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Gildan Activewear Inc. (GIL)

F1Q10 (01/03/10) Earnings Call Transcript

February 9, 2010 5:00 pm ET

Executives

Sophie Argiriou – Director, Investor Communications

Laurence Sellyn – EVP, Chief Financial and Administrative Officer

Glenn Chamandy – President & CEO

Analysts

Martin Landry – Desjardins Securities

Sara O'Brien – RBC Capital Markets

Jessy Hayem – TD Newcrest

Anthony Zicha – Scotia Capital

Omar Saad – Credit Suisse

Bill Fisher [ph] – Raymond James [ph]

Claude Proulx – BMO Capital Markets

Candice Williams – Genuity Capital Markets

Jim Duffy – Thomas Weisel Partners

David Glick – Buckingham Research Group

Doug Cooper – Paradigm Capital

Scott Rattee – CI Capital Markets

Vishal Shreedhar – UBS

Operator

Good day, ladies and gentlemen, and welcome to the first quarter 2010 Gildan Activewear earnings conference call. My name is Louisa and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator instructions) I would now like to turn the call over to Ms. Sophie Argiriou, Director, Investor Communications. Please proceed.

Sophie Argiriou

Thank you, Louisa. Good evening – good afternoon, everyone, and thank you for joining us. Earlier today, we issued our press release announcing our earnings results for the first quarter of fiscal 2010 and our interim shareholder report containing management discussion and analysis and consolidated financial statements. These documents will be filed with the Canadian securities regulatory authorities and the US Securities Commission and are also available on our website at www.gildan.com.

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.

At this time, 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 or 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 now like to turn the call over to Laurence Sellyn.

Laurence Sellyn

Good afternoon. This afternoon, we announced our results for our first fiscal quarter, which reflected a strong recovery from the first quarter of fiscal 2009 and were slightly ahead of our internal expectations as well as the consensus estimate of analysts filing with First Call.

EPS was slightly higher than the company’s internal forecast as impact of lower than anticipated promotional activity in the US wholesale distributor channel and more favorable product mix, more than offset the impact of the timing of replenishment of the US wholesale distributor channel, which is benefiting activewear shipments early in the second quarter of the fiscal year. In addition, we reconfirmed our business outlook and sales and margin assumptions for the full fiscal year, which we have provided in December.

Results for the first quarter continued to reflect the positive momentum begun in the third quarter of fiscal 2009. Before a small $0.01 restructuring charge related to the consolidation of our US retail distribution activities at our new retail distribution center at Charleston, South Carolina, EPS of $0.24 were significantly higher than $0.04 per share in the first quarter of last year when our business first experienced a significant impact from the economic downturn and were at the same level as the first quarter of fiscal 2008, which had represented our record earnings performance for the first quarter of the fiscal year for Gildan.

Compared with the first quarter of fiscal 2009, the recovery in EPS was due to strong growth in activewear unit sales volumes in spite of weak overall industry demand, significant gains in manufacturing efficiencies, lower cotton and energy costs, and more favorable activewear product mix, partially offset by lower activewear net selling prices.

Sales in the first quarter of fiscal 2010 amounted to $220 million, up 19.8% compared to the first quarter of last year. Sales of activewear and underwear increased by 32% and sales of socks were essentially flat compared to a year ago. The strong growth in sales of activewear and underwear primarily reflected a 31.5% increase in activewear unit sales volumes, due to higher market share in the US wholesale distributor channel, lower seasonal inventory destocking by distributors than in the first quarter of fiscal 2009, and increased penetration of international and other screenprint markets.

The strong growth in unit volume sales was achieved in spite of an 8.9% decline in overall industry unit shipments from US distributors to US screenprinters. The higher volumes, together with more favorable activewear product mix, were partially offset by an approximate 3.5% reduction in net selling prices for activewear compared to the first quarter of fiscal 2009.

Market share for all product categories combined in the US distributor channel based on the S.T.A.R.S. report increased significantly to 61.3% in the first quarter compared to 57.1% in the fourth quarter of fiscal 2009 and 53.3% in the first quarter of last year. Unit shipments in international and other screenprint markets increased by over 80% compared with the first quarter a year ago and accounted for close to 25% of our total screenprint unit sales in the quarter.

The rate of year-over-year decline in overall industry shipments in the US wholesale distribution channel appears to be moderating. Preliminary S.T.A.R.S. data for the month of January 2010 indicates a 1.5% decrease in overall industry demand, combined with a further significant increase in Gildan's market share, with our overall market share for all product categories combined increasing to 64.3% from 61.3% in the fourth quarter.

Overall industry inventories in the US wholesale distributor channel at the end of the first quarter were in good balance. Distributor inventories decreased by 15.5% compared with last year and the availability of supply in the channel maybe pressured if industry demand continues to stabilize. In addition, Gildan’s share of distributor inventories was 49.8% compared with our market share of 61.3% so the screenprinter demand for our brand significantly exceeds our share of inventories in the channel.

Sales of socks in the first quarter were essentially flat compared to a year ago in spite of the impact of discontinuing unprofitable sock programs and the elimination of baby apparel and layette programs under licensed brands, which did not fit with Gildan's business model. The impact of eliminating these programs was fully offset by the performance of continuing programs, including the strong performance of the new Starter men’s sock brand introduced by Wal-Mart during fiscal 2009.

Consolidated gross margins in the first quarter were 29.8% compared to 21.1% in the first quarter of fiscal 2009. The increase in gross margins compared to last year was due to significant gains in manufacturing efficiencies and lower cotton and energy, which together increased gross margins by approximately 950 basis points, as well as more favorable activewear product mix, which increased gross margins by approximately 270 basis points. These positive factors were partially offset by lower net selling prices for activewear, which reduced margins by approximately 300 basis points, as well as the impact of additional inventory provisions.

