Hanesbrands Inc. Q3 2008 Earnings Call Transcript

Oct.29.08 | About: Hanesbrands Inc. (HBI)

Handesbrands Inc. (NYSE:HBI)

Q3 2008 Earnings Call

October 29, 2008 4:30 pm ET

Executives

Rich Noll – Chief Executive Officer

Lee Wyatt – Chief Financial Officer

Analysts

Eric Tracy – BB&T

Omar Saad – Credit Suisse

Scott Krasik – C. L. King

Reade Kim – Merrill Lynch

[Arthur Rollack – CAI]

[Kenneth Tighe – CIBC World Markets]

Andrea Cohen – Aries Management

Operator

I would like to welcome everyone to the Hanesbrands third quarter earnings release call. (Operator Instructions) Mr. Brian Lance, you may begin your call.

Brian Lance

Welcome to the Hanesbrands Inc. quarterly investor conference call and web cast. We are pleased to be here today to provide an update on our progress after the third quarter of 2008. Hopefully everyone has had a chance to review the news release we issued earlier today. The news release and the replay of the audio web cast of this call can be found in the investor section of our Hanesbrands.com website.

I want to remind everyone that we may make forward-looking statements on the call today either in our prepared remarks or in the associated question and answer session. These statements are based on current expectations and are subject to certain risks and uncertainties that may cause actual results to differ materially. These risks are detailed in our various filings with the SEC and our most recent Forms 10-K and 10-Q as well as our new releases and other communications. The company does not undertake to revise any forward-looking statements which speak only to the time at which they are made.

With me on the call today are Rich Noll, our Chief Executive Officer and Lee Wyatt, our Chief Financial Officer. Rich will give a summary of business performance and trends for the third quarter. Lee with then provide further detail on the various aspects of our financial performance. Following our prepared remarks, we've allowed ample time to address any questions that you may have.

Before I turn the call over to Rich I want to take a moment to let everyone know that we are planning our Second Annual Investor Day for Tuesday, February 24 in New York. We will again have our extended management team review our achievements and opportunities in detail, particularly as they related to 2009. We will send invitations out in the fourth quarter and look forward to seeing you all there.

Now, I will turn the call over to Rich.

Rich Noll

Thank all of you for joining us today. I'd like to start with our performance in the third quarter and then I'd like to focus on three major topics; our view of the fourth quarter, our comfort with our debt structure and our 2009 price increase.

Total sales were unchanged at $1.2 billion. Hanes male underwear, Playtex and Champion active wear were all up double digits for the quarter. The international businesses, the Ballard brand and the sox category also performed well. The soft spots were in sheer hosiery and the small intimate apparel brands.

Even though our categories remained soft, our retail partners continue to focus on national brands like Hanes as they strive to improve their retail performance. This focus is reflected in our market share. In the latest market share data available through August, our rolling 12 months share remains strong in key categories with notable increases for Hanes men's underwear, up over two share points, and Hanes men's and women's socks also up over two share points.

When we focus in on our back to school share, we achieved gains in men's underwear and socks as well as women's intimate apparel and socks. Overall, our share gains are coming at the expense of other national brands and private label.

Excluding the effect of restructuring actions and the Mervyn's retail liquidation, Q3 EPS increased $0.08 as we continue to benefit from lower interest expense. However, operating profit was down $8 million as we were unable to fully offset with our cost savings efforts the $19 million of increased cotton and petroleum costs.

In terms of the fourth quarter, while sales will be a challenge in this environment, and most likely decline, we are optimistic about our operating profit and EPS potential. Versus Q4 last year, we will benefit from increased savings which has the potential to more than offset higher commodity costs allowing our gross margins to increase.

SG&A may be $15 to $20 million lower due to previously discussed expense time and other cost reduction efforts. And interest expense and taxes will remain favorable.

Given those positives and even with the sales decline of a few percent or more in Q4, exceeding 25% earning per share growth for the total year still remains a viable goal. Back in February, we stated that goal and it is an understatement to say that much has changed since then.

We have incurred $52 million of commodity cost increases, multiple retailer bankruptcies and liquidations, the worst consumer spending environment in decades and the worst financial and credit crisis since the great depression. But we still remain focused on achieving that earnings per share goal and it is within our grasp.

Our organizations' ability to perform while absorbing these issues is something for which we can all be proud. It demonstrates our people's resilience, fortitude, flexibility and commitment is why we will come through these difficult and uncertain times stronger. But we are not done.

Turning to the longer term, we are implementing an average gross domestic price increase of 4% effective mid first quarter of '09. We able to solidify this price increase because of our strong brands and the investment that we've made in those brands over the last few years. The range of price increases will vary by product category.

In some categories, our competition appears to be following with similar increases, especially in areas where they also have strong brands. In come categories they appear to be following but to a lesser degree. And in certain categories, our competition may not take price increases which generally seems correlated to a lack of brand strength.

