Q2 2023 Gildan Activewear Inc Earnings Call

Speaker 1: of product mix in active wear related shifting product preferences in this environment.

SG&A expenses for the second quarter were $78 million, down $11 million versus last year, mainly due to lower variable compensation expenses and our continued cost containment efforts, which more than offset the impact of cost inflation. As a percentage of sales, SG&A of 9.3% improved 70 basis points despite the impact of sales deleverage. Consequently, we generated operating income of 21.7% of sales during the quarter, which included a net insurance gain of $74 million related to the two hurricanes that impacted the company's operations in Central America back in 2020, partly offset by restructuring charges of $30 million, which include the closure of a sewing facility in Honduras. On an adjusted basis, operating margin of 16.5% was up 190 basis points sequentially, significantly better than expected, but down 310 points compared to the prior year.

After reflecting net financial expenses of $21 million and factoring in continued share of purchases, we reported GAAP and adjusted diluted EPS for the quarter of $0.87 and $0.63, respectively. Moving on to cash flow and balance sheet items. Cash flow from operating activities was $182 million in the second quarter, which includes the net positive effect from the insurance game mentioned earlier. This compares to $210 million in the prior year.

and the drop is primarily due to higher working capital and lower net earnings. We continue to maintain healthy inventory levels, ensuring product availability and depth. Furthermore, we expect our inventory levels to decrease sequentially, as was the case in Q2, and end the year below 2022 levels.

After capital expenditures of $56 million, we generated approximately $126 million of free cash flow in the second quarter.

On the CAPEX front, the progressive ramp-up of our new Bangladesh facilities is underway, which will continue through 2023 into 2024.

We also bought back 2.6 million shares in the quarter, reflecting our strong commitment to return capital to shareholders.

The company ended the second quarter of 2023 with net debt of $1.17 billion and a net debt to EBITDA leverage ratio of 1.8 times, in line with our 1 to 2 times targeted debt levels.

Moving on to the outlook for the full year.

With strong comparative periods now behind us, we continue to expect our revenues to grow in the second half of the year, supported by the planned roll-out of incremental retail programs.

However, despite continued market share gains, we are seeing current market conditions negatively impact active wear product mix in both North American and international markets as customers focus on lower priced products.

Combined with the near-term uncertainty related to the macro environment, we believe it is prudent to temper our previous full year 2023 expectations for revenue growth and operating margins, which now reflect the trade-down occurring within our ActiveWare product category.

Finally, our full year 2023 outlook is also factoring in the impact of higher than previously expected financial charges for the second half.

Accordingly, for 2023, we now expect revenue for the full year to be flat to down low single digits versus the prior year.

We also expect full year adjusted operating margin to be slightly below the low end of our 18-20% annual target range.

Although this said, we continue to expect sequential quarterly improvement in operating margins through the second half of 2023.

We expect adjusted diluted EPS in the range of $2.55 to $2.65, including the impact of assumed share repurchases of 5% of our outstanding public float in 2023.

And finally, we expect strong full-year free cash flow generation above $425 million after capital expenditures which we continue to expect to be at the lower end of our 6-8% target range.

So in conclusion, while we face some near-term headwinds driven by the macro environment, which we can see is driving customers to focus on lower-priced products, and which has largely driven the change in our 2023 outlook, we are encouraged by our performance relative to our peers as we continue to gain market share in a difficult environment.

Accordingly, we remain confident that as macro pressures subside, we will be positioned to fully capitalize on our market share gains and resume our growth trajectory.

This combined with our cost structure that we believe is well under control, in which we continue to improve, positions us well as we work towards delivering on our financial targets and creating long-term shareholder value under the Gilden Sustainable Growth Strategy focused on three key pillars of capacity-driven growth, innovation and ESG.

Thank you, and I will now turn the call back to Jesse.

Thank you Rod. Before moving to the Q&A session, I'd ask you to limit the number of questions to two and we'll circle back for a second round of questions if time permits.

Josephine, you may begin the Q&A session.

At this time, I would like to remind everyone in order to ask a question, press star then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster.

I'm just in the room.

Josephine, we're ready to take questions.

At this time, I would like to remind everyone in order to ask a question, press star, then the number one on your telephone keypad.

