Welcome to the Q2 2019 Gildan Activewear Earnings Conference Call. My name is Michelle, and I'll be your operator for today's call. Please note that this conference is being recorded. I will now turn the call over to Sophie Argiriou, Vice President, Investor Communications. Sophie, you may begin..

Thank you, Michel. Good morning, everyone and thank you for joining us. Earlier this morning, we issued a press release announcing our results for the second quarter of 2019. We also issued our interim shareholder report, containing management's discussion and analysis, and consolidated financial statements.

These documents will be filed with the Canadian Securities and Regulatory Authorities and the US Securities Commission and are available on the company's corporate website.

Joining me on the call today we have Glenn Chamandy, our President and Chief Executive Officer and Rhod Harries, our Executive Vice President and Chief Financial and Administrative Officer. In a moment, Rhod, will take you through the results for the quarter and our business outlook for the year and a Q&A session will follow.

Before we begin, please take note 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 the Canadian Securities Regulatory Authorities. And with that, I'll turn the call over to Rhod..

Thanks, Sophie. Good morning and thank you for joining the call. This morning, we reported that we delivered another record second quarter, both from a top and bottom line perspective. Sales came in at $802 million, up 5% and adjusted diluted EPS of $0.56 was up 8% over the prior year.

Sales growth was driven by a 6.5% increase in Activewear and a 52% increase in underwear sales, a highlight for us in the quarter as we completed the full roll-out of the new private label men's underwear program at our largest retail customer.

This new program takes up significantly more shelf space than our previous branded program, and features higher-end ring spun underwear products with enhanced consumer attributes.

Sell-through has been ramping up throughout the quarter and what's encouraging is our customer has confirmed that we'll be allocated additional shelf space to expand the product offering in Q4. Additionally, we've been asked to supply our customers Central American stores in 5 countries.

Although we will not really see the benefit of these incremental program wins until 2020, we see them as encouraging signs that our positioning as a strategic supplier for private brands is resonating.

So with the first 6 months of the year behind us, our financial performance so far is in line with our expectations and puts us firmly on track to achieve the targets we set for 2019.

Consequently, in our press release today, we reaffirmed our sales guidance for the year, calling for growth in the mid-single-digit range and for adjusted EPS to now come in within the upper half of our prior guidance range. Specifically, we have narrowed our adjusted EPS guidance to $1.95 to $2.00 from $1.90 to $2.00, previously.

I'll be providing some more color on our business outlook for the second half of 2019 a little later, but first, let me take you through the Q2 results. As I said earlier, we generated $802 million in sales, reflecting an increase of 5% over Q2 last year, with solid performance from the key growth drivers of our business.

We saw higher unit sales from fashion basics and fleece, volume growth in global lifestyle brand products and continued strong performance of our retail brands on e-commerce platforms.

In international markets, sales were up only slightly as growth slowed in certain markets like China and Europe, which we believe was largely tied to the pace of broader economic activity in these regions.

Nonetheless, in international markets, we were encouraged by POS growth in the month of June, which improved over the first 2 months of the quarter and we continue to target double-digit growth internationally during the second half of the year.

As I mentioned earlier, a key highlight for us was that underwear sales in the quarter grew 52%, reflecting incremental space gains over last year, which largely offset the decline in sock sales in the hosiery and underwear category.

Sock sales in the June quarter across the total measured market, declined by more than 3% according to NPD's retail tracking service. Further, as a reminder on socks, this year, we are exiting a low-margin sock program in the dollar channel.

We also saw some weakness in other channels such as sports specialty even though our sock sales to global lifestyle brands were up strong double digits for the quarter.

And finally, just to finish off on our overall sales growth for the quarter, 5% increase also included higher net selling prices and the impact of stronger product mix in both the activewear and hosiery and underwear categories, reflecting to a certain extent, our focus on moving out of low-margin programs.