It's not clear what impact our wholesale price increase will have on retail prices to consumers. Retailers set prices and there is a growing group of retailers who have their own strategic initiatives to optimize their retail pricing.

In the end, while this price increase may negatively affect unit buying in the short term, in this economic environment volume is likely to be a challenge regardless. More importantly, this price increase provides us substantial flexibility as we continue through this tough environment.

Turning to expenses and inventories, we will manage both very conservatively and maintain a strong focus on cash flow. We have identified $40 million to $50 million of discretionary spending which we will scrutinize for 2009. For example, while we will continue to invest in our brands with media, we will invest at lower levels that are more appropriate for this consumer environment.

In terms of inventories, we are on track with our previously stated goal that ending 2008, $1.35 billion and we have a goal of reducing inventories $200 million over the next 18 months as we complete the supply chain transition. The plant closures announced in September are an important element of our inventory reduction efforts.

Lastly, regarding debt, we have locked in low rates. We are comfortable with meeting all of our debt covenants and we'll use our free cash flow to pay down debt with a goal to pay down $75 million to $125 million by year end.

To recap, excluding the unexpected October numbers announcement, we had solid third quarter earnings. We are optimistic about our operating profit and EPS potential for the fourth quarter and we have tail winds of pricing, potential commodity declines and further cost reduction to help us successfully manage the economic uncertainty of 2009.

Now I'd like to turn the call over to Lee Wyatt who will review our financial performance.

Lee Wyatt

I will review third quarter results, provide thoughts on modeling the fourth quarter and discuss cash flow and long term debt.

With regards to the third quarter, sales of $1.2 billion were equal to last year. Sales in the underwear segment increased $15 million or 2% while outerwear segment sales declined $1 million. The hosiery segment declined $14 million or 22%, substantially more than the long term trend and the international segment grew 13%. Excluding the benefit of currency gains, the growth was 6%. The other segment declined $9 million due to lower sales of excess yarn.

Plant restructuring charges were $44 million in the third quarter compared to $15 million last year. These charges were incurred primarily as a result of the nine plant closures that we announce in September. Total restructuring charges announced since the spin off is now $206 million compared to the $250 million projected over time and approximately half of the charges have been non-cash.

The majority of my remaining comments will focus on our results excluding restructuring actions, but including the $0.04 impact of the Mervyn's liquidation announced on October 17 which we treated as a material subsequent event for our third quarter.

Gross margin decreased 110 basis points to 31.3% in the third quarter compared to last year. The decline was $13 million and the impact of increased cotton costs of $12 million at $0.69 per pound, and higher oil related costs of $7 million partially offset by $7 million of cost savings from our supply chain initiatives. These results were in line with the estimated impact previously discussed with investors.

SG&A expenses were flat in the third quarter compared to last year at 22.3% of sales. Lower spending of $8 million was offset by $6 million in higher bad debt expense due to the Mervyn's liquidation and $2 million in higher distribution costs.

Operating profit decreased $13 million to $102 million an operating margin rate of 8.9% versus 10% last year. Excluding the impact of the Mervyn's liquidation, operating profit decreased $7 million to $108 million or 9.3% of sales.

Our net income increased by $3 million or 7% in the third quarter due to lower interest expense and a lower effective tax rate partially offset by the lower operating profit.

Interest expense decreased $12 million to $37 million. Our income tax expense decreased $4 million due to our offshore supply chain investment. The tax rate declined from 30% to 24%. This rate is consistent with the first and second quarters.

Earnings per share increased to 8% to $0.52 or $0.04 above last year. Excluding the $0.04 decline due to Mervyn's liquidation, earnings per share increased to $0.08 or 17% to $0.56 in the third quarter. For the first nine months of 2009 our earnings per share increased 23% to $1.59.

Turning to the balance sheet, inventories were $1.36 billion, similar to last quarter. As I discussed last quarter, inventory in this range during the balance of 2008 is necessary to hedge the supply chain transition and reflects higher commodity costs. The higher commodity costs currently in inventory is $52 million and should come out of inventory over the next two quarters. Inventory levels are not expected to increase during the fourth quarter and should have either a neutral or positive impact on year end cash.

Year to date, net capital expenditures were approximately $100 million as we continue to invest in our supply chain.

To summarize the third quarter, we saw sales that were equal to the prior year operating profit was negatively impacted by higher input costs and the Mervyn's liquidation which offset the benefits from cost reduction initiatives while we continue to benefit from lower interest expense and tax rate. Excluding the Mervyn's liquidation, earnings per share was $0.56 a 17% increase.

Now let me give you my thoughts on modeling the business for the fourth quarter of 2008. Cotton was purchased last spring at $0.75 per pound for the fourth quarter and therefore cotton costs should be $17 million higher than last year. All related costs will be $9 million higher in the fourth quarter. This is consistent with our previous comments to investors.

