. Sellyn

That’s just an ongoing legal provision that we always take that’s required in Honduras as part of the local labor compensation practices. There’s nothing different about that.

Martin Landry - Desjardins Securities

Okay. All right. Thank you.

Operator

Your next question comes from the line of Omar Saad of Credit Suisse.

Spencer Hill - Credit Suisse

This is Spencer Hill at Credit Suisse, on Omar Saad’s team. Good morning, everyone. We were just hoping that you could discuss he notion of screen printing as kind of a late cycle category, and I think it’s prudent to plan your business conservatively for the rest of the year but as we start looking at an eventual recovery, we are just curious about the cadence of that recovery, you anticipate whether it tends to be v-shape curve or a longer, slower rebound that kind of lags the business cycle.

Glenn J. Chamandy

We are projecting a slower curve but if you go back to 2001, it actually bounced back right away, so there was -- you know, the following year the markets came back pretty strong but obviously we don’t think -- we think the economy today is much more severely affected this time around versus 2001’s recession. But one thing for sure is that if you look at the marketplace today and talking to our customer base, is that the actual order quantity, which is the orders that they take, hasn’t really deteriorated and what’s happened in the market is that the bigger orders, those big quantity promotional products, let’s say, for example, that’s really the part that’s being affected, so the every day business is still there and the order counts are still at an adequate level and basically it’s just a question of bringing back the bigger pops that really drove the volume in the marketplace, and I think that’s what is missing so far.

So when that come back, the industry will come back relatively quickly.

Spencer Hill - Credit Suisse

Great. Thank you very much.

Operator

Your next question comes from the line of Anthony Zicha of Scotia Capital.

Anthony Zicha - Scotia Capital

Good morning. In the event of a bankruptcy with Broder, what are your contingency plans? Like how long would it take to replace this business volume in terms of time?

Glenn J. Chamandy

Well, the way the market works is that we have, we believe, sufficient --

Laurence G. Sellyn

Maybe before we answer that, Glenn, we should say that Broder does not seem to be envisaging a liquidation scenario. We are optimistic that they are going to be successful in completing their exchange offer and we will know the results of that very shortly. So that’s scenario number one.

And failing that, they’ve indicated that they are preparing to go into Chapter 11, not Chapter 7, and are -- you know, as part of that, that would involve getting debt financing to be able to operate under Chapter 11. So a liquidation is not Plan A or Plan B. But what we’ve always said in that kind of a situation is that end use demand in the market will not change from screen printers, distributors and other distributors would ramp up to fill the void in that eventuality which we don’t foresee happening.

Anthony Zicha - Scotia Capital

Okay. With reference to [inaudible] Five and Four, are you still [deferring] the construction of Five? And when do you plan to have it back on? And with reference to the [Rio Nancy] Four are you still deferring the ramp-up and utilizing as a distribution center? And how long will it be back online?

Laurence G. Sellyn

Before Glenn answers, we have in our updated capital expenditure estimate that we have, we have further expenditures for Four where we are putting in infrastructure for the expansion of the facility, so we are still planning to move ahead with Rio Nancy Four. It’s just a question of timing. And Rio Nancy Five is not in or capital budget for this year.

Anthony Zicha - Scotia Capital

Okay. Thank you.

Operator

Your next question comes from the line of David Glick of Buckingham Research Group.

David Glick – Buckingham Research Group

Good morning. Laurence, just a clarification -- on gross margin, you said that it would improve by potentially in excess of 1,000 basis points in the back half, before the impact of discounting and down time. So are we to assume that it may not improve on a net basis by that amount? I am just trying to get some clarity on what you really mean by that. Obviously it’s up on a gross basis but on a net basis --

Laurence G. Sellyn

Well, what I said or intended to say was that on a gross basis, we would expect to achieve in excess of 10% improvement from a combination of improved manufacturing costs and more normal product mix. That would be -- that plus 10% number would be offset by the shutdown, the costs of production downtime we take in the second half and if there is further discounting in excess of what we experience in the second quarter.

