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Hanesbrands Inc. (NYSE:HBI)

F3Q09 Earnings Call

October 28, 2009 5:00 pm ET

Executives

Brian Lantz - Vice President, Investor Relations

Richard A. Noll - Chief Executive Officer

E. Lee Wyatt, Jr. - Chief Financial Officer

Analysts

Omar Saad - Credit Suisse

Jim Duffy - Thomas Weisel Partners

Scott Krasik - C.L. King & Associates

Rishi Parekh -Stern Agee

Eric Tracy - FBR Capital Markets

David Schmookler- Kingsland Financial Services

Operator

At this time, I would like to welcome everyone to the Hanesbrands third quarter 2009 earnings conference call. (Operator Instructions)

Brian Lantz

Good afternoon everyone and 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 of 2009. Hopefully everyone has had a chance to review the news releases we issued earlier today. The news releases and the audio replay of the Web cast of this call can be found in the Investor Section of our Hanesbrands.com Web site.

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 such as our most recent Forms 10-K and 10-Q as well as our news releases and other communications. The company does not undertake to update or revise any forward-looking statements which speak only to the time at which they are made.

Also, any references to gross margin, SG&A, operating profit, earnings per share, or EBITDA on today's call will focus on results excluding restructuring and other actions, unless otherwise specified.

With me on the call today are Rich Noll, our Chairman and Chief Executive Officer, and Lee Wyatt, our Chief Financial Officer. Rich will highlight our 2010 net space gains and give a summary of our business performance for the quarter. Lee with then provide further detail on the various aspects of our financial performance.

Following our prepared remarks, we have 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 third annual investor day on Tuesday, February 23, in New York. We will again have our extended management team review our achievements, strategies, and opportunities in detail. We will send the invitations out in the fourth quarter and we look forward to seeing all of you there.

I will now turn the call over to Rich.

Richard A. Noll

I am pleased with our performance through the recession and I am very optimistic about our potential in 2010. Overall, both the quarter and the year are unfolding as we stated and we continue to invest in our business. As a result, we are poised to begin 2010 with significant momentum.

We have secured substantial net space gains and program expansions that will result in approximately 5%, or $200.0 million of sales growth, in 2010. We are following a simple path to growth. While we were number one or number two in all our core categories, we are not number one or number two in all accounts or in all of our core programs. In 2010 we are growing our market share by capitalizing on these distribution opportunities, sort of filling in the holes in our distribution grid, so to speak.

Let me hit a few of the highlights. Our inner wear segment accounts for the majority of the increases, specifically men's underwear is benefitting from confirmed net space gains at all major accounts, including Target, Walmart and Macy's, plus new distribution of Dollar General, JP Penney's, and BJ's. These net gains should produce high, single-digit growth for men's underwear in 2010.

Intimate apparel also has substantial gains. We have confirmed expansions for bra programs at most major accounts, including Kohl's, Target, Walmart, and Macy's, as well as expansion across all of our brands.

Hanes panties are also gaining space in new distribution at major accounts. Overall intimate apparel gains should produce mid-single-digit growth in 2010. We are remaining in categories that have both space gains and losses, which are generally offset or provide low, single-digit gains.

Outerwear segment growth will be driven by the multi-year agreement with Walmart to significantly expand our Just My Size brand in casualwear. This program could provide $75.0 million in incremental casualwear sales in 2010, growing to $150.0 million over time.

Champion has confirmed space and distribution gains in sporting goods, department store, and mid-tier accounts.

The only segment with net losses is sheer hosiery. Retailers continue to reduce space in this category as the industry continues to decline.

Some of these programs began shipping in Q4 but the bulk of the programs start shipping in Q1, resulting in much of 2010's growth being weighted in the first half, therefore these new programs allow us to begin 2010 with top-line momentum, even if consumer spending does not rebound. If it does rebound, we have upside potential.

To support all of this growth we are very quickly increasing our production capacity. Our Nanjing textile facility started production this month, and we have secured additional capacity with outside contractors. These capacity expansions, coupled with our continued planned cost savings, will go a long way in 2010 in helping us achieve our annual operating expansion goal of 50 basis points to 100 basis points.

We will provide further 2010 top-line and EPS guidance early next year, after we see holiday results, which will allow us to further gauge consumer sentiment.