Barring any unforeseen circumstance, we could see cost reductions of $20 million to $30 million in the quarter from supply chain initiatives and other cost reduction actions. Many of these costs are already reflected in inventory and could allow our gross margin to be 50 basis points higher than prior year in the fourth quarter on lower sales.

SG&A could be lower $15 million to $20 million in the quarter due to the previously discussed timing shift of media and IT spending as well as other cost reductions. So even if the year to date sales decline of 3% continues, we could see operating profit increase in the fourth quarter. Interest expense should be lower than last year by $8 million and a 24% tax rate is assumed.

In terms of inventories, we are on track with our previously stated goal of ending 2008 at $1.35 million dollars as we begin to execute the supply chain restructuring announced in September. Year end inventory should include about $40 million higher commodity costs which will come out of inventory in the first half of 2009.

Capital spending for the full year 2008 should be around $155 million on a net basis. Our goal is to pay down between $75 million to $125 million of long term debt by the end of 2008.

Turning to the longer term, as Rich mentioned earlier, in this challenging environment, we will be conservative in our management of expenses and inventory. We will focus intensely on maximizing our cash flow to pay down long term debt.

So let me spend a moment on debt management. We proactively managed our debt structure since the spin off. Let me highlight our recent actions. In July, we fixed interest rates on our $500 million of floating rate notes at 7.64% for four year. In September we kept LIBOR on $600 million of floating rate debt at 3.5% for one year. And in October, we fixed LIBOR on $400 million of floating rate debt at 2.8% for two years. Of our company's $2.3 billion in long term debt, LIBOR rates are either fixed or capped for 2009 on $2 billion, so 86% of our debt has either been fixed or capped provided little material exposure to higher LIBOR levels and we have no short term maturities.

Let me quantify the impact of this interest rate strategy. We expect full year 2008 interest expense of around $155 million. Given that most of our debt is fixed or capped, we now expect 2009 full year interest expense to be in the range of $140 million to $155 million.

We've received a number of questions about our ability to manage our debt through this financial crisis and economic downturn. So let me address this next. Let's begin with our bank group. First, when we became an independent company we chose strong banks to work with based on broad experience with many banks. These were apparently wise choices as they are turning out to be the strongest banks.

Second, these banks are confident in our ability to manage through this environment and are in fact, eager to support us.

Now let's turn to covenant compliance. We've closely monitored compliance with all of our covenants since the spin off. We continually test our compliance under a broad range of scenarios and are comfortable with our ability to remain in compliance through 2009.

Before I address this issue in more detail, I'd like to make two broad comments about the leverage covenant calculation. First, the leverage ratio is calculated based on the most recent four quarters. This significantly dampens any negative impact from the most recent quarter and it provides time to both anticipate and react to negative trends.

For example, EBITDA would have to decline more than 80% in the first quarter of next year in order to fail the leverage covenant in the first quarter. For 2009, with the benefit of price increases, lower commodity costs and other cost initiatives, our current analysis shows that we would continue to meet our covenants even with an 8% to 10% sales decline.

My second broad comment is about what if there are large negative charges. Under our covenants significant events are added back to EBITDA. The definitions for both EBITDA and debt are very broad under our covenants.

For example, covenant EBITDA adds back items such as restructuring, start up costs, non-cash and one time charges. Year to date total add backs increased our $337 million reported EBITDA by around $118 million. In addition, the definition of debt excludes items such as the $250 million accounts receivable securitization. So these calculations are significantly different from our published leverage ratios.

So how will we reduce the covenant leverage ratio in 2009 to 3.0? Well consider the denominator and that's EBITDA. Price increases of $100 million to $125 million in addition to lower commodity costs should bolster EBITDA even if units decline and promotional activity increases.

Let's consider the numerator, debt. Debt can decline from multiple actions. Let me mention a few. In the fourth quarter of 2008 our goal is to pay down $75 million to $125 million of debt. Assuming a $100 million payment, this alone would reduce our covenant leverage to around 3.25. To reach 3.0 in 2009, we would then need to pay down another $165 million of debt, and this assumes that EBITDA remains flat in 2009 in spite of price increases and lower commodity costs.

So how can we pay down debt in 2009? Well first, our normalized annual free cash flow is $200 million to $300 million annually. In addition, we have a goal to reduce inventory by $200 million over the next 18 months as we complete our supply chain restructuring. $40 million of the decrease should be due to lower commodity costs alone with the remainder driven by reducing units.

So while the current financial crisis and economic environment is extremely challenging we have confidence that we can manage through it. In summary, you should now have a clear picture of third quarter results, our expectations for the fourth quarter of 2008 and how we will manage debt through 2009.