David Glick – Buckingham Research Group

Okay. Any possible range of impact that you could give us, just some sense of how much of that could be offset?

Laurence G. Sellyn

I think we don’t have the visibility to be able to say that. I mean, Glenn did give you some comments on what he though pricing pressures would amount to but in this unique environment that we are in, we don’t really have visibility and I don’t think it would be appropriate for us to try to guide you better than we are doing.

David Glick – Buckingham Research Group

All right. Fair enough. And then on the SG&A line, that was a lot better than -- certainly than we were forecasting. I would think you would have a little more visibility on that line. How should we think about the SG&A dollars for the balance of the year? Should we still think of them as being down similar to the level they were down in the second quarter?

Laurence G. Sellyn

Well, we are -- some of the SG&A is volume related but also we’ve placed significant emphasis on cost control and we are achieving efficiencies in our supply chain and distribution costs, which are also favorably impacting SG&A. Plus another factor is the negative impact that you are seeing on the sales line with currency fluctuations is partially offset by the benefit in SG&A due to the impact of the lower Canadian dollar on our corporate administration costs.

David Glick – Buckingham Research Group

So then at least through the third quarter, we would see that benefit -- is it the fourth quarter where that FX benefit starts to subside?

Laurence G. Sellyn

It depends what happens to exchange rates.

David Glick – Buckingham Research Group

I mean, given where they are now.

Laurence G. Sellyn

I would say that we should be potentially looking at lower SG&A in both the third and the fourth quarters of last year.

David Glick – Buckingham Research Group

That’s helpful. Thank you very much. Good luck.

Operator

Your next question comes from the line of Doug Cooper of Paradigm Capital.

Doug Cooper - Paradigm Capital

Good morning. I just want to concentrate on market share gains. It looks to -- this is the biggest market share leap I’ve seen, I guess, in quite some time. What do you attribute it to? Is there people that are having financial issues or who do you think you are taking share from?

Glenn J. Chamandy

Well you know, I think it’s contributed to the momentum that we have in the market and the strength of our brand amongst its distributors. You know, it’s taken a long time to build the reputation, the quality, in the channel and this is just a reflection of 15 years of consistent, delivering best quality value relationship in the market. And we believe that there’s still further upside in terms of our share and that’s really what it’s contributed to.

So the other thing is that we -- we are very large in the t-shirt area and 100% cotton t-shirts, but the 50-50 category was still a growing opportunity for us. We only moved that product offshore when we built Rio Nancy Two. Our current market share there is under 40%. It’s in the high 30s, and as we continue to get traction in that product, that’s going to bring our overall share of t-shirts up.

In fleece, we have a huge momentum in the marketplace, again because of the quality value relationship that we’ve been able to achieve through our Rio Nancy Two facility, and the product enhancements that we have made over time.

And the area where we still see lots of opportunity, actually, believe it or not is the sport shirts where we haven’t achieved the same type of share as we have in t-shirts and in fleece, and that’s going to be a big emphasis for us as we go forward. So we believe that there’s still continued opportunity and we are very excited about the outcome.

Doug Cooper - Paradigm Capital

You used to talk about 60% being the target, I think. You’re at 57% today, so are you ahead of schedule? And how do you see the industry evolving over the next say three or four years in terms of the number of players in it?

Glenn J. Chamandy

Well you know, it’s hard for us to say, to be honest with you, and I don’t want to comment on the other players in the industry. All I can say is that I think there’s a little bit of upside for us -- there’s definitely upside for us in terms of taking more share and that’s what we are going to position and how we are going to position our company.

Doug Cooper - Paradigm Capital

Okay. In terms of cotton costs, what is the delta, do you think, year over year in terms of cents per pound, 2010 versus -- or first half of 2010 versus first half of 2009?

Laurence G. Sellyn

I don’t think I really want to give you a number, Doug, but as what we said is as we go through -- what we said at the beginning of this year is that as we go through the year, our cotton costs will come down significantly between the beginning and the end, even though not as low as what cotton reached at the bottom of the commodity cycle. But our cotton costs are coming down and the carry-over of the lower cost cotton from the second half of the year into the first half of next year will result in significantly lower cotton costs in the first half of next year, compared with the first half of this year.