Now let me turn to recent consumer spending trends. Over the last quarter, we have not seen a sustained, consistent rebound in consumer spending, but rather mixed results. Back to school started weak in July and early August, then we saw five weeks of strength from mid-September, before it softened again for a couple of weeks. More recently, we have seen October retail sales show strength due to colder weather.

So for back-to-school, it felt as if consumer spending was bouncing along the bottom. As we overlap last year's fourth quarter declines, bouncing along the bottom may imply relative flat sales.

While important, however, the fourth quarter is not a gauge of how we will perform in 2010. Whether Q4 sales are a few points better or worse remains to be seen, but our momentum in 2010 is driven by space gains rather than a rebound in consumer spending.

2010 has great potential. Our projected sales growth, combined with our cost savings, should drive greater operating profit growth, and when combined with our debt paydown, should drive even higher EPS growth.

Let me now turn to our third quarter financial results. Overall sales declined 8%, in line with what we projected on our last call. EPS grew 21% in the quarter and I am particularly pleased with our 10.5% operating margin. We also ended the quarter with $153.0 million less inventory than at the start of the year, achieving our year end goal a full quarter early and we remain firmly committed to paying down $300.0 million of debt in 2009.

For 2010, we see the potential for robust cash flow and our major priority will be to continue to de-lever and pay down another $300.0 million of debt. Additionally, we want to be prepared to use 2010 excess cash flow for potential both on acquisitions that could provide value by leveraging our low-cost global supply chain. To that end, Lee will discuss our thoughts on refinancing.

As I have said before, it is tough times like these that test organizations and our people are truly rising to the occasion. Through their collective efforts, we have overcome this recession and laid a solid foundation for a successful 2010.

I would like to turn the call over to Lee Wyatt.

E. Lee Wyatt, Jr.

To summarize the third quarter results, earnings per share, excluding actions, were $0.63, 21% above last year. Operating profit increased $9.0 million, or 9%, despite the sales decline. Operating profit margin increased 160 basis points to 10.5% and we paid down $117.0 million of debt in the quarter. We are very pleased with these results in this environment and they again confirm our modeling assumptions for the full year.

Let me review our results for the third quarter in more detail. Sales of $1.06 billion decreased $95.0 million, or 8%, from the same quarter last year. This decrease was in line with our previously announced projections.

Restructuring and related charges were $16.0 million in the third quarter. These charges were incurred primarily as a result of plant closures and consolidation actions. Year-to-date charges have been $53.0 million. Total charges since the spin-off have been $262.0 million. Our current estimate for the fourth quarter charges are around $18.0 million, bringing the total restructuring charges since the spin-off to $280.0 million. Approximately one half of the charges have been non-cash.

The restructuring charges will be completed in 2009 so in 2010 we will no longer report results on an XA basis, we will only report on a GAAP basis.

The gross margin rate for the third quarter was 33.7%. The third quarter rate was higher than the 2008 rate, due primarily to the benefits of our price increase, cost-savings initiatives, and lower cotton costs, that more than offset higher trade spending.

Our decision to increase trade spending has proven valuable in building momentum with customers and had contributed to the significant space gains in 2010. The gross margin rate has improved sequentially in each quarter of 2009.

Cotton costs for the third quarter was $0.49 per pound, approximately a $14.0 million positive impact. We have visibility to cotton costs for the fourth quarter of 2009 and first quarter of 2010. The fourth quarter should reflect costs of $0.48 per pound, approximately an $18.0 million positive impact. The first quarter of 2010 should reflect costs of $0.52 per pound, approximately a $12.0 million positive impact.

Turning to SG&A, third quarter SG&A expenses were $246.0 million, or 23.2% of sales, $12.0 million lower than last year. The quarter reflected $10.0 million in savings from the cost-savings initiatives, and lower bad debt distribute and IT expenses that more than offset $8.0 million higher pension expense.

Operating profit of $111.0 million for the third quarter resulted in an operating margin of 10.5 %, 160 basis points higher than the same quarter last year and better than the 2008 full year margin of 9.7%.

Interest expense for the third quarter was $43.0 million, $6.0 million higher than the same period last year.

Our revised expectations for the full year tax rate is 16% due to a higher mix of offshore profit caused in part by restructuring charges in 2009. Our income tax rate in the third quarter was 14% as we trued up our year-to-date tax expense to our full year rate.