While we're planning for a challenging top line environment, we have tail winds to help us successfully manage the economic uncertainty. I'm optimistic about our operating profit and EPS potential and I'm confident in our ability to manage our debt structure and balance sheet effectively.

I'll now turn the call back over to Brian.

Brian Lance

That concludes our recap of our performance for the third quarter of 2008. Before we begin taking questions, I want to reiterate that we have a policy of not providing quarterly or annual earnings per share guidance. However, we have stated that we will provide information about our perceived business trends as appropriate. We decided to provide more trend information on today's call to help investors better understand our business in this challenging environment.

Now we will begin taking your questions and continue as time allows. Since there may be a number of you who would like to ask a question, I'll ask that you limit your initial questions to two or three and then re-enter the queue to ask additional questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Eric Tracy – BB&T.

Eric Tracy – BB&T

Starting with sales trends, certainly Q3 from the innerwear standpoint seemed to come in above our expectations, maybe talk through a little bit of what transpired there, whether there was a little bit of pull forward from Q4, just some timing versus market share.

Rich Noll

First all with Q3, we're overall pleased with our results, especially when you look at from a share perspective because as I talked about, we are gaining share in back to school. We had a similar offering for back to school as we did the prior year with the exception that we actually decided to increase our use of bonus packs. So last January when we started seeing the tough environment, we decided that this might be a year to provide a little bit more value to consumers and I think that actually helped us.

In terms of timing shifts in the quarter, you may remember that Q2 was a little dampened because there was a little bit of a shift from Q2 into Q3. There is absolutely no pull forward from Q4 into Q3.

Eric Tracy – BB&T

You mentioned into Q4 the trends obviously decelerating meaningfully. Can you talk about you assumptions that these trends continue at those levels of minus three or single digit declines for the balance sheet?

Rich Noll

Q4, everybody's calling for a tough environment and we're very similar. In terms of the patterns, there are three distinct time periods I think about for 2008. Business seemed soft from January through April/May, and then it got a little bit softer. It was a clear impact from gas prices and that's when overall retail traffic was down.

The last week of September with the financial crisis and the first couple of weeks of October, we saw not only in our categories but retailers very broadly; saw a real slowdown in sales. In fact, one of the retailers has commented that the day the DOW dropped 777 points; they had the worst comp store sales day than they had since September 11.

So I think the last couple of weeks has just gotten everybody a little bit nervous. I don't think that trend is going to stay and continue for all of Christmas, but I do think it's going to be challenging and we think that sales will decline. Exactly how much I'm not sure. The trend that we're seeing year to date has been 3% to 6%. Will it be a little bit more than that, a little less, it's hard to tell right now.

Eric Tracy – BB&T

Turning to the price increases, prior the expectation was for those price increases to offset the higher input costs. Maybe talk a little bit through obviously the environment and slowing demand has certainly taken back some of those commodity costs, so the expectation for those price increases for next year as well as coupled with the supply chain and the cadence of how we should expect that supply chain move to manifest next year.

Rich Noll

Let me focus a little bit on pricing. I really want to talk about a couple of things with pricing; what these price increases demonstrate, what allows us to do and also our thoughts about how it might impact volume. First of all, these price increases are locked in. We're now in execution mode with all of our retailers.

What this demonstrates in our categories, brands matter. No ifs, ands or buts about it. Price increases in our categories don't need every single competitor to move in dollar for dollar, penny for penny. We're very comfortable and routinely deal with the price premium at retail and at wholesale.

I think it also demonstrates that we are important to our retailers. They need and want strong partners that can invest in their brands, invest in innovation and invest in supply chain, and we've heard that over and over again from them.

In terms what this allows us to do relative to cost increases and so on, this increase allows us to cover our cost increases, not only commodity costs but also wage inflation that we've seen over the past year or so and other cost increases that don't move up and down like commodities. But it also provides us the flexibility to continue to invest in our brands as well as take advantage of promotional opportunities that I think may be out there in 2009. So it really gives us a lot of flexibility to get through this pretty tough environment.

From a volume perspective, we have not had any space declines because of this price increase and I think that's very important for people to understand. The other thing is in how retailers set prices. A lot of them have already been working on optimizing their own price mix and covering their own costs, and we've started to see prices in our categories start to float up over the last six or nine months.

So the actual impact on retail prices remains to be seen. We'll have to wait until February and March to really see what transpires at retail. So the volume impact at this point is also unclear.

But we feel good about it. We think it's a good reflection of our brand strength and as they kick in in February, obviously in Q2 and beyond we'll start to see their benefits in a strong way.

Eric Tracy – BB&T

On the supply chain and the assumption that Asia begins to ramp next year and it's fully operation by fall next year, is it still in that time frame?