Doug Cooper - Paradigm Capital

And just one final question on the retail side -- the sock program is the private label program with Walmart, I’m assuming, that is going well?

Glenn J. Chamandy

Well, all of our programs are doing pretty good. I mean, Walmart is doing extremely well. You know, most of our programs basically on a -- if you take a program on a year-over-year basis something that is consistently sold to a department or within a retail store, on average we are up anywhere between 6% and 8% on the existing program, so we are very excited. We did a lot of work on rationalizing our product lines over the last 12 months and streamlining our manufacturing in Central America. And although our margins have increased in socks, there’s still a lot of upside on margin but I think more importantly what’s happening is that the price/value relationship at retail is very good and that’s what’s driving our market share in the hosiery area and we are looking for new programs as we go forward, and also leveraging this sock opportunity and success into other categories, like underwear and activewear as we go forward.

Doug Cooper - Paradigm Capital

So just on that, is the -- are the major retailers, are they migrating their private label business from socks to activewear?

Glenn J. Chamandy

Well you know --

Laurence G. Sellyn

Our thrust is clearly to build on our strong market position in socks to achieve our targeted penetration in other product categories and be a [inaudible] supplier of basic family apparel.

Doug Cooper - Paradigm Capital

And just one final question on the -- Glenn, you were talking about the big, sort of the big unit orders on the screen print channel is what’s necessary to get this thing going again. Is that mostly on the corporate promotional side, as opposed to say tourism or sports teams and so forth?

Glenn J. Chamandy

You know, it’s a combination because it’s basically -- it’s in the auto industry a little bit. You have it in the promotional products, you have it everywhere, basically, so -- the thing which I think is important is that the order count is a big criteria in terms of making sure that everyday business is there and the volume that has disappeared from the market are these larger type programs and once the economy turns, these programs should come back and that’s what we saw in 2001 and hopefully we’ll see the same rebound again. But we’re still projecting conservative -- in my mind, I am still conservative only because of the severity of this recession but hopefully things will come back a lot quicker than we think.

Doug Cooper - Paradigm Capital

All right, so 2010 you are forecasting the market will still be down 10% plus versus where it was in 2008?

Glenn J. Chamandy

You know, we haven’t made our forecasts yet, so it’s hard for us to say but in my mind, what I feel today is that will it bounce back to last year’s levels? I mean, I still find it is going to take a little longer than that only because of the severity of the recession but we believe it will bounce back and the question is when.

Doug Cooper - Paradigm Capital

Thank you very much.

Operator

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

Claude Proulx – BMO Capital Markets

Thank you. Good morning. First question, just to make sure that we have the right figure, you are talking about a thousand basis points of improvement in gross margin, not the 10% improvement?

Laurence G. Sellyn

We’re talking about 1,000 basis points, yes, which is a 10% increase, not 10% of 15 but 10% of 100.

Claude Proulx – BMO Capital Markets

Okay, just to clarify -- the other thing is you said before down time and potential additional pricing pressure, are you factoring in the six days of down time that you have already taken in the second half, or that’s going to reduce the 1,000 basis points that --

Laurence G. Sellyn

Yes, that’s right. That’s in the base.

Claude Proulx – BMO Capital Markets

You mean that if --

Laurence G. Sellyn

That’s in the Q2 base.

Claude Proulx – BMO Capital Markets

Okay. You mean it’s 1,000 basis points including the impact of the [fixed base]?

Laurence G. Sellyn

No, it’s 1,000 basis points -- including the equivalent of what downtime we took in Q2, so additional downtime on top of that, if it is required in the second half of the year will reduce the impact of the positive manufacturing costs and the positive product mix, along with any increase in selling price [inaudible].

Claude Proulx – BMO Capital Markets

Okay. I thought I understood that you had already taken some in the third quarter.