Our cost of cotton consumed in our cost of sales in the first quarter was approximately $0.60 per pound, which continued to be higher than industry competition due to our decision to fully cover our fiscal 2009 cotton requirements before the plunge in cotton and other commodity costs in the latter part of 2008. Cotton costs in Q2 2010 will be slightly lower than Q1 and are expected to increase in the second half of the fiscal year, in line with the recent increase in market prices for cotton, which were impacting the apparel industry.

Selling, general and administrative expenses in the first quarter were $34 million compared to $33.5 million in the first quarter of fiscal 2009. The slight increase in SG&A expenses from last year was due to the impact of the higher-valued Canadian dollar on corporate administrative expenses and higher performance-driven variable compensation expenses, partially offset by the non-recurrence of provisions for doubtful receivable accounts recorded in the first quarter of fiscal 2009 as well as lower legal and professional fees. As a percentage of sales, SG&A expenses declined significantly to 15.4% compared with 18.2% a year ago.

We generated EBITDA of $44.4 million and free cash flow of $42.5 million in the first quarter, after investing $34 million in capital expenditures and paying $13 million for the provincial component of the Canadian tax settlement, which have been recorded and fully provided for as a charge against earnings in the fourth quarter of fiscal 2008.

Accounts receivable were reduced by $82 million compared with the fiscal year end and we continue to be comfortable with our credit exposures. Inventory levels increased by $43 million during the quarter, primarily to build finished goods inventories of activewear in order to be well positioned to capitalize on demand in the peak summer selling season for T-shirts.

The main capital expenditure projects in the first quarter were the new retail distribution center and office building in Charleston, South Carolina, which was announced in December, and a ramp-up of the second sock factory in Honduras, Rio Nance IV. Both of these investments are being undertaken to support our projected sales growth in retail and to continue to drive further efficiencies in our cost structure.

During the first quarter we continued to make exciting progress in implementing our strategy to become a major full line supplier of basic family apparel for mass market and regional retailers. We are currently shipping the new strategic underwear program, which we announced in December. This is the first underwear program under the Starter brand from Wal-Mart, which is already available in certain key store locations and which will be rolled out nationally over the next month.

The other major new programs, which we announced in December and which are also currently being shipped to retailers, are the new Starter performance sock program, three additional new sock programs for Dollar General and a private label boy’s underwear program for Target under the Cherokee brand.

As stated in our press release, we are in active discussions to supply further new programs for mass retailers and other regional and specialty retail chains. These further programs under discussion include important programs to supply activewear as well as socks and underwear, as well as back-to-school promotions for the fall of 2010. Based on opportunities under discussion, we are comfortable that we are positioned to maintain strong sales growth in retail in fiscal 2011. We believe that mass retailers now recognize and accept Gildan’s unique positioning and advantages as a manufacturing partner, as we consolidate their supplier base and introduce new private label brands.

These advantages are as follows. Firstly, driving strong retailer sales to consumer is due to incorporating enhanced quality features. Two, providing our retail customers with quality products at globally competitive prices, which allow the retailers to generate attractive margins. Three, strategically located large-scale, capital intensive, manufacturing and efficient supply to provide flexibility and quick response in supplying large replenishment programs. And fourthly, our excellent reputation for corporate social responsibility and sustainability, which is an important element in the branding of retail products for consumers.

In this regard, the packaging for the majority of our new private label programs carries Gildan’s logo for sustainability and social responsibility and direct consumers to the web link www.gildancsr.com. In addition to our private label programs for national retailers, we are continuing to make steady progress in expanding our Gildan branded products in approximately 1,700 retail outlets in regional retail chains as well as in Wal-Mart stores in Canada.

We have reconfirmed our business outlook and sales and margin assumptions for the full fiscal year, which we had previously provided in December. We have continued to base our outlook and assumptions on our continuation of weak overall economic conditions and are therefore projecting zero growth in overall industry demand from US distributors to US screenprinters for the balance of the fiscal year. Therefore we continue to expect to achieve full year sales revenues in excess of $1.2 billion, up approximately 17% from fiscal 2009.

We also continue to be comfortable with assuming gross margins for the full fiscal year of approximately 26%, which reflects the assumption that higher cotton costs in the second half of the fiscal year are now pass through into higher selling pricing. We have assumed a reduced level of promotional discounting in the US wholesale distributor channel compared to our previous forecast.

We are now assuming the net selling prices in the US wholesale distributor channel will decline by approximately 4% from fiscal 2009 compared to our previous assumption of approximately 5%. But this benefit is assumed to be offset by the impact of short-term incremental manufacturing and transportation efficiencies resulting from the disruption of production in Haiti plus the cost of our aid programs, which are together estimated to impact EPS by $0.02 to $0.03 per share. Additional training and ramp-up costs as we integrate more new retail programs into our manufacturing operations and the impact of the recent decline in the value of the euro.

Although Gildan has put in place short-term contingency plans to ensure that it can continue to fully serve as its customers while the rebuilding process continues in Haiti, the company has committed to play a proactive role in supporting its contractors and their employees and to maintain our important strategic presence in the country as part of our global supply chain.

Our contractors in Haiti have restarted program although rapidly implementing plans to do so, including Palm Apparel whose main building was entirely destroyed in the earthquake resulting in significant loss of life among its workforce. Palm is planning to restart production imminently at two new locations. All buildings or all contractors are being inspected and approved by Gildan. Our selling capacity in Haiti is expected to be at approximately 90%, a pre-earthquake capacity by the beginning of our third fiscal quarter, with the balance being replaced by the acceleration of the ramp-up of our Dominican Republic selling facility.