Rich Noll

The start up happens in Asia in the Nanjing facility in '09. It really spill into full operational and full capacity in 2010 because it's about a year ramp up. But it will clearly be providing a lot of benefits towards the back half of '09. So the supply chain strategy, we're still right on where our plans call for and right in line with achieving our plus or minus $200 million gross savings.

Eric Tracy – BB&T

Could you just remind us how the covenant resets as the year progresses?

Lee Wyatt

In the third quarter the requirements was 4.0. It was down to 3.75 for the quarter. If it stays there in the first quarter of '09, moves to 3.5 in the second quarter of '09 and then goes to 3.25 in the third quarter and 3.0 at year end.

Eric Tracy – BB&T

And it's just running through all the puts and takes that you provided; it seems to come in well below that three times at the end of '09.

Lee Wyatt

We have a lot of opportunity to manage this. We're comfortable with being compliant with all of our covenants. There are so many factors that give us that including the way the calculation is made to all the positive price increase, to the lower cost around commodities. All those things are very positive to us and we think we'll have normal cash flow next year which should allow us to get that.

I would remind you that in the third quarter of this year, the covenant was 4.0 and we were 3.5, so half a turn is a nice cushion there.

Eric Tracy – BB&T

The normal cash flow, the $200 million to $300 million, obviously lower CapEx that you talked about, and you mentioned the $200 million inventory reduction through the next 18 months. Are you able to quantify the expectation over the next 12 in '09?

Lee Wyatt

Not really. On the inventory, a large piece of it should come up some time in '09 but we don't really have that kind of detail.

Operator

Your next question comes from Omar Saad – Credit Suisse.

Omar Saad – Credit Suisse

On the price question, was this a surprise to your retailers? Are they in the mindset that this is the kind of environment that we're in? How did you set that up? Have you been in discussions with your retail partners? Can you give me some flavor on where they're coming from and how they could react to this?

Rich Noll

We've actually been talking to them about this for quite some time. In fact, it was as far back as late July, early August, so this isn't something that we just sort of dropped on them just lately. These things take a good 60 to 90 days to get to the point where it's all locked in.

There was a wide range of reactions from retailers. There's a number of retailers that actually fully understand and appreciate the benefit of retail prices going up as long as they're in the same relative competitive position. So for them, national brands taking price increases allows them to increase their average unit ring. They recognize that that's good. Their costs go up. It helps them cover because they get more margin. So we saw that reaction.

There's a number of other retailers that are independent of wholesale prices working to optimize their own retail prices, and generally in this environment that's been actually taking price up over time. And then there's a number of retailers who like and believe that prices should be low and should stable and shouldn't go up at all.

So we've had that whole range of reactions. At the end of the day, it really comes down to two things. All of our retail partners want and need strong brands, people who can invest in innovation. I can tell you supplier reliability is clearly something that's on a lot of retailers' minds and they want to make sure that they're aligned with big companies that have big strong cash flows and can invest in their supply chain.

And then our brand. At the end of the day, they understand that we've got strong brands and that can help support higher prices.

Omar Saad – Credit Suisse

Can you throw a scenario out there for next year if sales were down 8% to 10%? Obviously that's not necessarily a guidance number, but can you talk about some of the areas where there's risk to the revenues and what you're seeing in the category and how things might play out throughout this deep downturn in consumer spending. Are there certain businesses, whether it's hosiery or some of the areas that might be viewed as more discretionary as some of the other segments?

Rich Noll

When Lee was talking about that, that is just a method of stressing the outlying range of what could happen as a way to make sure that we're always within covenant compliance. By no means do we think that volume would be down close to 8% to 10%.

Let me talk a little bit about recession and history. Around here we've actually been looking at a lot of data in our industries over the last 15 to 20 years to try to get a good understanding of what happens in downturns. It's interesting. In innerwear, you will tend to see the apparel category in total drop maybe 4% or 5% and that would include basis or replenishment apparel such as our underwear category.

The difference is however, innerwear will generally stay down for at most a year whereas the apparel category can stay down and be soft for two to three years and that's because of the replenishment nature of our products. They tend to wear out and people replace them and they're a low dollar value.

That's actually the worst example we've seen in the last 20 years. It was actually in 2001. The other recessions or pull backs were in '91, '92 and actually '97 and '98. They were less severe of a down turn and they actually lasted a shorter period of time. So I think that's a good pattern to look at on how things may behave through this recession.

Omar Saad – Credit Suisse

On your inventory and cash flows, if you look historically where your free cash flows have been on a normalized basis, it seems like there's the opportunity to generate a free cash flow next year given the inventory take down, given the pricing and some of the other flips and takes even in a down revenue scenario, that the free cash flow could be quite significant. Am I missing something there?

Rich Noll

When we think about $200 million to $300 million normalized free cash flow that does not consider any significant working capital changes. So any success we have with inventories coming down and generating cash that would be added to that.

