Chairman’s Speech (AGM – May 15 th , 2014)

Kitex specializes in infant wear (0-24 months). This is the only market which is not affected by recessions (as infant wear is the last thing to cut on parents’ minds) and there is lesser competition due to the specialized nature of the business. Only 12 companies in the world manufacture such large volume required for the large players. There are multiple small players manufacturing 5K pieces, but the big players are not interested in such volume. Kitex manufactures 5.5L pieces per day

Winlu (China) is the No. 1 player in the infant wear manufacturing market with 7.5L pieces per day. However, they have been reducing their manufacturing to 6.5L pieces per day due to the twin challenges of rising labor costs along with the steep rise in social and environmental compliance costs, required by large customers. There are rumors that they may further reduce it to 5.5L pieces per day.

The 2nd largest player in Gyn (Singapore) who have manufacturing facilities spread across various countries. They manufacture 6.5L pieces per day.

Kitex is the 3rd largest player with 5.5L pieces per day in FY14, going up to 7.5L pieces per day in FY15 and 11L pieces per day in FY16.

Fabric capacity was expanded from 24T per day to 48 T per day along with technology upgradation in both fabrics and garments. The total cost of expansion was around 100 cr.

We are No. 1 in infrastructure, technology, discipline, systems, social and environmental compliance. We have a in-house CSR department looking after this panchayat, with 36K people and 8000 houses.

2000 houses are below BPL. Biggest threat is increase in labor (and related costs). Till 2009, local sourcing of labor was done. After

2009, started recruiting labor from other states (Bihar, West Bengal, Nagaland etc) through a NGO called Don Bosco. Labor rates are going up 20% every year (in India and globally).

The big customers (Walmart, Target etc) don’t increase prices in the retail markup (in US & Europe). Price war in the retail market is going on. Buyers keep pushing vendors for cheaper prices. Most vendors skimp on safety aspects, environmental aspects, packaging aspects etc. From last January, 10-15 safety audits (after the Bangladesh incident) were conducted in our office. We were more than 100% compliant. All big customers source from companies with full compliance and safety aspects. Kitex is the best company in social compliance globally. The cost of real social compliance is upwards of 40% and hence all other players (including the largest players) are facing challenges to meet them. Smaller players will be decimated because of social compliance and safety (600 factories shut down in Tirpur due to pollution issues).

Till last month, yarn dyeing was sourced from Tirpur (10% of total yarn needed to be dyed). Now, it’s completely in-house (best machine for dyeing yarn). Bleaching machine does 28T per day. It is the longest machine in the entire factory. Whatever was installed in 2006, we are upgrading now. We need to upgrade technology every 5 years.

We are taking our capacity from 5.5L to 1.1M without adding labor, and purely by technology (and automation). We are upgrading all our cutting and sewing machines to increase productivity. Quality of the garment is totally dependent on the specific standard of yarn quality – and we produce the best standard on yarn (increased fabric capacity).

Why are there only 12 companies in the entire world for infant wear, compared to 1000s of factories for men and women wear? Because, infant wear is a specialty product. We know better than anyone

in the world on infant wear. We started in 2000 and have a huge learning curve behind us. All other big players will invest in garment capacity but not in infant wear due to steep learning curve.

We use only top grade yarn and materials (Ocuotex – Class 1). Ocuotex Class 2 doesn’t pass the saliva test and saliva may react with fabrics causing a lot of issues(the saliva problem is very common with infants). We are the only company in India to manufacture Ocuotex Class 1 fabrics. We are the only company to use organic dyes (100% organic based). We source threads from Madura Coats.

Based on all this, and continuing to invest in infrastructure, we will be No. 1 in the world well before FY16.

Q&A with Sabu Jacob (May 15 th 2014)

Capex this year will be only 8-10 crs for sewing and cutting machinery. No more capex. Our basic limitation was fabric capacity. But now the capacity has been increased from 22T per day to 44-48T per day.

Noone makes profit on spinning or fabric. In-house processing like us assures us of 100% quality compared to outsourced fabric. There is huge wastage in outsourcing. Between spinning, fabric and garments, it’s difficult to apportion costs and profits.

Any garments industry like men’s, women’s clothing is a buyers market. However, the infant wear market is a seller’s market. Price is on the basis of ‘take it or leave it’.

We supply to Gerber, who is the No. 1 wholesaler in infant wear, reselling to 14000 stores in the US (including Walmart, JC Penney). We have been supplying to Gerber for the past 14 years. We also supply to Carter, who are one of the biggest retailer and wholesaler. They own 600 outlets, and we have been supplying to them from the last 4 years.