In addition to support for contractor and Gildan employees, Gildan is providing financial assistance to its contractors to assist in the process of restarting and rebuilding their operations. In the absence of a market for bank financing in Haiti, Gildan has provided working capital and equipment financing through its contractors to support the process of rebuilding and providing employment in Haiti.

Gildan’s aid efforts in Haiti are being primarily directed towards providing direct assistance to our contractors’ employees, the families of the workers who lost their lives in the collapse of a Palm facility, and our own team of approximately 40 employees who monitor quality control at our contractor operations and ensure compliance with our Code of Conduct for labor practices. All our Gildan employees have been accounted for and are confirmed to have survived the earthquake without physical harm. Our aid and relief initiatives are outlined in detail in a separate press release, which we issued this evening concurrently with our first quarter earnings release.

Our capital expenditure forecast for fiscal 2010 has been increased from approximately $130 million to approximately $145 million, due to the acceleration of planned sewing capacity expansion projects required to support the company's projected sales growth, and further expansion of the Rio Nance IV sock manufacturing facility, and additional investment in the biomass project in Honduras, which is expected to generate further incremental cost savings.

We continue to expect to have approximately 60 million dozens of production capacity for activewear and underwear in place by the end of fiscal 2010. And we continue to be comfortable to proceed with our investment in the Rio Nance V facility based on our confidence in our plans to penetrate the mass retail market.

We continue to expect to generate free cash flow in fiscal 2010 after undertaking our capital expenditure program. And as stated in December, during the course of this fiscal year, we will evaluate our capital structure and options for the deployment of our cash balances in order to achieve maximum value for our shareholders.

In conclusion, we are pleased with our first quarter results and with our current momentum. We are continuing to increase market share in our screenprint business and it appears industry demand may be stabilizing. In addition, we are excited at the same competitive strengths and business model, which have made Gildan successful in the screenprint market, are now being recognized by mass retailers.

We continue to be confident that even without the possible benefits and potential upside of a turnaround in economic conditions and recovery and industry demand, we are positioned to sustain strong sales and earnings growth in fiscal 2010 and throughout our current planning horizon.

Sophie Argiriou

Thank you, Laurence. Before moving to the Q&A session, I would just like to remind everyone to limit your questions to two or three in order to give everyone the opportunity to ask a question and time permitting, we’ll circle back for a next round of questions. Thanks. Operator, we are now ready to begin the Q&A session.

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from the line of Martin Landry with Desjardins Securities. Please go ahead with your question.

Martin Landry – Desjardins Securities

Good evening. In terms of your market share gains for January that the preliminary numbers at 64.3%, it looks like it’s up 300 basis points sequentially. That’s pretty strong. Has there been any unusual situation that your competitors have enabled you to gain such market share?

Glenn Chamandy

That’s just basically the momentum that we have behind our broad. And it continues – we've been continuing to gain market share quarter-after-quarter. So it’s just a continuation of just the momentum we have today in the market.

Martin Landry – Desjardins Securities

Okay. On the international market, it seems like it’s been a little bit of helping out gain from sales. Do you have any numbers in the local currency that you can give us or in terms of units that could give us a little bit of color as to your performance?

Glenn Chamandy

No, I think we prefer to talk about this it in aggregate more time. We mentioned that the growth when you take the other screenprint markets outside of our screenprint wholesale distributor channel in North America reflects growth of over 80% and in the quarter represented approximately 25% of our overall sales. But we are strong in all markets. I mean, I’m happy to say that. It’s not driven by one geographical area over another. All regions showing comparable strong growth.

Laurence Sellyn

And this is all part of our development. And since the downturn, we put big emphasis on developing these markets and we put the resources and inventory in the market required support the sales. And this is just the momentum again we have in each one of the markets. The opportunity is much larger, and we believe that this is going to be a growth opportunity for the company as we go forward.

Martin Landry – Desjardins Securities

Great. Last question, any timeline on Rio Nance V that you can share with us?

Glenn Chamandy

Well, we are in the process of starting the building. We will start construction most likely at the end of the second quarter. And then it’s going to take approximately nine months to 12 months for the Shell and the equipment will be solved. And we will be in the ability to start production. The facility is going to be a little bit more suited for our retail business, particularly in the underwear category. As we grow our share and our volume of underwear, this will allow us to maximize our cost efficiency on that product category like we’ve been able to do in all the other product categories in wholesale and continue to drive cost at producing underwear and obviously make us more effective and more efficient in the long run.

Martin Landry – Desjardins Securities

Okay, great. Thank you very much.

Operator

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

Sara O'Brien – RBC Capital Markets

Hi, guys. Impressive market share in the wholesale channel. Just wondering, Glenn, how much do you think there is room to grow there? And is that contingent on promotional pricing – continuing promotional pricing through the year? Or do you think that the market share you have now with stabilized pricing you will be comfortable holding it there?

Glenn Chamandy

I really don’t want to answer that question. I think that as far as we are concerned, look, we are happy with our position in the market. What we’ve been able to do with our pricing is actually to bring stability to the market. Since beginning of the year, we actually have probably the most stable pricing we’ve seen in a long time. And we’re hopeful that our market share will continue to grow. And we are not just focusing on this one market, but we are focusing on our international markets, which is the major emphasis on again. On all the other markets that you see that we are going significantly under lots of the opportunity in the other markets as well. And of course, retail is a big, big opportunity for us with continued growth. So we are going to continue to grow everywhere, and I rather not just pinpoint where we think our opportunity is also.