Your first question comes from the line of Jsoul.

Drive line is open.

Great. Thank you so much. I'm wondering if you can elaborate on the current market conditions that you're talking about that are unfavorably impacting active wear. What exactly is going on? Is it sort of a customer issue? Is it a consumer issue? If you can elaborate, that would be very helpful. Thank you.

I'll start with that one. We'll look at, I think what we're saying is that our market conditions are actually pretty strong ourselves. We're gaining share in the market.

The overall market we think is down low double digits in terms of active wear in the North American market, but we know obviously we're gaining share with a positive 2%.

The real change, and I think what we're looking at, is that the customers that are buying products

are actually changing the type of product they're buying. So they're buying lesser value type products. So for example, instead of buying a hooded sweatshirt, they're buying a crew neck sweatshirt. Instead of buying some of the fringe items that we sell, they're buying more basic items. And then they're also buying some of the recognize Des chickens, which is probably what we have today, a

One area we're seeing is a shift back to basic product from the fashion product as the price points are lower. So that's really what's happening but the unit volumes are good. It's just a shift in the mix of product which is reflecting the actual net selling prices that we sell to these consumers.

but our volumes are on track, our volumes are good, we're taking share in the market, although the market is weak and being challenged.

That's really what's happened.

Got it. And then Glenn can talk about just the factory closure and maybe put it in

you know, how that decision came about and sort of what the implications are.

Well look, I wouldn't take that factory closure as anything but continued optimization of our whole manufacturing supply chain and optimization in terms of really focusing on our back to basics so it's not a capacity driven thing. We're still running our capacity relatively at the same levels we were.

in Q1 and Q2 and where we are today. So we haven't changed our capacity. We're just continuing to optimize. And these markets, I mean, we're not running at full. You know, like what we said last time is we're running between 85 and 90. We're still at those levels, but we're constantly optimizing our structure, our cost structure and positioning ourselves to be.

low cost as we move forward into the future. So it's more of a back to basics approach than anything. Okay, thank you so much.

Your next question comes from the line of George Noemie of Scotchabank.

Your line is open.

Hi, thanks. Good morning, Glen and Rod. I think last quarter you mentioned we're seeing pretty good yield in PoS for fleets. You mentioned high, single, low, double. Can you just talk a little bit about how that's been trending now?

Chuck, we'll answer that. Good morning. Yeah, we're still, FLEECE is still trending well. It's not as strong as it was. I think the big thing that Glenn mentioned is sort of we're seeing a mix change between hoods and crews, which, you know, the hoods sell a slight premium to the...

to the crews, so we're seeing more of a mix shift, but fleece is still performing well. And the mix shift is significant, like you know, just to put things in perspective, the price difference is in a neighborhood of 40% differential in price between a hood and a crew. So we're selling the unit volume, the share is going up, we're still in mid-single digit type growth in fleece.

But the thing is that the price point of the items from a crew to a hood is significant. It's in the neighborhood of 40% difference between a crew and a hood. So they're just buying a lesser priced item but we're still selling the unit volume.

Okay that's helpful and maybe on the 380 basis points of contraction on the gross margin, can you talk a little bit about how much of that was cotton and just how should we think of maybe Rod, how should you think of the second half that recovery in the margins driven by lower price cotton? Anything you can maybe help us out there just to model that out? Thanks.

Okay George, so if you look at the margins, what happened in the second quarter, margin actually, our performance was better than we anticipated, right? We had said last quarter that for the second quarter we would be up 100 to 150 basis points over the first quarter and we actually came in a bit stronger. I would say we were...

we're very pleased with that overall and if you look at what happened with our margin actually MIX as we said drove a weaker margin overall probably about 170 basis points of headwind in those numbers but because of our performance on our cost structure

performance on SGA and other areas, effectively we were able to achieve a good operating margin of 16.5%. If you look at the fiber impact, we had headwind in the first half and then as we go into the second half, that abates and it turns into a tailwind.

So if you look at the second quarter, basically, if you look at cotton or fiber on our cost of sales, we still had, or sorry, if you go into the third quarter, if you look at what's gonna go on there, we're still gonna have a little bit of headwind, but as we move through the quarter, basically, you're flat and then as you go into the fourth quarter.

it turns into a tailwind for us. So if you look at our margins overall, good performance in the second quarter, we're very pleased with the way it unfolded, and if you look at the third quarter effectively you get sequential improvement in our margins.