Laurence G. Sellyn

Some what?

Glenn J. Chamandy

We took six days in April.

Claude Proulx – BMO Capital Markets

Okay, and lastly -- I mean, you’ve stepped up the effort to sell more in Mexico, Europe, and also the direct selling to those big private brand screen printers -- I mean, how much of that impact is in the Q2 and I suppose we’ll see a lot more impact in Q3 and Q4, is it fair to say that?

Glenn J. Chamandy

Well you know, that’s a growing business for us and it just doesn’t happen overnight but I think one thing for sure is that these other markets have been adversely affected from the recession as well, so we’ve actually seen growth, except for that one market in Hungary -- all the other markets have actually grown. But the actual markets themselves have gone significantly backwards. So our share gains and unit volume is exceptionally well relative to the overall market performance, so I think we’ve done very well in penetrating these markets. And they may be down equal to or even worse in the states. We don’t know at this point because we don’t have the same type of data from Stars as we have in the United States.

But we are going to continue to penetrate. There’s a longer term thing and what I said before was that this will be part of the piece of the puzzle that will continue our overall volume increase on a year-over-year basis and contribute growth for the company.

Claude Proulx – BMO Capital Markets

Okay. Thank you.

Operator

Your next question comes from the line of Eric Tracy of BB&T Capital Markets.

Eric Tracy – BB&T Capital Markets

Good morning. If I could just follow-up on the Broder Brothers -- assuming that that gets done, could you talk about the restocking expectations for the back half and the terms at which you would sell or deliver product to them? Can we assume that would be profitable sales or just maybe talk through that dynamic?

Laurence G. Sellyn

We would see no reason why we wouldn’t resume normal trajectory of sales and the margins have been and will continue to be reflective of our overall margins.

Eric Tracy – BB&T Capital Markets

Okay. And when you say normalized levels, Laurence, in terms of that, is that [sort of merge] into the mean there or are we still -- are they in a position with the cadence being still a bit slower there?

Laurence G. Sellyn

The margins for them will be consistent with any one of our other customers, so there will be no difference, if that answers your question.

Eric Tracy – BB&T Capital Markets

Okay. And then just -- is it possible just to follow on this gross margin to get the quantification of the impact of the down time plus the lower selling prices in Q2 of that, call it 13 percentage points year over year decline, which -- how much came from the lower selling prices and down time?

Laurence G. Sellyn

Well, as far as selling prices, I don’t really want to say more than what we have already said, which is that the deductions offset the majority of the gross price increase that we implemented during the course of last year and there was a slight net benefit in the second quarter. And the downtime, you can extrapolate from what Glenn’s said, that we took -- you know, he’s given you the amount of down time and the cost per week.

Eric Tracy – BB&T Capital Markets

Okay. And then maybe just talking -- I know you had a really strong fleece program last year and Glenn, I think you mentioned that you still have huge momentum in that category. Could you talk a little bit about sort of the visibility you have for the back half for fleece?

Glenn J. Chamandy

Well you know in terms of share and market share, we believe our share will continue to grow. The only thing I would say is that up until now when we actually are managing again our credit exposure, so typically in fleece we do major dating programs and so that may reduce a little bit the sales in Q3, let’s say, for example, but those sales will still -- will appear, just at a later date. So there would be a little bit of a timing switch, I would say, from quarter to quarter. But ultimately, we will sell an increased volume of fleece for this fleece season.

Eric Tracy – BB&T Capital Markets

Okay, so the expectations sort of a shift from Q3 to Q4?

Glenn J. Chamandy

Yeah, and maybe some of it even to Q1, because the fleece season really happens in -- from August through December, January is when the season actually transpires.

Eric Tracy – BB&T Capital Markets

So last year was just an early delivery?

Glenn J. Chamandy

Typically it’s early every year and we will have some early sales but more of the portion of the sales will be sold when the garments are required in season.

