Gildan Activewear Inc. said its fourth quarter earnings met expectations, but projected a loss for the first quarter of fiscal 2012 as the company finishes consuming inventories produced with high-cost cotton and achieves projected manufacturing efficiencies.
The Montreal-based maker of activewear and blanks for the screen printing industry, Gildan reported net earnings for the fourth fiscal quarter ended Oct. 2, 2011 were $48.5 million or 40 cents per share on a diluted basis, down respectively 14.6% and 14.9% from $56.8 million or 47 cents per share in the fourth quarter of fiscal 2010. Results for the fourth quarter include restructuring charges totalling $2.3 million after-tax or 2 cents per share, to write down the carrying value of facilities held for sale and to recognize additional pension costs for the former Gold Toe Moretz pension plan, which the company intends to terminate in 2012. Before the restructuring charges in both years, adjusted net earnings were $50.8 million, or 42 cents per share, down respectively 12.9% and 12.5% from $58.3 million or 48 cents per share.
The decline in adjusted net earnings and EPS in the fourth quarter compared to last year was due to the significant increase in the cost of cotton, which was not fully recovered in higher net selling prices, lower unit sales volumes for activewear and the non-recurrence of insurance proceeds and a cotton subsidy received in the fourth quarter of last year. These negative factors were partially offset by the positive impact of income tax recoveries in the fourth quarter of fiscal 2011, more favourable activewear product-mix, lower SG&A expenses and the earnings accretion from the acquisition of Gold Toe Moretz.
Adjusted EPS slightly exceeded the company's guidance for the quarter of approximately 40 provided on August 4, 2011. Compared to its August guidance, the unfavourable impact of weaker demand and increased promotional discounting in the wholesale distributor channel, lower inventory replenishment by mass-market retailers and lower than forecast sock manufacturing efficiencies was more than offset by the later than anticipated timing of destocking of inventories by wholesale distributors, which is now occurring in the first quarter of fiscal 2012, and the benefit of income tax recoveries.
Net sales in the fourth quarter amounted to $481.8 million, up 30.6% from $368.9 million in the fourth quarter of fiscal 2010. The company had forecast in August that sales in the fourth quarter would be slightly below $500 million. Sales of activewear and underwear amounted to $368.9 million, up 20.0% from fiscal 2010, and sales of socks were $112.9 million, up 83.6% from $61.5 million a year ago.
The growth in sales of activewear and underwear compared to the fourth quarter of fiscal 2010 was due to an approximate 23% increase in average net selling prices, partially offset by a 7.6% reduction in unit volume shipments which declined due to a 6.3% reduction in industry shipments from distributors to screenprinters and seasonal destocking in the screenprint market which was less than anticipated. Gildan's market share in the distributor channel in the fourth quarter was 62.3%, according to the CREST report, and was essentially unchanged from 62.1% in the fourth quarter of last year. Consequently, the company has recaptured the slight loss of market share incurred earlier in the fiscal year, when it was unable to fully service demand for its products due to capacity constraints and sub-optimal inventory levels.
The increase in sales revenues for socks was due to the acquisition of Gold Toe Moretz. Shipments of socks in the fourth quarter of fiscal 2011 were negatively impacted by weak market conditions and inventory destocking by mass-market retailers. Also, sales of socks in the fourth quarter of fiscal 2010 were positively impacted by the later timing of shipments of back-to-school programs.
Gross margins in the fourth quarter were 20.4% compared with the company's guidance in August of approximately 22%, and 27.3% in the fourth quarter of last year. Gross margins were lower than forecast due to higher than forecast selling price promotions in the wholesale distributor channel in the month of September and lower than projected sock manufacturing efficiencies.
The decrease in gross margins compared to last year was due to the significant increase in the cost of cotton, which was not fully recovered in higher selling prices, and the non-recurrence of the proceeds from the insurance claim for the Haiti earthquake and a cotton subsidy received in Gildan's yarn-spinning joint venture, which together positively impacted gross margins by over 400 basis points in the fourth quarter of last year. These negative factors were partially offset by more favourable activewear product-mix and the impact of the acquisition of Gold Toe Moretz.
