Earnings Call Transcript - GIL Q1 2023

Elisabeth Hamaoui, Executive Vice President, Head of Investor Relations

Good afternoon, everyone. Earlier, we issued a press release announcing our results for the first quarter of 2023. We also issued our interim shareholder report with the Canadian securities and regulatory authorities and the U.S. Securities Commission, which are available on the company's corporate website. As a reminder, please note that we will be holding our virtual AGM tomorrow morning at 10 Eastern Time. More information can be found on our Events page. Joining me on the call are Glenn Chamandy, President and CEO of Gildan; Rhod Harries, our Executive Vice President and Chief Financial and Administrative Officer; Chuck Ward, President, Sales, Marketing and Distribution; and Jessy, our new Vice President, Head of Investor Relations, who Rhod will introduce in a moment. Before I begin, please take note that certain statements included in this conference call may constitute forward-looking statements, which involve unknown and known risks, uncertainties, and other factors, which could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. We refer you to the company's filings with the U.S. Securities and Exchange Commission and Canadian securities regulatory authorities. During this call, we will also discuss certain non-GAAP financial measures. Reconciliations to the most directly comparable IFRS measures are provided in today's earnings release as well as our MD&A. And now I'll turn it over to Rhod.

Rhodri Harries, Executive Vice President and Chief Financial and Administrative Officer

Thank you, Elisabeth, and thank you all for joining us today to discuss our first quarter results. Before I start, I'd like to welcome Jessy, our new Vice President, Head of Investor Relations at Gildan, who, as Elisabeth called out, is joining us on the call today. Many of you may know Jessy, as prior to her last role, she spent much of her career as a sell-side analyst, including tenures covering Gildan. We are extremely pleased to have Jessy joining the team, and I know she is looking forward to meeting with all of you. Now moving to the results. The quarter unfolded largely as we anticipated, with sales in line with our expectations and year-over-year demand trends showing meaningful improvement sequentially across all categories and channels. We did experience some margin pressure during the quarter, which came in slightly higher than we had anticipated due to the timing of fleece shipments, which I'll address a little later. But all in all, we were pleased with our quarterly performance. And even though the economic environment remains uncertain, we remain comfortable reconfirming our outlook today. Further and more importantly, I'd like to highlight that we are continuing to make progress with our GSG strategy. And after one year of execution, we are pleased with the initiatives we are driving under each of our strategic pillars related to capacity, innovation, and ESG, which all are reinforcing our strong competitive position. We also remain committed to our capital allocation priorities, including return of capital to shareholders, supported by our healthy balance sheet and strong annual free cash flow generation. With that, let's now turn to the details of our Q1 results. Net sales for the first quarter came in at $703 million, reflecting a decline in activewear sales of 12%, partly offset by 7% growth in the hosiery and underwear category. In activewear, as previously communicated, we faced a strong comparative period as we cycled post-pandemic inventory replenishment at U.S. distributors. Overall, although year-over-year POS trends at North American distributors remain down, they showed notable sequential quarterly improvement. Further, while international sales in the quarter were down 17%, we continue to maintain a positive outlook regarding recovery in international markets for the full year, encouraged by positive POS in the first quarter. Growth in the hosiery and underwear category for the quarter was mainly driven by socks both in the mass channel and with global lifestyle brand customers. While industry demand for men's underwear remained down year-over-year, year-over-year POS trends improved sequentially, and we are pleased with how our private label underwear programs are unfolding. Additionally, while our retail customers remain cautious on replenishment across all product categories, we were encouraged by improving inventory levels in the first quarter reflecting what we believe is an improving demand environment for our products. Turning to margins. Gross and adjusted gross margin came in at 26.7% and 26.2%, down year-over-year by 430 and 470 basis points, respectively. This is mainly a result of the anticipated flow-through impact on our cost of sales of peak fiber costs and higher manufacturing input costs. Margins were also impacted by unfavorable mix related to fleece sales. Specifically, despite strong fleece POS in the quarter, we saw lower fleece shipments than expected as distributors are being careful in this environment to buy as close as possible to their needs, which for this category tends to be more towards the back half of the year. Accordingly, while this impacted our margins for the quarter, the mix impact is expected to reverse throughout the remainder of the year. These factors were partly offset by the favorable impact of higher net selling prices in the quarter, which we implemented and called out last year. SG&A expenses for the first quarter of $82 million were largely in line with prior year levels. As a percentage of net sales, these were 11.6%, which was up from the prior year due to sales deleverage. We generated operating income of 18.2% of sales, which included the benefit of a $25 million gain from the sale and leaseback of one of our U.S. distribution facilities. Excluding this gain, adjusted operating income was 14.6% of sales, slightly below our expectations, largely due to the unfavorable mix impact of the lower fleece sales during the quarter. After reflecting increased net financial expenses of $17 million and higher GAAP income taxes tied to the lease sale and leaseback gain, and factoring in continued share repurchases, we reported GAAP and adjusted diluted EPS for the quarter of $0.54 and $0.45, respectively. Moving on to cash flow. Higher working capital investments and lower net earnings led to $179 million of cash flows used in operating activities in the first quarter. After capital expenditures of $74 million and net proceeds of $51 million from the sale and leaseback transaction, we consumed approximately $202 million of free cash flow in the first quarter. Higher capital expenditures during the quarter mostly reflected investments in our new manufacturing complex in Bangladesh. In fact, construction of the first facility is in its final stages, and progressive ramp-up of operations is now underway, which will continue through 2023 into '24. We also bought back 1 million shares in the quarter, reflecting our strong commitment to return capital to shareholders under our capital allocation priorities. The company ended the first quarter of 2023 with net debt of $1.15 billion and a net debt-to-EBITDA leverage ratio of 1.6x, in line with our 1 to 2x leverage framework. Moving on to the outlook. Today, we reconfirmed our full year outlook, which we provided on February 23, as we continue to believe we have the ability to drive top-line growth in 2023. Specifically, while the economic environment remains uncertain, and we are dealing with cautiousness on inventory levels with our customers, our POS trends were in line with our expectations for the first quarter. Further, we continue to expect incremental sales from the rollout of new programs servicing retail end markets to provide growth. We also expect continuing recovery in international markets driven by increased availability and depth of product at distributors. So even though the first half of the year will be challenging due to difficult comparative periods related to post-pandemic inventory replenishment in 2022, and the impact of peak raw material and higher input costs in our inventories flowing through our cost of sales in the first half of 2023, we see growth and margin improvement once these headwinds abate. Summing this all up, we continue to expect sales for the full year to be up low single digits compared to 2022. Further, with margin pressures from raw materials easing in the second half, we continue to expect our adjusted operating margin to fall within our 18% to 20% annual target range for the full year. We expect CapEx to come in at the lower end of our previously stated 6% to 8% range. And we expect strong free cash flow generation for the full year. And on the bottom line, we expect adjusted diluted EPS in line with 2022, which assumes the continuation of share repurchases aligned with our capital allocation targets of purchasing approximately 5% of our outstanding public float in 2023. So in conclusion, while we are mindful of the economic uncertainty, and we are seeing cautiousness in a mixed consumer environment, we continue to be cautiously optimistic on 2023 and continue to work hard towards delivering on our goals and creating shareholder value. Thank you, and I will now turn the call back to Elisabeth.