We also supply to Babies R Us, who are No. 1 in the US in infant wear (retailer). One year back, our garments were in the last row of Babies R Us store. Now, the first 10 rows in Babies R Us are Kitex products. Babies R Us also sources from Gerber and Carter, who in turn buy from us. Net-net, most of the garments in a Babies R Us store are from Kitex.

Carter buys $1.1B of infant wear. Carter CEO visited our factory. He wants to grow our share to $150M FOB. Carter is currently buying through agencies from various factories. The current CEO wants to cut down on middlemen and source directly from manufacturers and wants to take this share to $500M in 3 years. There are only limited factories to source for such a volume. Hence, the market structure is tuning to ‘as much as you can manufacture it, you can sell it’. Last 3 years, not even 1 manufacturer has been added to manufacturing the infant wear segment.

We are investing in our own brand in the US. We will set up the brand, distribution and marketing, so that the margin that Gerber is currently making, we can also get. However, this process is long and we are only expecting a $50M - $75M FOB in 5 years. Therefore, don’t expect much contribution from this branding exercise in the near term.

We have a minimum criteria that any customer who comes to us needs to source atleast $15M FOB from us. We actually dropped Tesco because of this reason. They reached $1M in the first year and kept giving promises but since they couldn’t source $15M FOB from us, we dropped them from our list. As I said earlier, it’s a seller’s market – you produce it, you can sell it. Customers come to our

factory location to approve designs instead of incurring to-and-fro courier costs and communication issues.

We also have a maximum limit of $30M per customer (+-10%) to restrict concentration issues. In 2009, we were supplying close to $50M to Gerber, and we realized we were exposed to a lot of risk.

KCL capacity is 400 cr sales. In FY14, we did about 255 cr of sales. It may take about 2 years to reach about 400 cr. We may merge KCL and KGL in the future (no timelines, and not a commitment) [Privately though, he conceded that he may merge it in about 2 years, once KCL hits the figure of 400 cr].

KGL sells fabric to KCL at 20-25% more than the market price. For every Rs.5 increase in yarn prices, these price increases are passed onto the customer. We also

have a proprietary formula to pass on the $ appreciation/depreciation costs/benefits to the customer also.

Our operating margins are definitely not coming down below 20% anytime in the near future. Bangladesh labor is very cheap at Rs.1500 salary per month. However, cost of production is going to

increase due to safety and environmental compliance. We are not going to get affected due to Bangladesh.

In India, there is only one other competitor to us in the infant wear segment – J J Mills. They have about 50% of Kitex capacity. They sell more to row stores than the likes of Walmart etc.

Winlu had serious labor issues (and costs) along with quality issues due to outsourced fabric. KGL + KCL – 5.5L capacity; KGL – 3.5L capacity and KCL – 2L capacity Our garments sales increase by 10% season to season at Babies R Us. Even after 10-20 washes, Kitex

products retain their quality, while competitors products don’t. We also supply to Jockey Stay Cool. This is a temperature controlled fabric at +-3 degrees, licensed

from Outlast technology. Arvind tried to manufacture it but failed. Kitex succeeded. Kitex is the only license holder from Outlast technology so far in the world.

New finishing to infant products being developed. For a smooth finish, Kitex initially tried Sheep fat instead of chemicals. Now, instead of sheep fat, they have implemented avocado finish to all their infant fabrics, thereby eliminating any possibilities of skin rashes due to such organic finish.

Currently Kitex is operating at 65% efficiency, and planning to push this to 75% efficiency (this is the max efficiency that can be achieved in a garment manufacturer). There can also be a 25% productivity improvement due to a lot of technology implementation and upgradation.

KGL can do approx. 600-700 cr in FY15 (GM Finance said that they would do a 650 cr sales in FY15). There is a large market demand out there, but recruiting labor has become extremely difficult. An

indent of 2000 labor demand generates 100 resumes. Out of that, 25 leave due to home sickness, 25 leave after initial 1 month of training. Currently, the labor force is 60:40 in favor of the locals. We have strict rules for not hiring under-age kids (we will get blacklisted otherwise). Not just hiring labor, it takes approx. 45-75 days to make a line productive.

Slower growth in 2010-2013 was because capacities were set up for customers, who couldn’t keep up with the pace (like Tesco). Then there are middlemen agencies like Liang Fong who don’t communicate and set up communication channels with end customers.

Due to being in this business for long, we are getting to optimum performance efficiency and hence cost of production is coming down. We are in a strong position to get better prices.

Our sales secret is that a baby in the 0-24 months category grows 40 gms every day. Every 10 days, the parents need new set of clothes. US consumption is very high, even compared to Europe, and we are seeing no signs of a slowdown in the infant wear market.