Operator

Your next question comes from Scott Krasik – C. L. King.

Scott Krasik – C. L. King

In your breakout you mentioned that you could get to 3.0 times by paying down $165 million assuming that you're going to generate significant more cash than that, could we expect even greater debt pay down than that $165 million in '09?

Lee Wyatt

I think as Rich and I both stated, we're going to take a conservative approach in 2009 given the environment that we're working in so our primary focus of excess cash would be to reduce debt.

Scott Krasik – C. L. King

Everybody viewed this commodity run up bubble with slanted eyes, but you held pretty firm. You did buy higher than you would have liked and you're paying for it now. How do you view that going forward in terms of your cotton costs?

Rich Noll

There's no question that the volatility of commodities is here to stay and as quickly as stuff can run down, I think that if the world starts to get a whiff, oh the world wide recession isn't quite as bad, we may see a run up again. Who knows? You can't predict.

I think what's important though, our price increases weren't just predicated on the commodity costs or cotton increase. Cotton is only one piece of our business. We are seeing and have seen other inflation around the world that won't reverse. Wages for example in Asia, Central American, the DR, the U.S. are tending to go up. In the United States, medical inflation this year, even down to little things like our local power utility raised rates.

Those things aren't going down regardless of the price of oil. So there is inflation built into our normal numbers that came in over the last year. It is here to stay. I don't think we're going to continue to see it increase. Cotton and commodities is just one piece of that.

Scott Krasik – C. L. King

I assume first quarter cotton will still be high, probably north of $0.70? Are you buying aggressively under $0.50 per pound, and how do you see by quarter at least for the second quarter, can you give us some direction on what the cotton per pound price will be?

Rich Noll

In the first quarter we're still flushing out some of the $0.73, $0.74 cent cotton. I think as we look at our buy now and the way we've staggered our buys and our hedging I think the second quarter is more in that $0.51, $0.52, 49% range. But we're not fully bought in or hedged for the second quarter yet but the early indications are that's the range we're buying in.

Scott Krasik – C. L. King

You mentioned $40 million to $50 million potentially in spending cuts in 2009. That's based on media. Does that also incorporate other synergies related to the restructuring? Would those be incremental to the $40 million or $50 million and should we see that flow? Is that net or is that going to be offset by basic increases?

Rich Noll

Think of that $40 million to $50 million that we've identified as clearly being discretionary. There's clear value in spending that. What it is, we are going to scrutinize it very closely and it gives us some flexibility that if things are a little bit slower than we anticipate to protect ourselves on the downside, but if things are a little bit better, for example media, then we may release those funds to take advantage of building our strong brands and innovation.

So think of it as giving us a little bit more flexibility to navigate a fairly uncertain environment rather than think of it as cuts that are definitively made and would flow through to the bottom line.

Operator

Your next question comes from Reade Kim – Merrill Lynch.

Reade Kim – Merrill Lynch

In light of the strange environment, does that open up acquisition opportunities for you looking through your supply chain? How should we think about that?

Rich Noll

We've always said that for the first two to three years to expand our brand creation was really not through acquisitions but it was all through cost initiatives around supply chain and consolidating the business. However, now as we enter that next evolutionary phase of our business, we'll always consider acquisition because we'll have opportunities after we get our cost bases in place.

Reade Kim – Merrill Lynch

Should we generally think of those as places where you can acquire a step in your supply chain or branching onto different price point within your categories?

Rich Noll

Let me talk a little bit about acquisition. First you mentioned supply chain acquisitions. We've actually been executing small acquisitions to help build out or speed our supply chain transition over the last two years. We purchased a textile facility in El Salvador, our first entry, a cell phone entry in Thailand was an acquired facility. So we've been doing that. We'll continue to look for opportunities to do that.

In terms of commercial acquisition there are some areas that we've been thinking about and targeting. There could be some opportunities within the United States to help round out our overall business. Requirements would be for any acquisition, both cost as well as revenue synergies.

Another area that I've talked about historically is potentially building a bigger commercial business in Asia as we build out our supply chain, and that could involve acquisition as well.

Reade Kim – Merrill Lynch

Given the change in the overall economy and markets is there any chance you might revisit your overall leverage goal, maybe take that deleveraging goal down a little bit further given the change in the world?

Rich Noll

I think the entire world's predisposition towards leverage is changing. Ours as well. Clearly we're going to focus on paying down debt now. Exactly what the new goal should be, we'll figure out. I think over the number of months and we may actually talk a little bit more about that on our Investor Day in February.

Reade Kim – Merrill Lynch

Does your bank agreement prevent you from opportunistically purchasing some of the term A on the open market? Is that a more restrictive covenant package and maybe that way you take some of the covenant discussion off the table?

Lee Wyatt

We currently have restrictions on buying in the market place but we're thinking about how to consider that.