Brandon Cheatham, Analyst

This is Brandon Cheatham on for Paul. So I just wanted to dig in on the international segment. POS trends seem like they were positive, the sales down 17%, which would suggest a pretty meaningful destocking. I guess if current trends continue, at what point do you think they kind of run through that product, and you can start to see that strong POS translate to sales?

Chuck Ward, President, Sales, Marketing and Distribution

We believe that most of the destocking has already taken place, and the inventory is well-positioned. As mentioned, we observed mid-single digit growth in point of sale internationally. We think the destocking process is complete, and we can now expect replenishment along with the positive point of sale trends.

Brandon Cheatham, Analyst

Got you. And where is POS trending currently versus what you experienced in the quarter? Have trends improved at all?

Chuck Ward, President, Sales, Marketing and Distribution

Well, you were asking before about international, so I'll address that first. The international POS continues to be positive. So it's trending as it did in the first quarter. From a U.S. perspective, it was flat to slightly down, but it has started to turn positive now.

Glenn Chamandy, President and CEO

And one thing just to remember is that in the previous quarter, Q4 was sort of like the bottom of our POS, and then it started to improve in Q1. Q1 was slightly down from last year, and now we're planning to be flat to slightly down in Q2, more like the flat level. But what's more important in Q1 is that, that's before the market really started to turn. So we're slightly below where the market started to retract towards the end of March. So I think we did relatively good. And then that's where we're pretty optimistic that we're seeing good trends. One thing that I think is still affecting POS is the weather. I mean the weather in April has been terrible. We're starting to see some good days right now, but it’s still not good anywhere. So I think weather has a little bit to do with it, but we're very cautiously optimistic as we move into Q2.