Gross margin in the quarter was 27.8%, down 50 basis points from 28.3% in the same quarter last year, in line with our expectations.

Despite higher net selling prices and favorable product mix, the positive impact of these factors was more than offset by anticipated higher raw material costs, inflationary pressure on other input costs and unfavorable foreign exchange compared to last year.

Turning to SG&A, with our continued focus on optimizing our SG&A spend across our system, we were able to keep spending flat compared to last year, $92 million, while driving further sales growth. Accordingly, SG&A expenses were 11.5% of sales, 50 basis points better than last year.

And as we said when we initiated our guidance, we expect full year SG&A as a percentage of sales to improve over 2018 and set us on track towards the 12% or lower level for next year.

Tracking on plan with our full year projection, we recorded $16 million of restructuring and acquisition-related costs in the quarter, tied primarily to textile, hosiery, sewing and yarn manufacturing optimization initiatives, which we previously announced.

These initiatives are expected to generate gross margin benefits starting in the fourth quarter, which will continue to flow through in 2020. So summing it up, operating margin for the quarter came in at 14.2%, down from 15.8%, reflecting the gross margin decline and the impact of higher restructuring and acquisition-related costs.

However, on an adjusted basis, we generated operating margin of 16.3%, 10% -- 10 basis points better than the second quarter last year as the improvement in SG&A leverage offset gross margin pressure in the quarter. Diluted EPS for the second quarter was $0.49 versus $0.51 last year.

Adjusted diluted EPS was $0.56, up 8% from the prior year quarter, driven by higher sales together with the adjusted operating margin improvement and the impact of a lower share based offset in part by higher net financial expenses.

Turning to free cash flow, we generated $26 million in the quarter compared to $98 million last year, due to higher working capital requirements and higher capital expenditures.

You may recall when we reported Q1 results, we highlighted our planned expansion in Bangladesh to develop a large scale manufacturing complex to house two large textile plants and related sewing operations, all of which will serve primarily to support our international business.

So, we spent $56 million in CapEx this quarter, which went mainly towards the land acquisition in Bangladesh for textile and sewing capacity expansion, with the remainder of the CapEx spread across our system in textiles, sewing, yarn distribution and IT.

Under our share repurchase program, we bought back 2.6 million common shares in the quarter for approximately $97 million. Year-to-date, we have bought back approximately 3.5 million shares for approximately $128 million.

We ended the quarter with net debt of $989 million, representing a net debt-to-adjusted EBITDA leverage ratio of 1.8x and within our leverage framework.

Now, going back to the outlook for 2019, as I said at the beginning of my remarks, we reaffirmed our sales guidance of mid-single-digit growth for the full year, and narrowed our adjusted EPS guidance towards the upper half of our initial range. So we are now projecting $1.95 to $2.00 for the full year.

We are also reconfirming our expectations for gross margin for 2019 to remain in line with the prior year level, and we are targeting SG&A expenses as a percentage of sales to continue to improve over 2018 levels. We now expect adjusted EBITDA for the year to be in excess of $615 million versus over $605 million previously.

And we continue to project free cash flow in the range of $300 million to $350 million. Further, although our full year guidance remain largely unchanged, we have adjusted our assumptions regarding the timing of certain sales between the last 2 quarters of the year.

Specifically, we have revised our forecasted timing of fleece sales for the year and now expect to fulfill more shipments of fleet -- fleece in the fourth quarter versus the third quarter than previously anticipated as we continue to ramp up production for these products.

With this timing shift of higher margin fleece sales into Q4, combined with the expected gross margin pressure in the third quarter from higher raw material and manufacturing expenses, which we previously communicated, we are projecting sales growth in the third quarter to be in the mid-single-digit range, lower than we previously expected, and adjusted EPS growth to be flat over the prior year.

Consequently, for the fourth quarter, we are targeting stronger sales growth and stronger adjusted EPS growth, driven by higher sales volumes and a richer mix than previously expected.