If you look overall, we're probably going to be just below the low end of our target range in the third quarter from an operating margin perspective. And then if you push into the fourth quarter, we're going to get to the high end of our target range.

And again, our cost structure is really well under control and that really will drive us as we move into the back part of the year and obviously that sets us up very well as we move into 2024. So I would say we feel very good about our overall cotton position and our overall cost position as we go forward. It's still a I believe it's.

Great, thanks for the call. Your next question comes from the line of Stephen McLeod of BMO Capital Market.

Your line is open.

Great, thank you. Good morning guys, good morning everyone.

Just circling back on that last question about the color you gave on the margins.

I know you were talking specifically around the operating margin. Do you have any incremental color you can provide around the gross margin and how the balance between gross and SG&A fits you into those consolidated margins you're talking about?

Yeah, look, if you look at effectively what's going to go on, it's all really going to flow through the gross margin, right, as we go into the back half because all of that cost structure, improvement in cost structure will be reflected in gross margin. We will have the weaker mix, right, that effectively will continue in the third quarter and the fourth quarter.

as it called out for the second quarter. And really, if you look at our full year outlook, our total outlook, and you look at our sales outlook and the way we've moved it, it's all being driven by weaker mix. So the real move from our prior guidance to where our current guidance is.

flat to down low single digit. If you go to the midpoint, it's all being driven by weaker mix. So we have that weaker mix that is flowing through in the back half very definitely, but our cost structure is really improving as we move through the year.

and effectively that will offset it. We get the improvement in margin as I said. And again as we go into 2024, you know, we'll see what happens from a macro perspective. We'll see what happens from a mixed perspective. But because of that strength in cost structure, we feel very, very good at the setup at the end of the year and as we move into 2024.

Okay, that's great. Thank you. And then Glenn, you mentioned that the overall market's down low double digit, but Gildan was up, you were up 2% in active war. Can you talk a little bit about where you're seeing those share gains? Is it partially driven by the fact that you're so much, you have such a strong position in basics, so you're capturing that trade down, or are there any other factors influencing that? Well, Stephen, I'll take that. This is Chuck. I think we're seeing gains in multiple places. We're seeing gains in the basics, but we're still getting share in the fast and ring-spun area as well. The ring-spun's not moving as fast as it was up a few quarters ago, but we're continuing to gain share against those competitors. Also, we're seeing more in the National Council of Service retail customers. They're more up mid-single digits as retailers have continued to experience improvement in sell-through, and they're doing continued replenishment. And also, maybe just to add to that, our fashion is maybe not as strong as it was. It's still high-single-digits positive, but our basics are now...

low single digits positive as well. So that was a big turnaround from what happened in the last previous quarter. So we're starting to see people trade down to obviously the basics which is great and those price differences, there's probably like a 30-35 percent gap between a basic and a fashion. So just like in the same business police category people are just trading down and looking for value in the market as we see it.

We're diagnostic and I think one other key point for us is even though there's somewhat of a shift in buying preferences from a crew to a hood to a crew or a fashion to a basic, other manufacturing facilities are able to be...

Very flexible to be able to support whatever selling, right? Because it's all made on the same equipment, which is a key part of our flexibility in our overall manufacturing processes. We've adapted to these types of changes and we're continuing to service whatever the customers are buying.

Great, thank you. Your next question comes from the line of Luke Hanan of Kanakor.

Your line is open.

Thanks, good morning everyone. I just wanted to ask a question on what the promotional environment is like. It sounds like the change in guidance is more related to, as you mentioned, Glenn, the fact that people are trading down. It sounds like volumes are still fairly healthy. I'm just curious to know if you are seeing anything from your competitors on the promotional side of things, whether now with consumers trading down.

some of the brands in the fashion category. However, even after they've adjusted some of their pricings, we're still significantly below them in the tune of 20, 25% in certain cases, right? So we're positioned well on price and with our product portfolio.

and all the different price points that we have, we think we're well positioned that you know, we'll see our price deteriorate on mix we won't see it deteriorate because we're lowering prices. I mean I think that's the way to look at how we're positioned.