Sara O'Brien – RBC Capital Markets

Okay. And can you just comment on the international sales growth? I mean, was that – when you shipped international, is there like a big push initially and then it’s every quarter or so, or is it constant replenishment, the same way you would with your US market?

Glenn Chamandy

Well, constant replenishment like our US market, but one of the reasons why we haven’t really pushed internationally up until now was we never had inventory really support it. Really volume in the downturn back in 2009 happened that we actually had inventory to actually supply these markets. So since then we’ve actually allocated inventory, we put the resources in place, and each one of these markets has grown, like Laurence said, we grew over 80% this quarter. So we think that’s momentum that’s melting. And everything is in place to continue driving the existing markets, but as well as we are looking at new and international markets as well. I mean, we are not positioned today in Central America, for example, which is a market that we are looking to expand into this year. And we have free trade into that marketplace. It’s quite a large T-shirt market. So we are going to continue to develop other markets as well and grow the ones we are in, and that’s really we believe the growth opportunity. And over time, these markets could be as equally as large as even our current US wholesale distributor market.

Sara O'Brien – RBC Capital Markets

Okay, great. And just on the retail front, can you talk a little bit about the underwear program? I haven’t seen the actual program that’s in Wal-Mart now, but just wondering – I mean, are you using regular, open end cotton, knit for that that product or is there some kind of ring spun addition or some kind of different fabric are you using?

Glenn Chamandy

Like everything we’ve done basically in terms of our successful retailers obviously through offer better quality features, better margins to our retailers, and have a replenishment scheme, and also market ourselves through a CSR platform. And we are repositioning this program basically. It’s probably the best value within the store today at the price they are operating it at. So I’d rather not talk too much about it. I mean, the products are available in the store for everybody go and see, and – but it’s – we believe that it’s positioned perfectly with all the characteristics and are going to make it successful in retail.

Sara O'Brien – RBC Capital Markets

Okay. And just a last question, just on margin at retail, given that there is sort of a quality – enhancement to this product, would you expect to be able to ramp up to your traditional kind of gross margin expectation in the whole sale channel with your retail products over a year or so? Or is that a longer term or shorter term kind of process?

Glenn Chamandy

Well, I think with the longer term, we definitely will make the same type of margins in retail as we do in wholesale. Right now we have experienced some startup costs in terms of developing and training the labor. There is a lot of people. The resources have been put into developing this program. And also there are some things that are little bit longer time like, for example, when we build a Rio Nance V, this is going to be the most state-of-the-art underwear plant in probably in the world, just like we’ve done in our soft facilities. So there are other things that we are going to do to continue reducing our cost as we go forward. But some of them are a little bit bigger in nature in terms of how we’re going to be specific in. And that’s really what our strength in the company as we’re building these big plants that support low-cost production. And this is something that will be online and we will continue to reduce our cost. The labor piece will take less time to enhance the margin. But ultimately not only we will be able to support the program we have now, but we are looking to support much bigger sales as we go forward. And this is just a base to lever off as we go into the future.

Sara O'Brien – RBC Capital Markets

Okay, great. And just clarification, the underwear program is across all Wal-Mart stores in the US – the Starter program?

Glenn Chamandy

It’s going to be – by the end of Q2, it will be shipped to all stores in the United States.

Sara O'Brien – RBC Capital Markets

Great. Thank you, and congratulations.

Glenn Chamandy

Thank you.

Operator

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

Jessy Hayem – TD Newcrest

Thank you. Just continuing all on the margins at retail, Glenn, would you be comfortable in any way providing I guess what the margin differential is currently maybe in basis points relative to where your wholesale activewear margins are?

Glenn Chamandy

I think – you know, at one point we will segment out the margins, but at this point what information we provide externally we treat our whole business as one segment. And I think it’s premature for us to give out segmented margins. But activewear margins in the wholesale channel are somewhat higher than our overall margins and the retail margins are a little bit lower.

Jessy Hayem – TD Newcrest

Fair enough. Thanks. And then just a clarification, is this Target’s first underwear program under a private label as well?

Glenn Chamandy

No, they have other programs. They provide – Target has a very extensive private label programs in general in terms of the whole branding strategy. But this is something new in terms of its pricing (inaudible).

Jessy Hayem – TD Newcrest

I’m sorry, in terms of its pricing and –?

Glenn Chamandy

Pricing it under the Cherokee brand is something new, but they have had other brand, Morona and other underwear brands at private label that they currently carry in the store in the past.

Jessy Hayem – TD Newcrest

Okay. And then, Laurence, could you tell us what the additional inventory provisions relate to in your explanation for sort of the offset to the positives in the gross margins in the quarter?

Laurence Sellyn

There was nothing really major in the positive in the entry provisions. So there is nothing really major in there. A lot of it related to products that are being replaced by new plans that are being phased out and that are being promoted.

Jessy Hayem – TD Newcrest

Okay. And then just finally, is there anything you could share with us as to your hedging positions, whether you’ve started doing anything regarding cotton for the second half of the year?

Laurence Sellyn

We have at this point largely covered our cotton for the second half of the year.

Jessy Hayem – TD Newcrest

You have. And just so I’m sure I’m understanding, you have lowered your expected promotional activity in terms of lower selling prices to 4% from 5%. You’ve assumed in your assumptions that the higher cotton costs prevail, but you haven’t assumed that it’s passed on into higher prices. Is that correct?