Combined together with higher selling prices, the abatement of higher raw material cost pressure on gross margin, and anticipated cost benefits from our manufacturing initiatives, which will start to flow through and which will continue to benefit gross margins in 2020.

So wrapping up, we had a strong second quarter and we feel good about delivering on the second half of the year.

We continue to remain focused on driving key areas of the business, including share in fashion basics and in international markets, capitalizing on the shift to private label, growing with our global lifestyle brand partners and driving our own brands, including leveraging their online platforms.

We're encouraged by recent wins and by the discussions we're having with customers as we work towards solidifying our growth trajectory for 2020 and beyond.

Further, we are executing well on our optimization initiatives from a manufacturing and SG&A perspective, which should translate to continued gross margin expansion and SG&A leverage next year and longer-term as we work towards a 30% gross margin target and SG&A well below 12%.

Beyond that, we continue to invest in expanding both near and long-term capacity, while carefully allocating capital where we think we can achieve strong returns and deliver value to our shareholders over the long term. That ends my formal remarks, and I will now turn the call back over to Sophie..

Great. Thank you, Rhod. That concludes the formal remarks, but before moving to the Q&A session, the first round of question, I ask that you limit the number of questions to 2 or 3 and as time permits, we'll circle back for a second round. I'll now turn the call over to the operator for the question-and-answer session..

[Operator Instructions]. And our first question comes from Heather Balsky of Bank of America..

Can you talk a little bit more about what you're seeing internationally, what you're hearing from your distributor partners and what gives you confidence that after I guess some deceleration in 2Q that things can pick up in the back half?.

Well, so far in this quarter, we really felt decline mainly in China and Europe. We've seen POS continue to grow in June and it's also much better in July. So we've put in what we think is a good initiative to continue achieving our goals as we go through the year.

And we're comping also lower volumes in the year-over-year basis in the second half of the year, so very comfortable with the double-digit number..

And as a second question, can you talk a little bit more about, I guess, the private label launch? You talked about getting additional shelf space. How meaningful is that? Is it the same categories you're selling in or is it expanding the categories? Additional color would be great. Thanks..

For sure, because look at our -- the underwear is performing very well. We're seeing our POS continue to grow through every week as we go forward. Don't forget that the store was only set sometime in the early June. It takes time for all this to really be set and launched so far, but it's going very well.

Based on the initial sell-through and the reaction we've had so far, this -- the retailer awarded us additional space that continue within the same configuration and same product with additional space. A little bit different configuration of what we're selling, but within the same product type and assortment.

Private label underwear at retail is growing dramatically over the overall market. Based on NPD private label underwear is now the third selling underwear category in men's underwear. And it's also growing heavily in socks as well.

And we think that that's going to continue to grow as we go into the future as these retailers keep developing more brands. So we're feeling very comfortable with our positioning.

We're looking to leverage our existing business, additional shelf space and we're also looking to -- for new opportunities to expand the product lines as we go forward into 2020. So we're very comfortable. We think this is a great opportunity for us to leverage our low-cost manufacturing and continue to drive topline sales as we go into 2020..

Our next question comes from Paul Lejuez of Citigroup..

It's Tracy Kogan filling in for Paul. My question is on American Apparel.

I was wondering if you could talk about the performance in the quarter and maybe your expectations for the year and then just wondering as you think about it longer term, how you're growing the distribution for the brand to the end consumer, whether it'd be just through e-comm or if you think about opening stores?.

Well, we're really -- the focus on American Apparel for us is a combination of both our footwear business and as well our e-commerce business. And I'll start out first with e-commerce is going well. We're continuing to drive our e-commerce site.

And our objective here is really to use the brand in the retail direct-to-consumer from the e-commerce perspective and not necessarily drive a big brick and mortar strategy. As far as our AA and printwear [ph] it's going very good.