Okay, so then in other words, if you look also at the rest of the competitive sets, I know you've mentioned before in the past that there's been this lever where you guys can take price because you're seeing inflation, not just on fiber costs, but on a variety of different cost buckets. As it stands today, are you seeing any evidence of competitors more broadly looking to take price as a result of...

We say like I said, some of our fashion competitors have lowered prices but are still significantly above us. It may not be because of inflationary reductions but it's maybe more from business, bad business. I think that they're losing significant share.

we're gaining share in this market. So one of the things that we mentioned earlier is that the market's down, you know, it's low double digits and we're positive, you know, low single digits. I mean, so we're obviously taking share and, you know, there is a reaction, but, you know, we're positioned ourselves perfectly because of our Vote for music being publishing on Apple.

product portfolio, the different levels of pricing, you know basics are coming back now. You know we're diagnostics of what's being sold. I mean I could accrue, we really don't care and we're taking shares. So I think we're well positioned and I think more importantly even one of the things that Rod said that even with this mix which is factoring to our forecast, you know we'll be

at the high end of our operating margins in Q4. And we would have been higher than that if the mix obviously would have been better because you would have added a couple of, like Rod said, the impact is 200 basis points or 170 for example in Q2. So we would have been higher than even the high end of our operating margins in Q4, but we're still there.

We're well positioned, we have a good cotton position, we have good visibility in our manufacturing so as we continue to move into the future, despite the mix change, I think we'll be well positioned to move into 2024.

Okay, thank you. Your next question comes from the line of Vishal Sridharov, National Bank Financial. Your line is open.

Hi, thanks for taking my questions. Just on the comments about being down 12%, can you maybe elaborate on that? Is that industry units? Is that industry sales? And how does that reconcile with what you saw last quarter when the April trends were down, call it flatish to slightly down?

And maybe you can give me the time period of that particular data point that you mentioned. Well, I think last quarter we said we were slightly down. You know, this quarter we're positive, low single digits. But what we're referring to is that the overall market is down low double digits basically. So I think that's the question, is the actual market itself and the conditions within the market.

Yeah, that's market in units and is that that's for just more yeah That's all you that's all you

Well that's for the quarter. For the quarter? Yeah, that's for the quarter. Then how would July trend?

Worse or stable?

July for us is trending better. We're mid-cycle digits positive on our active wear products.

Our underwear and sock products because of the new launches were basically probably low double digits today and we expect that to actually grow to probably high double digits as we move into the future, Qn, Q3, Q4 as we continue to...

momentum on our new products. And also, we're mid-July is like mid single digits for us, but as we also move into Q4, we're going to be comping easier comps for us, so we should see that grow a little bit as well, just from a comp perspective. But we're continuing to take share. I think we're taking more sharing beginning.

Is that something that you deem to be more of a base that we should reflect permanently in our earnings forecast? Or is this more of a transient thing and next year that mix might come back a little bit or we're going to have to lap that in Q1, Q2 kind of thing and we should build our earnings off this new guidance provided.

Look, I think it's not structural, I think it's going to come back. It's a risk-off type environment where people have to make a decision to buy something.

they're going to buy the thing that probably is the least risk for them and also looking at potentially margin impact in terms of what the end use would be or the end selling price. In our cases, you've got to remember that we sell t-shirts and we sell them to distributors, they sell them to a printer who sells them to somebody else they go down. So the average shirt that we sell for...

$2.50 ends up at $25, right? So it's going down the pipeline. So, you know, people are looking not to be stuck with inventory. It could be a souvenir shop, for example, where they had tank tops or pockets or long sleeves or, you know, hoodies, for example. So they don't want to take that risk. So they're taking the risk off themselves in terms of their purchase.

habits today because of the macro environment. But that's all going to work itself out. I think that that's part of what we're seeing. I think it's all driven by really the uncertainty in the environment. And ultimately I think people will revert back to normal behaviour as we see things subside.

Thank you. Your next question comes from the line of Brian Morrison of CE Securities.

Your line is open. Thanks very much. Question for Glenn or for Chuck. With the dichotomy here of your market share gains relative to the decline of low double digits for the industry, how's the channel inventory looking for both your products and maybe the industry in general and is there more D stock that has to take place or are we now in a pretty lean position?