And earnings per share were $0.63 for the quarter, up 21% compared to $0.52 last year.

Turning to the third quarter balance sheet, inventories were $1.14 billion, $153.0 million less than we began the year and $222.0 million below the third quarter of 2008. We have achieved our goal to reduce inventories by at least $150.0 million a quarter earlier than planned.

Debt at October 3 was $2.04 billion and we remain in compliance with all debt covenants. We paid down $177.0 million of debt in the quarter and have reduced debt by $134.0 million year-to-date.

Our cash flow statement reflects $211.0 million of net cash provided from operations year-to-date, reflecting the reduction in inventory. Year-to-date capital expenditures of $100.0 million were on plan with $16.0 million of proceeds from property sales reducing net expenditures to $84.0 million.

For the full year, we expect gross capital expenditures of $125.0 million with net capital expenditures of no more than $90.0 million.

In summary, the third quarter results were very much as we expected. We significantly increased our operating margin, sales declined at a rate within our projected range, we significantly paid down debt, and we reduced inventories. Despite the recession, third quarter profit results were strong and most importantly, we made investments in our business that have generated substantial top-line momentum for 2010.

Let's turn to our outlook for the fourth quarter. It's important to remember two aspects of the 2008 fourth quarter. First, it included a 53rd week of sales, worth approximately $50.0 million, or 5% of quarterly sales, and second, it included $16.0 million in unusual income from duty refunds from Costa Rica as the country adopted CAFTA [Central America Free Trade Agreement] provisions.

Our sales assumption continues to be that we will continue at a consistent run rate all year and as we overlap last year's fourth quarter declines, it implies that that sales should be relatively flat with last year, after adjusting for the impact of last year's 53rd week.

Other factors, such as lasts year's inventory de-stocking by retailers, and this year's timing of shipments as retailers manage the transition of our space gains, could positively impact sales by $20.0 million to $30.0 million in the fourth quarter. But this is still uncertain at this time.

Operating margin in the fourth quarter should improve over the 2008 rate, in spite of at least $8.0 million higher trade spending and $2.0 million to $3.0 million of increased supply chain cost, such as air freight, to transition retailers for the 2010 space gains. Should the operating margin show significant improvement, we may choose to use the excess to reinstate some media spending to drive additional sales momentum in 2010.

As for the fourth quarter balance sheet, debt should reflect total paydown of $300.0 million in 2009 and since the sale of our yarn operations closed today, we could realize up to $50.0 million in reduced working capital, with the majority reflected in lower inventory.

We would like to make two additional announcements related to fundamental shifts in our capital structure strategy. While continuing to generate strong cash flow since the spin-off, we have invested heavily in building out our low-cost global supply chain, in addition to paying down debt. This period of heavy investment is ending so we will now direct our strong cash flow primarily to achieving a lower leverage target. We will also be positioned to use excess cash to make acquisitions or return cash to shareholders.

But to realize these opportunities to create value, we will need a more flexible debt structure than today. So first, we are announcing a leveraged target of 2x to 3x debt to EBITDA with the potential to achieve the target range in 2011. Achieving this leveraged target would be a radical shift in our leverage profile and reflects both our stated priority to reduce leverage and our robust cash flow expectations during this period.

And second, we feel the time is right to evaluate refinancing our debt. Refinancing could both simplify the overall debt structure, and provide additional flexibility to create value. So we will begin developing plans on structure and timing and will communicate as appropriate.

To summarize, we were pleased with the third quarter profit results, the inventory reduction, and the debt paydown in the quarter, and we were excited about the prospects for 2010 sales and earnings growth and the opportunity to radically change our leverage profile over the next two years.

I will now turn the call back to Brian.

Brian Lantz

That concludes the recap of our performance for the third quarter of 2009. Now we will begin taking your questions and we will continue as time allows. Since there may be a number of you who would like to ask a question, I 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 Omar Saad - Credit Suisse.

Omar Saad - Credit Suisse

I kind of wanted to start with the commentary you have made around the sales guidance for next year and some of the things that are happening, it sounds like, that drove your ability to put out that plus-5 number. Help me understand, we knew about the Just My Size and that win out there, but can you point to some underlying fundamental things that are happening, either at the retail level, or from a competitive standpoint, what's really driving from an underlying basis, this meaningful shift in what could be underlying sales trends?