We're putting together for the back half of this year and going into a long-term relationship with driving the branch strategy with the promotional activity with a partnership with Live Nation. It's going to be the short amongst all concerts in America and beyond. It's pretty global.

So we're going to -- we're spending the money, we think, to promote the brand and really drive the fashion basics segment, which is growing opportunity for us. I mean we've got a lot of runway still in AA, which is the good news.

I mean it's still small relative to the overall size of the business, but objectively we see the big growth as we go into the future..

Our next question comes from Sabahat Khan of RBC Capital Markets..

Just going back to the private label a little bit, can you maybe give us some color as you head into H2 '19 and 2020 like other initiatives that you might be working on.

Is there other retailer that you think might come on board with new programs for you? Are they largely going to be in the underwear space? Kind of your thoughts on as we head into 2020? And also in terms of kind of some of the remaining socks programs that you have, are you expecting that there might be some drawdown there too, and that will be offset by private label? Just kind of puts and takes on the overall retail strategy..

We're continuing to drive by new programs. So if you look at how you leverage in '19 and going to '20, obviously we are going to get to wrap around effectively -- the large [indiscernible] that we have for this year. We have additional shelf space coming.

We're looking at adding potentially new products with other retail partners as well as existing retail customers. So we're pushing very hard in the underwear area to continue to grow and develop new programs. We were also focusing aggressively on our activewear products as well. And we have a lot of opportunities in activewear.

Underwear is relatively small, relative to the overall scheme of the size that the activewear company in Gildan is. So we think we have a lot to offer and we're also working aggressively with our -- with all of our partners to make sure that we pursue as much as aggressively as possible in the opportunity for activewear.

And as far as socks are concerned, look -- we are at the stable days of socks. We've really, I think, we -- this regarded all these low margin programs that we have and we stabilize our business.

So we feel comfortable that we've got some sort of [indiscernible] based on our sock business and we see good growth in some of our global lifestyle brands, and we're continuing to look at other opportunities to expand our sock business from the base that we have today..

And then maybe if you could share a little bit of color on what you're seeing in the broader wholesale channel, both in terms of your traditional basics offerings and also how the overall fashion basics category is doing as a market? And how some of your brands are performing? I was trying to get an idea of if there had been market share gains on the fashion basics side and how that strategy is trending?.

We're definitely gaining market share in fashion basics I'm sure. And then we have a portfolio of brands. They're all doing well. I mean our American Apparel, which I just discussed are comfortable, it is doing very well. We expanded the distribution of all of these brands. Our core deals and fashion styles are extremely doing well.

So fashion is just continuing to drive and go in the direction of increased market share. There is something -- somewhat offset a little bit from the decline in basics we see in the market, but our fashion business is really doing well. And all of our growth drivers initiatives are on par with where we need to be..

And then just one last one. Are you able to maybe share a little bit of color on your outlook for input cost? Cotton seems to have been a little volatile in the first half of the year.

What are you seeing for back half of this year and into 2020?.

Sabahat, I mean, it's in-line with what we have been communicating, right. So if you look at the way our supply chain works right, effectively we've got 6 months right in the whole chain. So what we're seeing in the back half of the year is in line with what we are seeing at the beginning of the year. So there is no real change.

As we move into Q3 and Q4, we've communicated that we would have pressure on cotton that we saw in the first quarter, we saw it in second quarter, let's say in the third quarter and then it starts to abate as we move to the fourth quarter. So that cadence hasn't -- it remains unchanged..

Our next question comes from Mark Petrie of CIBC..

I just wanted to follow-up on that last topic, sort of the pricing outlook in the printwear channel, and I guess just in the context of how you're describing the outlook for cotton? Could you just talk a bit, I guess, even beyond sort of Q3, Q4 and what your expectations would be for how that balance plays out in 2020?.

Well, look it's the -- the price of cotton is actually -- it was going down as you can see, but there is lot of other inflationary pressures that we have in the industry, labor, dyes, chemicals, transportation. I mean there is a lot of other inflation areas that more raw material will probably offset.