Well, look, the inventory at the end of Q2 was flat to Q1.

It was slightly higher than we anticipated, and we believe there will be somebody stuck in the back half of the year.

in our plan.

Okay, and then I guess two small questions. The sub 10% SG&A margin, is this achievable on an annual basis and if so, is that sustainable? And then Rod, maybe free cash flow, what's your working capital assumption with your free cash flow guidance? Will this be positive for the year?

did 10% last year. This year effectively it's going to be around that level, right? As we finish the year, this quarter we did 9% and as we go forward I mean we're going to try and drive those levels but I think given what's going on from a local sales perspective.

you get a bit of a deleverage. But I would say longer term, we really are trying to drive down below that 10% level, Brian , when you think about SG&A. And we think we can do that. We think as we continue to grow and given what our business model is, we can get operating leverage off SG&A, and that's a real competitive advantage for us. So.

Again, we're very focused on it and we see it as an area that we can manage well as we go forward.

On the free cash flow for the full year, free cash flow we're calling above $425 million. Effectively, if you look in the first quarter, we had negative free cash flow. We had good free cash flow in the second quarter and we expect good free cash flow in Q3 and Q4.

If you look, versus last year we had inventory build going on, now we do not have inventory build overall, as we talked about earlier, inventories are coming down, and that provides good support to free cash flow. I would say we feel very good about our free cash flow.

That supports our competitive position in the market. We've got a strong balance sheet. And what we're very pleased about is that we can return capital to shareholders. We had good return this past quarter and we're planning for good return as we go forward with the announcement of the new 5% NCIB program.

No, that's very helpful, Rod. Just the question, you have $325 million of negative working capital in the first half of the year. Where will that end by year end? Will that be flat, positive?

A little working capital basically in this quarter we're around 45-46% of sales, right, if you look at it on a LTM basis. What we called out in prior calls and we're still focused on it is effectively working capital around 35% by the end of the year.

So we will drive that working capital basically to the, I would say, closer to our target level as we get to the end of the year. And so we do feel good about the way that's unfolding.

Thanks for the color. Your next question comes from the line of Martin Lambjoy of Stifel.

Your line is open.

Hi, good morning.

I just want to come back on the guidance revision.

Your sales for the quarter came in ahead of expectations. Your point of sale trends were positive in Q2 in North America.

So I'm wondering what's driving, what's changing in the outlook? Are things decelerating in July for you to revise your guidance law or anything? Anything would be helpful just to understand given the positive trends you've seen lately.

Yeah, I mean the simple way to think about it Martin overall is it is the mix that's driving effectively the change in the outlook for the full year. So yeah, we came in better than we anticipated for Q2. That was driven by volume as we talked about the positive POS and active wear overall.

the back half. Glenn talked about the distributor inventory and the channel was flat but it came in a bit higher than we anticipated and that will reverse out as we go through the back half. But it's mixed. Mix is the real driver ultimately of what's going on in the forecast.

And if you look again for the full year, the full change in our outlook is driven by mix and we'll see that in Q2 and we'll see it in Q3. The POS is actually performing well as we talked about.

and we're driving market share gains and volume. If you look four years, it's exactly where we expected it to be. So we feel very good about the business overall. But this shift in the marketplace that's going on to lower price point products, obviously we're dealing with that.

And the good news is we have the broad range to be able to deal with it, and we have the cost structure to be able to deal with it. So we are well positioned as we move through the end of the year into 2024.

Okay, and then just a follow up, just to better understand that mix shift, is it happening across all your end markets? Because you do have end markets that have very different dynamics. You have some that are more recession resistant and some that are more cyclical. I'm just trying to...

Is this across the board or in certain end markets?

Okay, that's it for me. Thank you.

Again, if you would like to ask a question, press star, then the number one on your telephone keypad.

Your next question comes from the line of Chris Lee of Dushbam.

on the line of Chris Lee of Douchebag. Your line is open.

of risk that can cause guidance to revise further, lower in the back half. Just wanted to see how confident you are in terms of what's on the revised guidance. Thank you.