Operator

Your next question comes from [Arthur Rollack – CAI]

[Arthur Rollack – CAI]

From an outerwear Champion type of product line, what did you study say with regards to that in terms of percent decline and duration of it?

Rich Noll

In terms of our outerwear, specifically active wear categories that you're talking about, there a little less data because those markets have actually been just growing over the past 15 or 20 years so you don't see the same types of ups and downs, so I can't explicitly answer your question. Overall we're extremely please with Champion active wear. We had another quarter of double digit growth. It continues to grow.

If you think about it, it's active wear but it's also value prices so it has a little bit of tail wind in these types of economies.

[Arthur Rollack – CAI]

Oil has been a big head wind. We've seen it come from $150 down to the mid 60's now. Any thought about what cost savings that might give you? What do you expect from cost savings in '09?

Rich Noll

As you think about what rolled off on our P&L in the third quarter of about $7 million from oil related, and it looks like $7 million to $9 million will roll off in the fourth quarter. Those were based on oil costs of $100 to $120 a barrel. So I think as it rolls down over time, we'll see some of that come back, although those prices can be pretty sticky. You've got to go out and actually take down incremental freight charges for that. We could see that kind of range of reductions at some point in the future.

[Arthur Rollack – CAI]

You had set a goal for reducing inventories. Was it $200 million over the next 18 months?

Lee Wyatt

That's correct.

[Arthur Rollack – CAI]

Looking further out, the story had originally been roughly $50 million of inventory reduction per year over the next five years, we've rolled up now as you've been transitioning some plants. Is that $250 level from the original spin date of inventory still what you're targeting?

Rich Noll

When we think of what our long term turns should be, it should be around three times over time, and that's a multiple year process to get them there. We think this $200 million over the next 18 months is the result of completing supply chain and initiatives. To get to 3.0 times turn there's more processes. There's a lot of other things involved with that. But that's still our long term goal.

[Arthur Rollack – CAI]

Can you comment on retailers have seen in terms of trends in October? What's the severity level of shock to the consumer? Has it been down 10% or 5% type number?

Rich Noll

In those couple of weeks we saw decline a little bit more but I'm not going to talk about overall retail because I think they're reporting the numbers. You saw an additional couple of points of decline from what we were seeing over back to school. Not on the order of 10% or 15% or something like that. It was a little bit more moderate.

I also want to go back to the first question. You asked about outerwear in total. There's another category within our outerwear business which is the wholesale T-shirt market which actually behaves a little bit differently. So in outerwear, we've got active wear which is doing quite well and growing.

But in the hotel T-shirt business, a good portion of those sales, this is where we sell product to wholesalers who then sell it to screen printers, with that screen printer sells it to end users. The biggest portion of where those goods go is actually to businesses and corporations and our 25 year history of data in this business says that in these kind of down turns as corporations cut back spending, that channel undergoes sales declines as well.

It's very tied not only to recessions but also the stock market ups and downs as businesses pull back a little bit. So that's another area we're watching and managing very closely. Fortunately for us, it's a small part of our business. I think it's probably contributes less than 3% to 4% of our total profits.

Operator

Your next question comes from [Kenneth Tighe – CIBC World Markets].

[Kenneth Tighe – CIBC World Markets]

I just went through your revised CapEx. Could you give a little more color around the El Salvador and Dominican textile facilities particularly with regard to what impact this environment will have on your phase two expansion plans in those facilities and any additional color you have on the expansion of the facility in Central American and Caribbean?

Rick Noll

We're continuing to execute our plans as we've originally laid them out. One thing is though, as we've gone into fewer bigger facilities, we're actually starting to understand how to squeeze more production out of a certain amount of square feet. So we actually think we're going to be able to save maybe over the life of the supply chain transition, $25 million to $50 million and still be able to accomplish all the things that we've laid out.

That's the type of thing that goes with experience and getting in there and start operating and a good example of that is being able to run multiple shifts in Vietnam for example which we didn't anticipate going in. We also believe that that's the case in that whole El Salvador expansion. We're able to get out more pounds per square foot that we originally envisioned and so we're making sure we've got the right footprint for our business.

So we're getting close to our end state footprint in Central American and the Caribbean basin and we've now laid all the stakes in the ground for Asia and that will continue to ramp and start up over the next 12 to 18 months.

[Kenneth Tighe – CIBC World Markets]

You mentioned you have more efficiency in those plants in terms of pounds per square foot. Do you have any metrics on that, where you were when you began your contract production facility to where you are now and where you would like to be once the facility is in, or do you not have a fix and are unable to disclose that at this point?

Rich Noll

Actually I can give you a couple of anecdotes from a few facilities. For example, in Vietnam we're convinced we can run multiple shifts. The second shift isn't quite as big as the first shift, so that increases the productivity in those facilities by a factor of 60% or 70%. Another we highlighted in our last Investor Day last February, the facility we bought in Thailand. We're able to double production by installing our processes and methods in the same square footage with the same number of people and substantially reduced the costs.