Typically we've raised prices in the last couple of years to offset the increased price of raw material. And then probably -- you probably see as we move into 2020 more stable pricing where you have a little bit lower raw material, but offsetting some of the inflation areas that typically have raised prices in the last couple of years.

At the same time, what we see is in terms of margin expansion is our low-cost manufacturing, all the initiatives we're going to have a pretty good increase in our gross margins in Q4 with a fine year-over-year in cotton price.

So this is the initiatives that we set forth in terms of our optimizing our manufacturing and our big -- in fact the basic strategy are going to pay off and we should see some benefit in our margin, as we go into 2020..

And I guess just to follow-up, any comment or any insight with regard to distributor inventory levels.

Is there anything to call out there?.

No, distributor inventory levels are in track and normalized at this time of the year..

Our next question comes from Vishal Shreedhar of National Bank..

Just a quick one here on the EBITDA, the $615 million, was that -- that's increased for IFRS, right. That's the only change there IFRS 16? Okay..

It was pushed up because it effectively -- when we gave guidance for the -- our previous guidance was $1.90 to $2.00, obviously we've got to the higher end of the range, but we pushed it up in line with that, plus we don't -- reflected the impact of IFRS 16..

Okay.

And IFRS 16 for the year is about call it $15 million to $20 million?.

A little bit lower, $15 million..

Okay, okay, okay. The -- just switching gears here on the traditional printwear segment, so management called out the dynamics with the fashion basics still growing and --I think so should we think about like the traditional kind of basics basis business that's up there like big marquee Gildan 2000, that's declining.

Is that like a fair way to look at it?.

Well, that particular product is declining, but that's not partly what we don't understand, it could be a function of consumer preference in terms of wages. That's our [indiscernible] actually manufacture. But in general the way we classify our basic t-shirts, which would be our 2000 category.

It is slightly a decline over time and has been for couple of years, but offset by the boom in the fashion side of it, which is lighter weight software based upon t-shirts..

Okay. So should we think about it topline in that traditional printwear's business? Topline is growing because of the higher price of fashion basics, gross margin dollars are growing because of the margin benefit. But the units, they're probably not growing as quickly as gross margin or sales --.

They're growing as well because don't forget also that our fleece business is very, very strong. I mean fleece has been a big driver of our mix and our growth. So I think that that's also a big area of opportunity. Long sleeves have grown, which are still some of those basic categories.

So overall, we're pretty comfortable with the growth rate and we see that we should get unit growth and mix growth as well as we go forward..

Right, right.

And did you get unit growth this quarter?.

Yeah. If you look at the effectively for the quarter from -- on activewear, we're basically flat. The best way to think about it..

On units. Okay. Wonderful..

Our next question comes from Brian Morrison of TD Securities..

Nice to see the further progress in private label. Maybe you could just elaborate on the timing and size of the Central American contract.

Maybe just relative to the current USA and it would be 20% just based on the footprint and then I guess more high level, Glenn, just, it's not atypical for the mass merchants to use their size to pressure pricing as you successfully gain market share or shelf space, so how do you address or mitigate this trend as you're growing your shelf space successfully?.

So first of all, I'll answer the Central America as it's all relative to the whole big scheme of things, obviously because of the footprints in Central America.

Even though population perspective is still relatively small in the overall scheme of things, but it's just an important part of how we can leverage the relationship and how we build these programs, and it gives us product expansion and geographical diversification. So it's a positive thing.

It's not going to move the needle, but it's a starting point for us to continue to grow the overall relationship. As far as the margin, look we're very competitive.

If you look at the price points that we're selling our products in today in the market, and the quality of the product that we're offering, we've leveraged our low-cost manufacturing and working together with our retail partners who to make sure that it's a win-win for everybody. So we're very happy with our positioning.

Our pricing strategy and the product strategy and the margin strategy, both for us and our customers..