Laurence Sellyn

We haven’t, and right now, as we’re assuming 4% less pricing, negative pricing as we go through the year and as we go the balance of the year, we are obviously going to have higher raw material costs so that the margins will descend from where they are today, let’s say, for example, who the two, there and four.

Jessy Hayem – TD Newcrest

Okay. Thank you. I’ll circle back.

Operator

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

Anthony Zicha – Scotia Capital

Hi, good afternoon. Can you comment on the current replenishment of the US wholesale distributor channel, which is supposed to benefit shipments in the second quarter? Is it stronger than anticipated? And do you expect the demand to remain in the following quarters?

Laurence Sellyn

I think typically in Q1, distributors are watching their inventories towards the end of the year. But as you can see that our inventory in the channel was much lower than our share, we have 50% versus the 61% share of market share. So basically as we go forward, distributors need to bring inventory based on a go-forward sale and as we go into Q2. So obviously there is going to be some demand that needs to – inventories that need to be kept [ph] up, let’s say, for example, to support the go-forward sales. But even at that, even in January, our inventory position was still relatively in the same position because we also actually gained a little bit more market share.

Anthony Zicha – Scotia Capital

Okay, thanks. And just to be clear, assuming restocking demand remains strong in the second half of the year, can you give us a sense of how much of the higher cotton cost you can pass through?

Laurence Sellyn

Right now our plan is not to passing through as to absorb those higher cost cotton. And that’s sort of where our plan is today. Right now, we don’t have a long-term visibility in terms of where cotton is. I mean, it’s really going up and down. I mean, in the last two days, it’s jumped back up $0.05. It is on a downward trend. We don’t want to be in a position that we knee-jerk pricing, for example, and all of a sudden cotton drops $0.15 a pound. So we just need to have a little bit more exposure, and it’s premature at this point in time to make any conclusions on where pricing is and – where pricing is going. One thing for sure is that we right now have good stabilized pricing in the marketplace, and we’d like to see the commodity side of it stabilize as well, which is pricing of cotton as well as energy and so forth before we make any decisions moving price up.

Anthony Zicha – Scotia Capital

Okay. And Glenn, how much of your requirements have you purchased for the second half?

Glenn Chamandy

Well, I think we are –

Laurence Sellyn

That was a large portion of our cotton for the balance of our fiscal year cost of sales.

Anthony Zicha – Scotia Capital

Okay. And then last quick one, can you comment on your international expansion initiatives and which market are you targeting right now and where would be the most growth? Thank you.

Glenn Chamandy

Right now, all our markets are growing pretty good. I mean, we are in Mexico, Europe, UK, Japan, Australia. We have some sales today actually in China although in a small amount, but we are looking to actually grow that market as well. And like I said earlier, we are looking to expand into Central America and we are looking to develop new markets at the same time. So all the markets have actually grown significantly. I think it was pretty well across the board we had 70% to 80% increases. Almost every single one of these market in the last quarter. So it’s not one market that grew fantastic. It’s actually all been working together.

Anthony Zicha – Scotia Capital

Excellent. Thank you very much.

Operator

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

Omar Saad – Credit Suisse

Thanks. Good afternoon. I wanted to ask a follow-up question on the pricing that you guys discussed in your opening remarks. It sounded like your – the language softened a little bit, it sounds like the town in the industry softened a little bit, you kind of went from 5% to 4%. Is there something – is there change happening in the industry relative to last quarter or the inventory is getting cleared out a little bit quicker, has there been some competition that’s left? What’s given you the comfort to kind of back off the pricing dynamic a little bit?

Glenn Chamandy

Well, I don’t think we are backing up. I think what we’ve done is we have basically – we set out prices in beginning of the year to be aggressive. And not just be aggressive in pricing, but also to stabilize pricing in the market in which we achieve. We’ve spent a little less in discounting in Q1 because we stabilized pricing, which is a good thing. And part of the difference between original projection and the new projection is going to be offset by the loss we had in Haiti, potentially a little bit on the overall, and as well some additional small manufacturing costs for the startup environmental program. So we don’t have a crystal ball at this point in time. We think we are heading in the right direction in terms of stabilizing the market. And the wild cards are, we don’t know where raw materials and energy is going to go. And then as we go through this year, we will see what happens and we will adjust the pricing accordingly.

Omar Saad – Credit Suisse

Okay, great. And then a follow-up question too on the new retail programs that you discussed in more detail in the release and then in the prepared remarks as well. Can you talk about a little more detail about the program itself? The underwear program in Wal-Mart, is it one style, is it a number of styles, is it different colors, and price points or sizes and men’s and kid’s and –? Can you give us just a little bit more –?

Glenn Chamandy

I’ll tell you that we will see it in the store. Basically it’s a men’s program, it’s a T-shirt, a V-neck, a boxer and a – two versions of the boxer, let’s say. And it’s also an athletic performance sock. That’s primarily the program that the Wal-Mart on the Starter brand, the new program they have on the Starter.

Omar Saad – Credit Suisse

Got it. All under the men’s category.

Glenn Chamandy

In the men’s category, so far, yes.

Omar Saad – Credit Suisse

Excellent. Great. And then you also mentioned I think Laurence said in some of his opening remarks about some of the offsets coming from ramping up some of the infrastructure to support the retail? We talked about other program’s target and some of these other things. Can you talk about some of those SG&A line items, things that you need to add, you have been adding and building infrastructure to support a much bigger retail business in the future.

Laurence Sellyn

We are not really talking SG&A infrastructure, Omar. We are talking about integrating the retail programs into our manufacturing and ramping up sewing for different kinds of products.

Omar Saad – Credit Suisse

Understood. Understood. So the SG&A side of it pretty run rate kind of equation where we are now.