Those are just some examples of how we've been able to improve our productivity as we've been rolling out our supply chain.

[Kenneth Tighe – CIBC World Markets]

Would that apply to your Central America and Caribbean or is it more specifically focused around your capabilities and expansion capabilities in Asia?

Rich Noll

We're absolutely seeing productivity opportunities improvements within Central American and the DR as well.

[Kenneth Tighe – CIBC World Markets]

You touched on the wage inflation. Could you give a little bit of a refresh on wage cost pressures in Asia against your Central American or Caribbean, being in order of magnitude dollar wise?

Rich Noll

Over the past 12 months and especially in the last six months, we're seeing similar types of percentage increases on wages both in Asia as well as in Central America and the Caribbean basin. For example, I think it was in Honduras the government declared a 15% wage increase for government employees similar to the percentage increases that you're seeing in Asia. But there's one important thing to remember.

The wage rate in Asia is one-half to one-third of what it is in Central America. So at the same percentage increase, the penny increase or the dollar increase per hour is much higher in Central American and the Caribbean than it is in Asia. And that's one of the things that further reinforces our belief that balancing our supply chain equally across the western hemisphere and Asia is the right thing to do.

Operator

Your next question comes from Andrea Cohen – Aries Management.

Andrea Cohen – Aries Management

Can you give a little bit more color on the bad debt expense? Mervyn's was only 175 stores so $5 million seems high. As this goes on if you have more retailer rationalization, how are you managing the receivables balances and what do you think your bad debt expense could be on a go forward basis?

Lee Wyatt

As we thought about Mervyn's, recall that they filed Chapter 11 in July and we had about $6 million to $6.5 million of receivables. We assumed a recovery rate of about 75% on that. Once they filed a going out of business liquidation, we assumed on pre petition we would only get about ten cents on the dollar so we tried to take a reasonably conservative approach to that.

That's why we had the $5.5 million charge in the quarter.

And going forward, we have very strong receivable realization due to our customer concentration. Our overall bad debt rate is about 1.5% of receivables, so we feel very good about that. Occasionally you'll have a blip like a Mervyn's but those happen. To give you an example of how we think about receivables because our bad debt is built around how much of the receivable is aged.

For our domestic receivables, only about 2% of our receivables are over 30 days outstanding. So it's pretty solid.

Andrea Cohen – Aries Management

In your press release, in the P&L for the September quarter, you have an inventory write off included in cost of sales of $14 million. Can you speak a little bit about what that is? Obviously your EBITDA looks to be down around 41% and I know that there was a big hit to cost of goods sold. Is it something that we should be adding back? What is that?

Lee Wyatt

That $14 million is actually included in our restructuring charges. As we closed the last domestic plants, what you have is both work in process and raw material associated with those plans that it's basically just as economical to dispose of them than to try to ship them to Asia or somewhere. So that is work in process and raw materials associated with those high cost domestic plants we're closing. So it should be added back as restructuring.

Operator

Your last question comes from Eric Tracy – BB&T

Eric Tracy – BB&T

In talking through the wage increases, and you talked relative to Asia versus the Caribbean basin, can you just remind us given that labor is the biggest piece of the story, on an absolute dollar basis, domestic versus Asia versus the Caribbean basin in production, what it is on an hourly rate?

Rich Noll

You're going to see U.S. fully loaded wages $15 to $16 an hour. You'll see fully loaded wages in Central America and the Caribbean basin maybe $1.50 to $2.00 an hour and in Asia you're going to see anywhere from a low of $0.30 to $0.60 an hour.

Eric Tracy – BB&T

So the order of match is 20% to 30%.

Rich Noll

They're still fairly low so for example 3% on $16 is $0.48. 10% on something in Central America would be $0.17 but 10% or even 12% on $0.40 is only $0.08. So over time, Asia's advantage will continue to grow vis a vis Central America and the Caribbean basin and the United States.

It's important, I just want to reiterate that while Asia's advantage will continue to grow, for some product categories, Central American and the Caribbean basin makes all the sense in the world. A great example of that will be basic products that are heavy and expensive to ship. Basic fleece would be the classic example where it makes the most sense to make those products in Central America and the Caribbean basin.

Eric Tracy – BB&T

You talked about the sales trends in Q4, but I believe there is a 53rd week in Q4. Maybe you can quantify what that impact would be?

Lee Wyatt

It's always hard because it's not a full five days because it ends on January 3. It could be $20 million to $30 million in sales.

Operator

I'll now turn the call back over to your chairperson, Mr. Lance.

Brian Lance

We'd like to thank everyone for attending our quarterly call today and look forward to updating you after our fourth quarter call.

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