Okay. And then second one, maybe this is for you Rhod. Just in terms of the timing of initiatives, I assume that they don't all flow through in Q4, and I'm talking about gross margin.

I mean, as they start to ramp in Q4, when should we see them optimize, I'm talking about the rationalization of AKH and hosiery that sewing efficiencies, the in-sourcing, what's the sort of level of when you will reach optimization and get to this 30% gross margin target?.

Well, look when we gave the 30% gross margin target, we said that was basically a 24 months out there and we gave that target last quarter when we reported. So you have to think about that really is when we get into 2021.

We get into 2020, we are going to see the benefits of a lot of the manufacturing optimization initiatives that we've been working on. We call that out as 200 basis points, we hit the end of Q4, you'll continue to see some of that rolling into 2020, but the 30% is really we're going after that as I would call it a 2021 target..

So say in the 12% SG&A that's end of 2019 target?.

So 12% SG&A, we're trying to get below that for 2020. Okay, this year, our SG&A will be down very definitely, and what we're trying to do on SG&A, right. We're trying to basically keep our SG&A flat in growth dollar terms as we move from one year to the next. And so that will drive our SG&A down this year.

And then as we move into 2020, we expect to go below 12%..

Our next question comes from Keith Howlett of Desjardins..

Just had a question on the private label program.

How many days inventory does a typical retailer keep in terms of their underwear?.

Well, each retailer is completely different, the way their structure their supply chain. So I really kind of answered that question, because some of them shift to the store [indiscernible] warehousing, so it's a very loaded question. So I prefer not answer to be honest with you..

And then just in terms of expansion of the contract, is it correct that you're not doing those that private label underwear program in Canada or Mexico?.

No, not Canada, Mexico, Central America and the -- and US..

And is there some possibility that you could do it in Mexico or Canada?.

Yeah, well that's optionality. I mean look at, I mean -- that was my whole point as we build these relationships and these retailers look at consistent brand strategies amongst all of their regions, this is an opportunity for us to get geographical expansion to continue growing our opportunity..

And then I just had a question on China.

In a market like China are there, you know 9 distributors per big major city or what does the distribution network look like in China, is it sort of for you, is it -- do you have 90 of them or 4 of them or how does that work?.

We have -- look it's a much higher, much more fragmented the market, but the market size and we're just in the process of completing our study that we've done every 5 years, we update our study in terms of where the market is.

And the reality is in China today the market is growing and it's also growing because the opportunity for us to access the market in terms of the way that market functions, the price points in the market, et cetera, et cetera.

So we think that the opportunity for China has grown significantly over the last five years and the distribution network is becoming more fluid and allowing us to reach more people.

And think we had a little bit of a hiccup this quarter just because of all the uncertainty in the market, I mean but we feel comfortable that POS has come back, we feel that we have enough capabilities, enough distribution capacity to continue to support our growth rates and support double-digit growth as we go through back of this year into next year..

[Operator Instructions]. We have a follow-up question from Keith Howlett of Desjardins..

Yes. I want to ask on the printwear market in the US where there's, I guess, 2 players that sort of are the largest in the market.

Do you think that you're gaining share relative to those two players?.

In what sense you're talking about in the fashion segment?.

Sorry, in the fashion basics segment..

Yes, so I think we're getting share..

And we have no further questions at this time. I will now turn the call back over to Sophie for closing remarks..

Great. Thank you, Michelle. Before ending the conference call, I'd like to remind you that the registration is still open for our 2019 Institutional Investor and Analyst Conference, which will take place in Honduras in November.

The event will include tours of Gildan's manufacturing facilities in Honduras, as well as presentations by members of our management team. So for further details, please consult our Investor Relations events page online or you can reach out to investors@gildan.com.

With that, I'd like to thank everyone again for joining us today and we look forward to speaking to you again very soon. Have a great day..

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for joining. You may now disconnect..