Martin Landry, Analyst

I was wondering if you had discussed the inventory levels at your distributor. How many days do you have currently? And how does that compare to your historical levels?

Glenn Chamandy, President and CEO

Well, historically, the inventory level is normal, except for we think we're on the low end of the fleece, as Rhod called out. We had a bit more destocking than we anticipated in fleece. But the levels are pretty well in line with historic levels moving into the season.

Martin Landry, Analyst

Okay. And in your outlook, you mentioned the contribution that you expect from new retail programs. Wondering if you can discuss the size of these programs and timing.

Glenn Chamandy, President and CEO

Well, as we said earlier in our last call, if you look at the guidance we set out for the year, we said that the U.S. overall market was going to be down around low single digits. And we said our overall sales volume was going to be up low single digits. And the delta between those two is the new programs and also some growth in Europe.

George Doumet, Analyst

Yes, you mentioned improving inventory levels at retailers. Can you maybe give us some color there, perhaps in magnitude, and maybe how long you think it will take to get to a normalized level? And Rhod, on the last call, you mentioned that the impact of managing inventories tightly was around $75 million for Q1. So just wondering if you have a similar estimate for Q2.

Rhodri Harries, Executive Vice President and Chief Financial and Administrative Officer

Yes. Look, if you look at retail inventories and where we are, I mean, obviously, through the back half of last year, there was a lot of destocking going on. And then as we moved into the first quarter, we saw that stabilize somewhat. It was a little variable across the different channels. But I would say it was stabilizing. And as we're moving into Q2, we mostly believe the destock is behind us. If you look at Q2 sales overall, in the way we think about it. And maybe this is a good opportunity just for me to run through where we are on that effectively. We do expect that we will still get some price in Q2; effectively, we get to wrap around from price from last year. We saw that in Q1, and we're going to see it in Q2, probably around low single digits. And then volumes will be down from that. If you look at the distributor POS as Chuck and Glenn called out, we are seeing an improving environment as we moved into Q2. If you look at Q1, we were down low single digits, what we expected on the distributor side. But then as we move into Q2, it's improving, as we've said. And we're looking at more like a flattish type of environment. If you look on the retail side, the POS is improving also versus what we saw in Q1. In Q1, it was more like down double digits. Now we're probably down high single digits. So we have all of these factors together, plus we have the fact that we will not be able to comp the restocking seen in Q2 of last year and in Q1 and Q2 of last year, where we saw a lot of restocking. This year, in the first half, we won't be able to comp that. So if you think about where net sales for Q2 are going to end up, I would say it's going to look a lot like Q1 probably from a percentage perspective as to what we're going to see for the quarter. That sort of wraps it all together so you can get a sense of where we're going to end up. There will be difficulty comping the restocking, but that will all be behind us. And in many respects, that turns into a headwind in the back half.

George Doumet, Analyst

I appreciate your insights. For my final question, could you provide a breakdown of the 470 basis point decline in adjusted gross margin? I'm interested in understanding the extent of the negative impact from fleece. Additionally, what gives you confidence that we can recover some of that margin as the year progresses?

Rhodri Harries, Executive Vice President and Chief Financial and Administrative Officer

Yes. Look, our confidence is driven by the POS on fleece, right? So fleece has been a very strong category for us. It continues to be a very strong category in Q1. We saw a very strong POS. So we know that the demand will come through. We were expecting stronger demand in the first quarter than we saw, and the impact of that was probably about 100 basis points. So our margins came in about 100 basis points lower than we were expecting as a result of that. But then, of course, that will turn into a positive tailwind as we move through Q2 and leading more into Q3 and Q4, because that fleece will come through due to the strong POS, and ultimately, the demand will drive the sales.

Jay Sole, Analyst

Would it be possible to talk about the T-Shirt business, how the ring-spun T has performed versus open end and any trends that you're seeing in that business?

Chuck Ward, President, Sales, Marketing and Distribution

To your question around the difference between the ring-spun and the open end, we did see that open end was down during the quarter, high single digits, whereas we saw the ring-spun up high single digits. So we're continuing to see a mix shift there to the ring-spun t-shirts. That trend has continued through the first quarter, continues from last year as well.

Jay Sole, Analyst

Got it. And then can you discuss the ramp-up of the new facilities, both in Bangladesh and in Central America? Like is that connected to your ability to deliver these new programs that Rhod talked about in the prepared remarks?