Eric Tracy – BB&T Capital Markets

Okay. And then maybe just lastly, Glenn, for you in terms of strategic opportunities -- you’ve had success with the sock programs at retail -- any thought to -- I know you are pushing off capacity expansion but kind of why not, given that success, transition some of that capacity and trying to accelerate or penetrate retail a little bit quicker? Is there something else going on there that --

Glenn J. Chamandy

No, we are working very diligently on penetrating retail as fast as we can and we have the capacity right now and we also have the ability to incrementally increase capacity relatively quickly, which we did not have a year ago. So the stars and the moon are aligned right now, and between our service, leveraging our sock business, and building up our sales team, and also this is the overall company exposure with the major retailers now in a position to capitalize on our success.

So this is what’s going to happen. It just takes a little bit of time. Unfortunately you just can’t walk in overnight. Retailers plan anywhere between 12 to 18 months in advance as they determine their branding strategies or their placements on the floor. So we’re there today. We expect to penetrate business for next year and we basically feel comfortable with our positioning.

And the cart doesn’t come before the horse but we are comfortable and committed and this is the major emphasis on the company today, is to be successful in launching our retail initiatives.

Eric Tracy – BB&T Capital Markets

Okay, great. Thank you, all.

Operator

Your next question comes from the line of Sarah Hughes of Cormark Securities.

Sarah Hughes – Cormark

Just a few quick questions -- Laurence, can you tell us what your average cotton cost was this quarter?

Laurence G. Sellyn

It was close to $0.70.

Sarah Hughes – Cormark

Okay, and then just gross margins on the socks, you indicated that they were above activewear -- just wondering if they are getting close to where the activewear margins were post or prior to the downturn?

Laurence G. Sellyn

They are not that high but as we go through the year and improve our activewear margins, we expect the sock margins to -- and the sock business to be equally profitable to the activewear.

Sarah Hughes – Cormark

Okay, so we could see that --

Laurence G. Sellyn

We’re very happy with the way the economics of our sock business is developing as we have ramped up our facilities offshore and completed the integration of our sock acquisitions and the rationalization of our product mix.

Sarah Hughes – Cormark

Okay. And then just lastly, just on the international market, I know, Glenn, you indicated that going into 2010 you could potentially see a million dozen improvement there -- I’m wondering if that’s dependent on a return on Eastern Europe, or if that remains weak, you could still achieve that target?

Glenn J. Chamandy

I would say that that’s a conservative number and we feel that within all the markets we’re servicing, that’s something that is very conservative for us.

Sarah Hughes – Cormark

Okay, great. That’s it. Thanks.

Operator

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

Candice Williams – Genuity Capital Markets

Good morning. I’m wondering if you could tell me what your new CapEx plan includes, and maybe what you have excluded from your previous projections?

Laurence G. Sellyn

The three projects in the main projects in our capital plan for this year are the money that we have spent and are continuing to spend on Rio Nancy Four, the DR Biomass project, and the transition to the new office as we expand our infrastructure in Barbados.

Candice Williams – Genuity Capital Markets

Great. And when you speak about the seconds produced in 2008, can we assume those are from the DR production issues, throwback to that time? Or are there other issues that came up throughout the year that had you producing a greater proportion of second seed otherwise like?

Laurence G. Sellyn

This set accumulated over time and we took the -- you know, we had opportunities to blow out irregulars and significantly reduce our inventories.

Candice Williams – Genuity Capital Markets

Perfect. And then my last question would be on China -- there’s been some interesting news articles out lately, sort of outlining plans that may not necessarily have come from you and I was wondering if you could give us an update on your progress there?

Glenn J. Chamandy

Well, we are still making our plans. I mean, we are continuing to sell and Asia was a growing market for us this quarter. But that’s a market under development right now and we are continuing to assess the market and we’ve hired again a couple of individuals -- we have inventory in the market there and we are going to continue to drive our strategies in Asia.

Candice Williams – Genuity Capital Markets

Great, thanks.

Operator

Your next question comes from the line of Randy [Fullock] of EOS Partners.