SG&A expenses in the fourth quarter increased to $53.3 million from $42.0 million in the fourth quarter of last year. The increase in SG&A expenses was due to the impact of including Gold Toe Moretz, which resulted in approximately $15 million of additional SG&A expenses, partially offset by the non-recurrence of a $1.5 million provision for doubtful accounts receivable in the fourth quarter of last year and lower distribution expenses.
Adjusted EPS in the fourth quarter included income tax recoveries totalling approximately $7.6 million arising from losses in the company's legal entities.
Full Year Sales and Earnings
Net sales for fiscal 2011 amounted to $1,726.0 million, up 31.6% from $1,311.5 million in fiscal 2010. The growth in sales revenues was due to higher net selling prices and increased unit sales volumes for activewear and underwear, as well as the impact of the acquisition of Gold Toe Moretz, partially offset by lower organic sock sales. Unit sales growth in activewear and underwear of 7.7% reflected the recovery in market conditions in the wholesale distributor channel in the first half of the fiscal year, the company's penetration in other screenprint markets and increased shipments of activewear and underwear to mass-market retailers, partially offset by an approximate 8% decline in overall market demand in shipments from distributors to screenprinters in the second half of the fiscal year.
Net earnings for fiscal 2011 amounted to $239.9 million or $1.96 per share, up 21.0% and 20.2% respectively from $198.2 million or $1.63 per share in fiscal 2010. Adjusted net earnings before restructuring charges were $245.5 million or $2.01 per share, up 20.6% and 20.4% respectively from $203.6 million or $1.67 per share last year. The growth in earnings and EPS was due to increased sales revenues for activewear, which, together with the earnings and EPS accretion attributable to the Gold Toe Moretz acquisition and income tax recoveries, more than offset the impact of higher cotton and other input costs, lower organic sales of socks and increased selling, general and administrative expenses.
Cash Flow and Financial Position
The company ended the fourth quarter and the financial year with cash and cash equivalents of $88.8 million and $209.0 million of bank indebtedness. In the fourth quarter the company generated EBITDA of $65.6 million and free cash flow of $61.8 million. Inventories, which had been at sub-optimal levels to adequately service customer demand throughout the first three quarters of the fiscal year, increased by approximately $55.0 million during the fourth quarter. Capital expenditures in the fourth quarter amounted to $50.8 million. During the fourth quarter, the company utilized its normal course issuer bid program to repurchase 400,000 of its common shares outstanding.
EBITDA for the full fiscal year amounted to $312.5 million and the company generated free cash flow of $7.3 million in fiscal 2011.
Segmented Reporting
Beginning in the first quarter of fiscal 2012, Gildan will begin reporting its retail business as a separate operating business segment, in line with the new operating and internal financial reporting structure of the company. Gildan is now structured as two operating businesses, each of which has accountability for its financial performance and return on capital. The screenprint business will continue to be headquartered in Barbados and the new retail business operations are headquartered in Charleston, SC.
Beginning in the first quarter of fiscal 2012, Gildan will begin reporting its retail business as a separate operating business segment, in line with the new operating and internal financial reporting structure of the company. Gildan is now structured as two operating businesses, each of which has accountability for its financial performance and return on capital. The screenprint business will continue to be headquartered in Barbados and the new retail business operations are headquartered in Charleston, SC.
The company has made significant investments in its manufacturing and distribution facilities to support the development of its retail business, and has also undertaken the recent strategic acquisition of Gold Toe Moretz. The company believes that its investments in manufacturing technology and the consistently high quality of its products will enable it over time to successfully develop the Gildan brand for retail, and maximize the further growth potential of its Gold Toe, PowerSox, SilverToe, Auro, All Pro, and GT brands as well as its exclusive sock license for the Under Armour and New Balance brands. The company will also evaluate other possible consumer brand acquisitions to complement its organic retail growth.
A major objective for the company in fiscal 2012 will be to achieve more acceptable profit margins and returns on capital for its retail business, which has been unprofitable in fiscal 2011 due to a combination of factors, including the high cost of cotton, the transition of sock manufacturing from the to Honduras, the ramp-up of its new distribution centre, and the development of a significant overhead infrastructure to implement the company's retail strategy and drive the future growth of the business.
In addition, the company has been shifting its retail product-mix to de-emphasize and forego private label programs which do not meet its profit criteria and to focus on the development of its owned and licensed brands, together with selective private label programs which fit with its efficient large-scale vertical manufacturing and which provide acceptable profitability and returns.