Glenn Chamandy, President and CEO

The ramp-up is going to help us to continue to develop our ring-spun portfolio, including underwear and activewear-type products. But we're in a relatively good position from a capacity perspective. We have all of our capacity installed in Central America, like we said we would. We're currently running at around 85% to 90% of our capacity in Central America. So we've got ample capacity there to support these programs and other initiatives. We're building up Bangladesh to start and it's going to ramp up slowly during the year and really build up during 2024 for continued growth. And we're pretty optimistic. The key thing for us is that we've got the capacity in place to support the growth as we move into '23 and '24. We're well positioned both from a product perspective and a capacity perspective.

Stephen MacLeod, Analyst

Just wanted to circle around on the SG&A. I know it came in a bit higher as a percent of sales. But I just wanted to confirm, is there anything in there on higher costs? Or is it just a matter of deleveraging from the top line?

Rhodri Harries, Executive Vice President and Chief Financial and Administrative Officer

It's just deleveraging. We've got our SG&A, I would say, well under control. And I think as you go through the year, for a full year, and we called this out, we're basically running to a target of around 10% of sales. We have it well dialed in, Stephen. So if you look at what went on in the quarter, it was basically just deleveraging.

Stephen MacLeod, Analyst

That makes sense. As you consider the gross margin for the rest of the year, you mentioned some of the fleece headwind turning into tailwind, but it seems like that's primarily associated with the third and fourth quarters. If you could confirm that, it would be appreciated. Additionally, how does the recent decline in cotton prices affect your margins and cost structure moving forward?

Rhodri Harries, Executive Vice President and Chief Financial and Administrative Officer

If you look at effectively the cotton prices, I mean, we have high cotton prices coming through our cost of sales flowing through as I called out in Q1 and, to a certain extent, in Q2. But once we get past that, it will effectively be behind us. We know that in the back half, we have a lot of our inventory already in place now. As we move into the back half, we will see the benefit of that. We do expect our pricing will hold up well because of the way we priced; we never took our prices up to reflect peak cotton prices. Our prices are aligned with where cotton in our cost of goods is going to, not where it currently is because right now, we're seeing the pressure on our margins. Where it's going, I think we are well placed. So if you look at Q1, there was a fair amount of pressure on our overall margins as a result of cotton, and also it was related to manufacturing costs as well, higher inflationary costs that were flowing through. If you move to Q2, that is still going to be in our cost of goods, but it's going to start to abate. On a sequential basis, we expect a 100 to 150 basis point uplift as a result of improved cost position flowing through, and it really improves as we move into Q3 and Q4. We have a lot of that in inventory already, so we can see it coming. That's effectively how it's all rolling through.

Luke Hannan, Analyst

Glenn, if we think back to last quarter, one thing that you brought up was that your balance sheet being better equipped to handle financing more inventory than peers would be something that would help you capture share from those competitors. How has that played out through Q1 and thus far into Q2? Are you seeing that play out? And how is that playing out versus expectations?

Glenn Chamandy, President and CEO

I think we're playing right where we want to be. And we think we're gaining share in every category. To be perfectly honest with you, I think we're outperforming the market. We're giving you our POS. I think the market is below our results significantly. We're actually outperforming the market right now, and I think we're well positioned. The inventory is in good shape, and our inventories are high right now, mainly because we have a lot of fleece that we're gearing up to ship as we get into the season. We've also geared up to supply the new programs we have. But at the end of the year, our inventory should be equal to or slightly below where we started the year in '23 or the end of '22. But everything is in line. Our capacity is in line, our inventory is in line. Our products are in line, and our POS is performing. We're working hard to build new programs and are very optimistic as we continue to move into '24.

Luke Hannan, Analyst

For my follow-up, Rhod, correct me if I'm wrong, but I think I heard you correctly that there will be a low single-digit benefit from price in Q2 from the carryover effect of the price that was taken last year. What do you see playing out for the balance of this year with that carryover effect, and how should that play into results?

Rhodri Harries, Executive Vice President and Chief Financial and Administrative Officer

Luke, if you think of where we were in the first quarter, it was mid-single digits; second quarter, low single digits; full year, low single digits. I think I called out on the prior call, it's about low single digits. So we're not assuming price in the back half effectively. We'll have worked our way through the wrap-around by the end of the second quarter, and then that will be the full year effect, Luke. I think we're trying to be very balanced in the way that we think about price. Again, I think it's going to hold up well as we move into the back half because of the reasons outlined. But effectively, it's low single digits for the full year.