Randy Fullock - EOS Partners

Most of my questions have been touched upon but I was just curious -- it seems like you are doing a pretty good job in Walmart in particular, and in addition to that, I heard you say on the call that you were doing better in the underwear category. So a couple of questions -- do you expect that -- it sounds like there are share gains going on in some of the big box retailers. Would you agree that you are taking share and do you expect that to continue? And what’s the basis of your ability to take that share?

Glenn J. Chamandy

Well obviously the more unit volume in which we sell to these retailers is taking share from somebody. I mean, we’re not sure where and who the share is actually coming from today but based on our value/quality relationship that we put together, really it’s the same -- we believe we have the same opportunity, like in wholesale -- I mean, what’s made us so successful in wholesale is the best value product for the best price. And those are the same dynamics that we believe that we can offer these retailers. And as retailers continue to look at expanding their margins, enhancing their stores and their brands and their stores, we believe we can capitalize on that and share in that opportunity, and that’s what we are going to -- that’s really the crux of our whole retail strategy.

We are going to combine that strategy in terms of helping them with their own brands as well as supplying our brand to regional retailers, which has also been very successful and we’ve seen significant growth in every one of those accounts.

So again we feel comfortable. We are positioned where we need to be and as we lever this opportunity from our success in our socks, this will give us an open door to other new programs in activewear and underwear at the big box retailers.

Randy Fullock - EOS Partners

Thank you. One more question -- is there any big opportunities ahead, either bids for chunks of business or anything like that at Walmart or any of the other big retailers that you are either involved with or would like to be involved with?

Glenn J. Chamandy

Again, we are not going to specify any type of programs. We are working, building a long-term relationship and a long-term base and I think we’ve covered exactly our positioning so far.

Randy Fullock - EOS Partners

Okay, well, it sounds like you guys are doing a good job. Thank you.

Operator

Your final question comes from the line of Vishal Shreedhar of UBS.

Vishal Shreedhar - UBS

Thank you. I just have a few quick ones -- in the MD&A, you mention that there’s increased likelihood of credit concerns with your other wholesale customers. Can you talk about that?

Laurence G. Sellyn

I think that’s in the risk factors as a risk exposure, but we do not see -- we do not have any specific concerns about credit in any of our wholesale distributors.

Vishal Shreedhar - UBS

Can you talk about what gives you the confidence that Broder is going to be able to restructure? I mean, obviously you are saying margins are going to improve at H2 -- the implication is that Broder is going to be there, so can you talk about that?

Laurence G. Sellyn

Well, in their press release, they talk about the fact that they are close to their tender target for the [inaudible] exchange and hopefully they will get over the hump and I am only really going by what they have indicated in their public announcements. They also have said that if they don’t achieve that increment to meet their target, they are preparing to go into Chapter 11, which implies having all the -- everything in place to continue to operate under Chapter 11 and based on what they are saying, hopefully that is what will transpire, that they will be able to achieve the implement exchange offer and failing that, operate under Chapter 11. And they have a good business that they have built up over the years.

Vishal Shreedhar - UBS

So does your guidance of 10 bps or 10 points of margin improvement in H2, does that also contemplate a scenario where they go into Chapter 7, or Chapter 11, sorry?

Laurence G. Sellyn

That number is not sensitive to what happens with Broder.

Vishal Shreedhar - UBS

Okay. And just a last one, last quick one -- what is your maintenance CapEx?

Laurence G. Sellyn

I would say there’s probably $5 million to $10 million in our capital expenditures for this year.

Vishal Shreedhar - UBS

Okay, thank you.

Operator

Ladies and gentlemen, that concludes the Q&A session. I would now like to turn the call back over to your host, Ms. Sophie Argiriou.

Sophie Argiriou

I would like to thank everyone for joining us today. We appreciate your interest and we look forward to talking to you again at our next earnings conference call. Thank you and have a good day.

Operator

Ladies and gentlemen, that concludes the presentation. Thank you for your participation. You may now disconnect. Have a great day.

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Source: Gildan Activewear F2Q09 (Qtr End 4/5/09) Earnings Call Transcript
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