Gildan is projecting that its retail business will begin to report operating profits during the course of fiscal 2012, due to lower-cost cotton and manufacturing efficiencies. Subsequent future growth in retail operating margins will be driven by unit volume growth, which will result in increased manufacturing efficiencies and increased SG&A leverage, as well as by projected additional synergies from the Gold Toe Moretz acquisition.
Outlook
The company is providing sales and earnings guidance, based on the assumption of continuing weak overall economic conditions and weak industry demand. Also, the industry is managing through a unique transition from rapid inflation in cotton costs to rapid deflation.
The company is projecting a loss of approximately 40 cents per share in its first fiscal quarter on projected sales of approximately $300 million, compared with EPS of 30 in the first quarter of fiscal 2011 on sales of $331.3 million.
Short-term promotional discounting began to increase at the end of the fourth quarter, and has continued to increase in the first quarter of fiscal 2012. Also, in the first quarter, in anticipation of selling price reductions, distributors have been supplying screenprinter demand without replenishing inventory levels, resulting in excess producer inventories and further increases in promotional discounting as producers seek to maintain capacity utilization in their manufacturing facilities. As the market leader, in order to enable distributors to plan their business and stimulate screenprinter demand for Gildan products, Gildan announced yesterday that it is reducing gross selling prices in the wholesale distributor channel effective December 5, 2011, and applying the benefit of this price reduction to existing distributor inventories. The impact of the special distributor inventory devaluation discount on first quarter results is projected to be approximately 16 cents per share.
Although Gildan is no longer constrained by lack of capacity and is maintaining a high market share, the combination of weak end-use demand and distributor destocking is projected to result in an approximate 40% decline in Gildan's unit sales volumes in the screenprint market in the first quarter, compared to the first quarter of fiscal 2011. In addition, the first quarter is seasonally the lowest-volume quarter of the fiscal year.
The projected results for the first fiscal quarter are due to a combination of factors including the significant destocking of inventories by distributors, increased promotional pricing at the same time that the company is consuming inventories produced with high cotton costs, the impact of the special distributor inventory devaluation discount, and extension of the normal holiday production downtime in December, in order to manage inventory levels.
In the second half of the fiscal year, the company expects to benefit from significantly lower cotton costs compared with both the first half of fiscal 2012 and the second half of fiscal 2011. Also, the company is projecting increased efficiencies in its sock manufacturing operations. Adjusted EPS for fiscal 2012 is projected to be approximately $1.30, down 35% from $2.01 per share in fiscal 2011. Net sales revenues in fiscal 2012 are projected to be approximately $1.9 billion, compared with $1,726 million in fiscal 2011. Sales revenues for the screenprint business are projected to be approximately $1.3 billion, and retail sales revenues are projected to be approximately 6 billion.
The projected reduction in full year EPS in fiscal 2012 compared to 2011 is primarily due to higher cotton costs in the first half of the year, lower selling prices for activewear, the special distributor devaluation discount and the non-recurrence of income tax recoveries during fiscal 2011. These negative factors are assumed to be partially offset by assumed lower cotton costs in the second half of the year, projected higher net selling prices for socks and underwear, projected higher activewear sales volumes, more favourable manufacturing efficiencies, after taking account of shutdown costs assumed in fiscal 2012, and the EPS accretion from a full year of earnings from the acquisition of Gold Toe Moretz.
It is emphasized that the current environment for the company's business is highly uncertain and volatile, and the financial projections provided for fiscal 2012 could be significantly impacted by any improvement or further deterioration in conditions and in the underlying assumptions for the business.
The main assumptions underlying the company's sales and earnings guidance for fiscal 2012 are set out below. Projected results are highly sensitive to changes in assumptions for unit volumes and unit selling prices, as well as for future cotton prices and the company's ability to achieve projected manufacturing cost reductions.
– Overall industry shipments from distributors to screenprinters are assumed to be down by approximately 2.5% in fiscal 2012 compared to fiscal 2011. Industry shipments in the second quarter of fiscal 2012 are assumed to be down by 5% compared to the second quarter of fiscal 2011, the same decline as projected in the first quarter. Industry shipments in the second half of fiscal 2012 are assumed to be essentially unchanged from a low base in the second half of fiscal 2011. The company is assuming an average market share of approximately 65% in the wholesale distributor channel in fiscal 2012. The company is projecting growth in sales volumes in international and other markets in fiscal 2012. The company estimates that every one million dozen change in demand for activewear impacts annual EPS by over 05. The company has scheduled additional manufacturing downtime in addition to the shutdown in the first quarter due to the assumed weak market demand.