Christopher Li, Analyst

Glenn, I just wanted to dive a bit deeper into the POS trend. You mentioned that it's up slightly positively in Q2 so far. Just curious, when you look at your end-user demand, which segments are driving that growth? And it sounds like also from your earlier comments that you are gaining share because the market overall is down below where you are trending.

Glenn Chamandy, President and CEO

In the distributor market, there are different categories such as travel, entertainment, and events. Those are the categories that are continuing to drive momentum in the distributor channel. In terms of T-shirts going into the retail channel, which saw a big boom that really slowed down last year, we're starting to see that pick up again as well as inventories subside and retailers start to buy more products. Overall, we feel pretty comfortable with the POS. It's really more of the same. There is nothing that has changed, just a matter of taking share in our distributor business and ensuring retailers are starting to place orders and work through their inventories. The key point is that we will have all the new programs in the second half of the year, which will significantly boost sales.

Brian Morrison, Analyst

Rhod, I just want to circle back to the color on the Q2 margin. Last quarter, you said that we should be back in our historical range. I appreciate the headwinds that you talked about with the sales outlook and fleece mix and input prices. Can you provide some color on the decline since the last Q4 call on your outlook? Is it the fleece mix that's taking the margin down a little bit?

Rhodri Harries, Executive Vice President and Chief Financial and Administrative Officer

Yes, it is. We're being a little cautious. As I called out, what we're seeing is people are effectively taking the product a little bit closer to the season this year. Based on what we saw in Q1, we want to be a little bit cautious as we look at Q2. Again, it's going to come through. We know this absolutely will. So I would say that's what's driving a little bit more caution on Q2 versus where we were when we reported Q4.

Brian Morrison, Analyst

Okay. So the input prices will still be a headwind, but that had been anticipated previously, correct?

Glenn Chamandy, President and CEO

We don't have all the information on the industry market share data, but we are seeing good POS. It's high single, low double-digit growth.

Sabahat Khan, Analyst

There's a lot of commentary earlier that you shared on the inventory position of the distributors. Big picture, what kind of demand environment are the distributors generally preparing for? Are they expecting moderation in POS through the back half of the year, or are they expecting growth? What's your perspective on the demand uptake?

Glenn Chamandy, President and CEO

I think that everybody is cautiously optimistic, which is the way to position it. Inventories are in good shape now. We've called out the year-over-year impact. As we go through, I think the feeling is improving. The vibe of how people view the market and opportunities is better than earlier in the year. It leaves us with optimism. We're optimistic but cautious about our strategies moving forward. That seems to be the consensus among our customers and end users.

Sabahat Khan, Analyst

When I think about the EBIT margin range you're providing for the year, given that you've got pricing sort of in place already, is it really volume or POS that determines whether you're at the low end or high end of that range from here on forward?

Rhodri Harries, Executive Vice President and Chief Financial and Administrative Officer

We do have our cost structure well under control. As we go through the year, yes, it's going to be driven by what we've highlighted regarding low single-digit growth, which includes the rollout of new programs internationally. There are a lot of positive things occurring as we move through the year. So we feel good about margins and delivering between the 18% and the 20%. There are a lot of positive things happening across the business.

Mark Petrie, Analyst

I just had one question actually. On the corporate inventory levels, there some normalization there, and you've already called out the impact of fleece. Where do you think those inventory levels will normalize as we progress through the year or by the end of the year?

Rhodri Harries, Executive Vice President and Chief Financial and Administrative Officer

If you look at the inventory levels, Mark, we were up a bit versus the end of the year. You expect that seasonally, but also due to what happened with fleece and the rollout of new programs. We've seen peak inventory levels, and as we move into Q2, we should see some progress there. At the end of the year, I think Glenn called it out; we're expecting our inventory levels to be below where we started the year. The good news is we have a strong depth and ability to service, which is very important. We expect strong free cash flow for the full year, which we called out previously. If you compare it to last year and take into account that inventory is slightly lower, our free cash flow could be north of $450 million for the year. To clarify the comments regarding gross margin progression into Q2, I said 100 to 150 basis points uplift based on improvements in cotton and overall manufacturing costs. It’s driven by the mix and pricing as well. I believe this is a good estimate of what's going on as we go through Q2, Q3, and Q4.

Operator, Operator

There are no further questions at this time. This concludes today's conference call. You may now disconnect. Thank you.