Laurence Sellyn

Yes, we feel we’ve got infrastructure in place to drive our –

Glenn Chamandy

We have a couple of add-ons in personnel, but we have a lot of synergies we’re going to create through our distribution consolidation. In fact, we’re actually going to reduce SG&A somewhat on the shipping side as we consolidate both our Martinsville distribution center and our (inaudible) distribution center into a new state they are building that would be located in Charleston. And so overall we continue to look for cost reductions from the distribution side, and there are going to be some ongoing developments people who will need to keep growing the volume we have based on the opportunity we have at retail in terms of personnel, sales, merchandising, et cetera.

Omar Saad – Credit Suisse

Got it. Okay, great. Thank you. Good luck.

Operator

Your next question comes from the line of Bill Fisher [ph] with Raymond James [ph]. Please go ahead with your question.

Bill Fisher – Raymond James

Hi, guys. Question for you. If the market improves a little bit from here and you are able to raise cost to cover your increased cotton cost in the second half of the year, what would be the rough earnings impact of that?

Laurence Sellyn

(inaudible)

Glenn Chamandy

We are not going to answer that, Bill, because as far as we are concerned right now, our model is to continue to keep pricing, like we said, where it is. That’s premature for us to make any of those decisions right now. We need to go through the next two, three, four months to where the commodity pricing will end up. And then from there we can decide what the strategy is going to be. So we’d rather not commit on what the upside would be.

Bill Fisher – Raymond James

Okay. Fair enough. And a follow-up question for you. On the Wal-Mart opportunity, I’m trying to just measure the sizes of the different buckets in terms of socks, underwear. And I know you are not in fleece yet, but just to know what that opportunity set is as well. What are the relative sizes of each one of those buckets?

Like, is underwear the same size as the socks, and is fleece the same size? Or how do they all differ?

Glenn Chamandy

There is – you can sort of go to the store and have a look, and you can see the space allocation that each retailer has for each one of the different product categories. It will give you a good reference of, I think, the opportunity. But it’s not really for us to comment on what the positioning and how retailers are going to drive their store strategy. All I can say is that we believe that with our cost position and the method we have in retail, all we have to offer retailers with the enhanced quality features, the better margins, the replenishment and mass scale, and our CSR initiative, we believe that the significant opportunity will continue going forward, not just to continue building our own momentum and secure additional programs hopefully for the back half of this year that will incrementally increase our volume and keep the momentum going for next year. And that’s where we are focused on right now.

Bill Fisher – Raymond James

Okay, thanks.

Glenn Chamandy

Thank you.

Operator

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

Claude Proulx – BMO Capital Markets

Thank you. Good afternoon. Couple of questions. First one, the state-of-the-art underwear facility Rio Nance V, what kind of capacity is it going to have, because I assume it’s going to be more since you need less fabric for underwear?

Glenn Chamandy

I’d rather not discuss that right now. I mean, I think one of the things we’re trying to do, Claude, is we are going to hopefully have the investments within the next between now and 12 months where we can bring you and we can explain to you a little more what we are doing. But it’s going to be large state-of-the-art. It’s going to be similar to our approach in terms of socks where we’ll have the globally lowest cost competitive facility, allowing us to enhance our quality features and make better products at a better price. So that's really our focus and it’s going to be geared strictly to support our growth in the underwear category.

Claude Proulx – BMO Capital Markets

Would it – if it were to do T-shirts, would it have the same capacity as the two other textile factories over there?

Glenn Chamandy

It actually will be similar, but these are the different types of equipment we will have in facility, but it takes some [ph].

Claude Proulx – BMO Capital Markets

Okay. The other thing is I was looking at your inventory at the end of the quarter versus the same date last year and it's down like probably 11%, 12%. Can you talk about it? Do you feel good about your inventory? I mean –

Glenn Chamandy

Down in dollars, but it’s not down in units. In units, it’s in very good shape because the cost is down on a year-over-year basis. It’s actually up couple million dozen.

Claude Proulx – BMO Capital Markets

Okay. Thank you very much.

Glenn Chamandy

Thanks.

Operator

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

Candice Williams – Genuity Capital Markets

Hi. Most of my questions have been answered. But I am curious if you can give us some of the expected savings from the biomass project in Honduras at current fuel levels.

Glenn Chamandy

We won’t have any savings this year from the biomass in Honduras. The biomass in the DR is up and running now, which started in early January. And it’s going to – it's running in full blast as we speak. The two facilities – we have two biomass facilities going in in Honduras that probably will start this year but won’t impact really our P&L until next year. Biomass is a big savings relative to bunker [ph], let’s say, for example. And it could be basically where – anywhere from $35 a barrel, let’s say for example.

Candice Williams – Genuity Capital Markets

Great. Thank you.

Glenn Chamandy

Thank you.

Operator

Your next question comes from the line of Jim Duffy with Thomas Weisel Partners. Please proceed.

Jim Duffy – Thomas Weisel Partners

Thanks. Good afternoon. Most of my questions have been asked as well. I did want to follow up a little bit on pricing. What are you seeing from competitors in the screenprint channel? Are they following your lead on pricing?

Glenn Chamandy

Like I said earlier, pricing has stabilized. And so far, pricing has stabilized and we believe that we are in a relatively good market right now. And we are typically the price leader in the industry. So we’ll see what happens from this point on.

Jim Duffy – Thomas Weisel Partners

Historically when you've seen big swings in cotton pricing, how has pricing from suppliers through the screenprint channel reacted?