Okay, Chris, thanks for the question. If you look overall effectively as we said, we've given you a range for the full year. If you go to the midpoint of the range, we see the mix changes that are occurring effectively. That drives us to the midpoint of the range. And then if you go to the low end...

Obviously what we've effectively done is reflective macro uncertainty. Actually even a little bit of that is probably in the midpoint. So we really do feel that we've de-risked the back half with our forecast.

What we tried to do is give you what we think is a very good baseline for the overall environment, the shifts that we're seeing with respect to the consumer, how they're effectively trading down and we factored in some, as we said, macro uncertainty because we know the environment is tough to forecast.

It's tough to know exactly what inventory levels people are going to carry, especially as the year unfolds. So I would say we feel like we really have de-risked the forecast for the full year and we feel good about delivering. Actually we feel good about performing against it and as we said, as we come out of the back end of the year, we feel we're very well set up for 2024.

The next question comes from the line of Paul Lejoie of Citi.

of Paul Lejoie of Citi. Your line is open.

Hey everyone, this is Brandon, Cheetah Month for Paul. I just wanted to see if you could give us a little more details on the underwear business you've gained. And as it relates to the Bangladesh facility opening early next year, are you having any other conversations with –

potential customers to try and utilize that capacity that's going to come online.

Well, I'll answer that one. Look, the underwear programs have been rolled out a little behind schedule I would say in terms of actually, not from our perspective, but just how long it took for us to get the floor set at our retail partners, but they're doing very well.

We're continuing to get new opportunities as we move forward. Look, Bangladesh for us is a key part of our whole strategy. I mean, look at the plant is starting this quarter. It's going to be ramped up to about 25% of its full capacity by the end of this year, which is factored into the year 2020.

all of our working capital assumptions, our inventory levels, etc. And at the same time, it's going to really give us the ability to strengthen our cost structure and really go after gaining share not just in our underwear categories but also in the fashion basics.

as well as our international markets. So it's really going to be something I think that's going to be very important in terms of the overall manufacturing cost structure for Gildan as we move into 2024 and 2025.

You know, it's going to give us room to go after new programs. We actually have a stream of programs we're looking at as we move into 24. And a lot of these types of programs will be supported by as we ramp up Bangladesh.

And how do things shift around as that comes online? Do you shift your underwear business over there kind of wholesale, or is it really piecemeal depending on how these conversations go? Well, we already make a lot of our underwear in Bangladesh today because we still have other operations there.

You know, underwear is being made in that hemisphere today, as well as a lot of our fashion shirts. So all of our incremental, you know, fashion basics, underwear, all of our growth will be supported really by the development of Dangle Dash as we move into the future.

Got it. And one more if I can. With the shift away from fashion more towards basics, are you able to shift what you're manufacturing to kind of meet that demand? Like how quickly can you change things so that you don't get over inventoried and...

category that isn't selling through as well as you'd hope. Well our cycle time is five weeks so it doesn't take very long. I mean we've already adjusted all of our manufacturing, all the products in which we manufacture, it's a t-shirt, the fashion shirt, the basic shirt, they're all made on the same machine.

So we can adjust our equipment and in the case of you know our fleece where we make a hood of our crew it's all made in the same factories there's just less operations you know to make a crew than the hood. In sewing it's a little more difficult to go from you know make more hoods and crews because it takes more labor to make a hooded sweatshirt it's a lot easier going.

We've adjusted our manufacturing to reflect all these types of changes on a daily basis as we get POS from our customers and it goes to our planning groups. Our planning groups make the adjustment and our manufacturing groups respond to whatever is being sold in the market.

None of that is really an issue for us and you know as we said before we're well positioned. You know we have good visibility despite the fact that you know we've seen some of these mix changes. So we're going to be driving at the high end of our operating margins as we move into Q4 with our cotton position.

And we've got a good visibility on our cost structure as we move into 24, even with this type of mix. So we're well positioned and we're excited about as we go into the future.

Got it. Appreciate it. Good luck guys. Thank you. Thank you.

There are no further questions at this time. Ms. Jessie Hayem, I turn the call over back to you.

Okay, once again we'd like to thank everyone for joining us this morning and we look forward to speaking to you soon. Have a great day.

This concludes today's conference call. You may now disconnect.