- It has been assumed that net selling prices in the screenprint market will decline slightly during the balance of fiscal 2012 and that selling prices will be lower than in fiscal 2011. However, there is no assurance that selling price competition will not be more severe than projected, as manufacturers seek to maintain mill capacity utilization. The company estimates that every 1% change in screenprint net selling prices impacts projected EPS for fiscal 2012 by approximately 10 cents.
- Selling price increases which were recently implemented in the retail market did not reflect the full pass-through of high-cost cotton. Therefore, while gross margins for retail products are continuing to be adversely affected in the first half of fiscal 2012 by the high cost of cotton, it is not currently expected that Gildan's selling prices to retailers will decline when the company benefits from lower cotton costs in the second half of the fiscal year.
- Cotton costs in the first half of the fiscal year will be significantly higher than the first half of fiscal 2011. The weak demand environment is projected to result in slower consumption of inventories manufactured with high-cost cotton. The consumption of such inventories is now assumed to continue until early in the third quarter of fiscal 2012. However, based on current futures, cotton costs in the second half of the fiscal year are expected to be significantly lower than the second half of fiscal 2011.
- SG&A in fiscal 2012 is assumed to increase by approximately $25 million compared to fiscal 2011, due to the inclusion of Gold Toe Moretz for the full fiscal year. The income tax rate in fiscal 2012 is currently assumed to be approximately 1%.
The company expects to generate free cash flow of approximately $75 million – $100 million in fiscal 2012. The company expects to use cash in the first half of the fiscal year, due to the loss in the first quarter and working capital requirements for the peak summer selling season in the T-shirt industry. Capital expenditures are projected to amount to approximately $100 million, including the ramp-up of the Rio Nance V facility. Although the company is continuing to accelerate its ramp-up of the new facility, it plans to carefully manage production in line with market demand. The company is currently planning to manage capacity and inventory levels by temporarily reducing capacity at the Rio Nance I facility.
The company is also one of the world's largest suppliers of branded and private label athletic, casual and dress socks sold to a broad spectrum of retailers in the Gildan markets its sock products under a diversified portfolio of company-owned brands, including Gold Toe®, PowerSox®, SilverToe®, Auro®, All Pro®, GT®, and the Gildan® brand. The company is also the exclusive sock licensee for the Under Armour® and New Balance® brands. In addition to socks, the company is increasingly becoming a significant supplier of underwear and undecorated activewear products in the retail channel.
Gildan Activewear Inc.
Consolidated Statements of Earnings and Comprehensive Income
(in thousands of U.S. dollars, except per share data)
Three months ended Twelve months ended
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October 2, October 3, October 2, October 3,
2011 2010 2011 2010
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(unaudited) (unaudited) (unaudited) (audited)
Net sales $ 481,755 $ 368,935 $ 1,726,041 $ 1,311,463
Cost of sales 383,304 268,268 1,288,293 947,206
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Gross profit 98,451 100,667 437,748 364,257
Selling, general and
administrative expenses 53,291 42,045 199,132 154,674
Restructuring and
acquisition-related
costs (note 1) 3,554 2,783 8,465 8,705
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Operating income 41,606 55,839 230,151 200,878
Financial expense
(income), net (note 2) 1,825 (1,132) 5,485 751
Non-controlling interest
in consolidated joint
venture 198 2,691 504 3,786
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Earnings before income
taxes 39,583 54,280 224,162 196,341
Income taxes (8,951) (2,536) (15,742) (1,904)
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Net earnings 48,534 56,816 239,904 198,245
Other comprehensive
(loss) income, net of
related income taxes (330) (3,425) 1,034 (1,710)
—————————————————-
Comprehensive income $ 48,204 $ 53,391 $ 240,938 $ 196,535
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Earnings per share:
Basic EPS $ 0.40 $ 0.47 $ 1.97 $ 1.64
Diluted EPS $ 0.40 $ 0.47 $ 1.96 $ 1.63