Glenn Chamandy

Historically, cotton has been trading at a much lower level. What’s important is that I think that when for our purposes as long as cotton goes up and stays consistent, it’s going to be good for everybody because those costs will be passed on, but we don’t want to be with something that’s going up and down too fast because that makes it for a tough market. And then that would make for a disadvantage or advantage, but more of a consistent approach I think is it’s something that would be passed on into the cost of goods sold over a period of time.

Jim Duffy – Thomas Weisel Partners

I understand. And then final question, you may have mentioned this, but what's the timing for the opening of the Charleston facility?

Glenn Chamandy

Charleston is actually open now. We are in the process of moving with two major distribution sites right now. One of them will be moved in the next couple months, and then the second will be moved and everything will be in place before the back-to-school shipping.

Jim Duffy – Thomas Weisel Partners

Great. Thank you. Good luck.

Glenn Chamandy

Thank you.

Laurence Sellyn

Thank you.

Operator

The next question comes from the line of David Glick with Buckingham Research Group. Please proceed.

David Glick – Buckingham Research Group

Yes, good afternoon. Congrats on a very nice quarter. Just a follow-up on the international business and the direct to screenprint business. Coming into the year you thought you might be looking for a million dozens incremental versus last year in each of those two channels which is, call it, $40 million. With the run rate in Q1, obviously it looks like you are going to achieve a lot greater. I was wondering if you could give us perhaps an updated – your updated thoughts on how much you can pick up in incremental dozens versus last year in each of those channels and maybe remind us what the dozens were sold last year.

Glenn Chamandy

Maybe we can get back to you on this in terms of the dozens sold last year. But I can say the complete momentum here is really in our international markets. That’s where we were seeing the biggest momentum. Europe is on fire. Mexico is on fire, like I said before. Australia is up. Some of these markets are up even 100%, 150%. So that’s really where we are seeing the biggest opportunity right now. And Laurence can get back to you on the exact numbers after the call.

David Glick – Buckingham Research Group

So obviously you are looking up and taking up a lot more than 1 million dozens this year in international?

Glenn Chamandy

We are excited about opportunities. It’s a little bit early. It’s early in the year. Let’s say, for example, so we have huge momentum and hopefully we will get some extra dozens. We’ll just not share at this point in time.

David Glick – Buckingham Research Group

All right. And just one last question if I could. The Li & Fung deal with Wal-Mart, I know it's early in that stage and it's a relatively small percentage. I was just wondering if that changes the competitive dynamics at all, and how active they are in the categories that you compete in.

Glenn Chamandy

I think that I don’t really want to answer for Wal-Mart. That’s question for them. But I think that what they said is that they are looking to consolidate their vendor base to fewer vendors, and this is maybe one of their strategic moves basically to reduce the amount of vendors that are supplying them. I guess that’s what they had in mind with the Li & Fung.

David Glick – Buckingham Research Group

Okay, great. Thanks a lot. Good luck. Thank you.

Operator

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

Doug Cooper – Paradigm Capital

Hi, good evening, gentlemen. I just want to touch on the second quarter here for a second. If we assume flat unit growth year-over-year in the second quarter and you improve your market share by, say, 1,000 basis points, and you’ve got obviously this inventory and I guess you have 50% of the inventory channel but you have a 64% market share, that would translate into some pretty strong growth year-over-year in Q2, would it not?

Glenn Chamandy

We are projecting strong growth in Q2, yes.

Doug Cooper – Paradigm Capital

But would it be in advance of the year-over-year growth in Q1?

Glenn Chamandy

I don’t think we are providing quarterly guidance unfortunately, Doug.

Doug Cooper – Paradigm Capital

Okay. Just on the international, I know it's been touched on a lot, but is it around $35 million? Is that the number I get?

Glenn Chamandy

I’m sorry, I didn’t hear the question.

Doug Cooper – Paradigm Capital

The international, in the quarter you said it was 25% I think of your total sales or the wholesale sales. I get ballpark around $35 million. Is that in the ballpark?

Glenn Chamandy

For dollar sales, for international?

Doug Cooper – Paradigm Capital

Right.

Glenn Chamandy

What are you – what are you including in the international?

Doug Cooper – Paradigm Capital

I guess I think your sales were, you said, what was it, $153 million in the activewear and underwear if you assume the underwear is retail. I'm just trying to get 25% of that – that number – I'll get around $35 million.

Glenn Chamandy

I’ll try to solve [ph] that number. Yes, that’s ballpark.

Doug Cooper – Paradigm Capital

Okay. And is it too – is it even relevant to talk about what your market share on an international basis is?

Glenn Chamandy

We don’t have the same type of ability to get the same market share information like we have in the US market.

Doug Cooper – Paradigm Capital

Yes.

Glenn Chamandy

There is no formal process like in S.T.A.R.S. But we know that we are one of the one, two type suppliers already in all these markets. Maybe one, two or three, I’d say in each market that we are in today.

Doug Cooper – Paradigm Capital

But with the rest of the world, the equivalent about the size of the US wholesale channel?

Glenn Chamandy

I think the rest of the world is probably much larger at the end of the day than the distributor channel. We’ve done some preliminary work just to give you an example in China. We just had a study and the actual activewear market in China is actually larger than the US screenprint market. So the direct markets in which we are directing today, which is Mexico, we think that that market is – that's – and some of these markets, those markets that we can obtain because it’s business which we can get and there are just certain business that’s very difficult to get because a lot of it is underground, like in Mexico, for example. But I would say that overall the market opportunity for us is equal to our US distributor market for sure.

Doug Cooper – Paradigm Capital

And would you anticipate the year-over-year growth to trend the same level for the rest of the year in the international market?

Glenn Chamandy

I would probably say maybe not because once we get to the height of summer selling season in the US, basically it will be a larger portion of our percentage sales. But we’re going to have significant growth relative to what we saw year-over-year in each one of those markets I think if we look at it. So the same type of momentum will be there, but as an overall percentage of the market of our sales won’t be as significant.

Doug Cooper – Paradigm Capital

All right. And just a clarification, (inaudible). When are you going to actually start shipping products from that facility?

Glenn Chamandy

We’re going to actually start the plant towards the – probably May 1st is a probably really good date that we’re going to actually physically be in production, and then the plant will be ramped up from that point on and stages as we go.

Doug Cooper – Paradigm Capital

Okay, perfect. Thank you very much, gentlemen.

Glenn Chamandy

Thank you.

Operator

Your next question comes from the line of Scott Rattee with CI Capital Markets. Please proceed.

Scott Rattee – CI Capital Markets

Great. Thanks very much. I just wanted to follow up just actually on the last question here. When you were referring to the fact that the rest of world could ultimately be larger than the US distributor channel, the rest of world, is that specific to the markets that you're currently in when you sort of see the opportunity to grow there? Or is that actually every single market, the ones that you are in and the ones that you aren't in?

Glenn Chamandy

That’s just the ones we are in now.

Scott Rattee – CI Capital Markets

That's just the ones you're in now. Okay, great. Second question just on SG&A, as a percent of revenue it's 15.4%. I think on the last conference call, I think Laurence had sort of indicated that your long-term goal is sort of around 11% and that for fiscal – for this full year it would be something around 11.5%. Is that still what you're thinking?

Glenn Chamandy

Yes. The reason it’s higher in Q1 is because of the seasonality of the sales. As we pointed out, the first quarter is the lowest seasonal quarter for activewear sales. So SG&A has the higher percentage.

Scott Rattee – CI Capital Markets

Okay. So, so it –

Glenn Chamandy

But we are still good with our full year numbers.

Scott Rattee – CI Capital Markets

Yes, okay. And just on the CapEx with the incremental –

Glenn Chamandy

The only thing that would change that would be fluctuations in the exchange rate, which would benefit our – which would have a corresponding offsetting impact on sales.

Scott Rattee – CI Capital Markets

Okay, yes. Yes.

Glenn Chamandy

The Canadian dollar increases or decreases our SG&A.

Scott Rattee – CI Capital Markets

Okay, that’s great. And then another question just on the CapEx, the $15 million sort of increase that you’ve got. Does that – just so I get an idea of what the driver was, does that sort of cover off the shipping demand from the selling [ph] capacity that was interrupted? Or is that more a reflection of just sort of number one, or basically sort of looking out and seeing stronger demand and realizing that you need to develop and build to meet that?

Glenn Chamandy

Well, it’s (inaudible) build the demand. And what we are doing right now is we are actually ramping up our production so that we are going to be an average run rate of roughly about 60 million dozens a year by the end of September. So annualized production at the end of September would be roughly about 50 million of activewear and underwear. And this extra sewing is to support there to ramp-up. And obviously a large portion of that is to support our big retail opportunity.

Scott Rattee – CI Capital Markets

Okay. Okay, that’s great. And thanks very much and great quarter.

Operator

Your next question comes from the line of Vishal Shreedhar with UBS. Please proceed.

Vishal Shreedhar – UBS

Hi. I just want to get a sense of wholesale volumes. One of your peers said that wholesale volumes could snap back. That's obviously in contrast to your understanding that there is flat unit growth. I want to understand, if wholesale volumes did snap back, would you have the capacity so source that?

Glenn Chamandy

I’d say two things. The thing is that right now, we are still in a very good inventory position. Would we be able to handle the whole snapback when the market has declined significantly? I think it is short-term. It came back all in one time. Next week it would be frenzy of T-shirts, but I don’t think that’s going to happen. But with all the added capacity we have coming online as we go forward, we definitely will be able to support additional capacity opportunities. In the short-term, it definitely would firm up pricing for sure, I mean, if the market did come back and it did well.

Vishal Shreedhar – UBS

Okay. Is it in your experience that the market is unpredictable and it could snap back at any moment, or do we have fairly good clarity here that it’s going to be flat for the year?

Glenn Chamandy

I think that we are – basically the market has stabilized. I think we are going to start seeing the pulse a little bit that were going to start to see a little bit of spending against, because obviously the part of the market that shrank is not the everyday type business. A lot of it is the corporate promotional spending from major companies. And as that freeze up and people start to spend again, we will start to see the market bounce back and hopefully we’ll see – right now, at least we have now stabilized the market. It’s no longer declining. And hopefully from this point on, we start seeing an uptick as we go forward into the future.

Vishal Shreedhar – UBS

Okay. Thank you.

Glenn Chamandy

Thank you.

Operator

With no further questions in the queue, I would like to turn the call back over to Sophie Argiriou for any closing remarks. Ma’am?

Sophie Argiriou

Thank you. Just before ending the conference call, I’d like to remind you that management will remain available tonight to take any follow-up questions, as tomorrow you may know that we are – Gildan will be holding its Annual Shareholders Meeting at 11:00 AM Eastern Time in Montreal at the Centre Mont-Royal. With that, we’d like to thank everyone for joining us and we look forward to talking to you again at our next earnings conference call. Thank you, and good night.

Operator

Thank you for your participation in today’s conference. This concludes your presentation. You may now disconnect and have a great day.

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Source: Gildan Activewear Inc. F1Q10 (01/03/10) Earnings Call Transcript
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