Richard A. Noll

I think when you're talking about this kind of increase and it's so broad-based across many different accounts from department stores through dollar stores and across most of our brands, it's really a reflection of the investments that we've been making in our brands over the last three years. Retailers are seeing that they can use our brands to drive traffic to their store and help them drive both their sales and profits. And I think that's the fundamental reason for a lot of these gains.

Additionally, I don't want to also lose sight of this fact that while we are number one or number two in all of our categories, we've still got a lot of distribution voids out there to gain share. And we are going to aggressively go after it.

I think one of the prerequisites was we needed to have a low-cost global supply chain in place from which to competively go after this share. We now have that. And so you think of this as a new phase, this optimize it and leverage this supply chain and it's all about driving the top-line and leveraging that supply chain to the best that we can.

Omar Saad - Credit Suisse

Is there a shift in the way retailers are thinking about their different suppliers that is triggering this now? What is different today versus a year ago? Is it really just a completion of a large chunk of the supply chain restructuring.

Richard A. Noll

I think it's a couple of things. One is that our brand equities continue to build over time. Two, during the recession, what a lot of retailers were gravitating to, was driving well-known national brands with broad appeal to bring people in their stores, because well, their number one issue is traffic, right?

And it's one of the reasons why, for example, in our innerwear category, we haven't seen a big shift on our retailers' parts towards private label. They are actually shifting more towards driving national brands.

But importantly, the gains that we are seeing are coming from our major competitors, as well as minor brands in the marketplace and private label. So I really do think it speaks to our brand equity that's been building over time.

The second factor is that there is a strong desire on a lot of retailers' parts to drive what I would call moderate-price brands. And it's interesting, so if you go to the dollar stores, they want to drive moderate-price brands, not for them, but relative to the marketplace, hence they're pushing Hanes. You can go all the way to mid-tier department stores and they want to drive moderate-price brands, such as a Hanes or a Bali. So I think that's also been a factor that's helped us.

Importantly though, retailers aren't looking at this as sort of a short-term reaction to the recession, they're really looking at it as a way to build their business long term.

Omar Saad - Credit Suisse

I know it's not all—you alluded to the fact that there are space gains, but there are also some space losses. What are the toughest parts of your business as you look out over the next year or two, excluding the hosiery business. What are some of the areas where you are finding it tougher to generate space gains?

Richard A. Noll

Every year we always have space gains and losses, especially around this time because a lot of major retailers reset their floors for in the February/March time frame. And so we always have pluses and minuses on gains and losses. So this year we had losses across all of our categories like we normally do. They are relatively minor but the gains just swamp those losses that we have. And I think it goes back to retailers wanting our brands to drive their traffic. So we saw losses across all of our categories. It's not like there are more in some places than the others.

But I am quite pleased with the strength that we are seeing in men's underwear. As I said, we should be up high-single digits and that's probably the one that's got the broadest new distribution, as well as women's intimate apparel should be really, really strong.

Omar Saad - Credit Suisse

I know you said you are not assuming any sort of consumer rebound in these assumptions, but what is your view on the consumer today? The weather has gotten colder but is there really anything you can read into the mindset and the health of the consumer and their willingness to spend, given what you have seen over the last few months?

Richard A. Noll

One of the reasons actually went through almost a week-by-week or month-by-month playout of how back to school went was to give you a feel for, you know, it's sort of bouncing along the bottom. It's mixed. We see some pockets of strength and then you get a couple of weeks that are soft. So from our perspective we haven't yet seen a consistent, sustained rebound. What's going to be interesting is really watching what happens in November and December and that's why we wanted to wait until next year to give our thoughts on will consumer spending rebound.

I'm going to guess, I'll go out on a limb without that information, and say usually there's no catalyst in Q1 or until later in spring, towards Easter, for people to change their spending habits, so more than likely you're not going to see a spending rebound until late spring or back to school. So you could see some real strength in the second half of the year, but we want to go through holiday to better gauge it.

And that's why I'm so excited about our prospects for 2010, because we can have strong, robust growth from a top-line perspective, cascading down to a bottom-line perspective, irrespective of that consumer-spending rebound.

Operator

Your next question comes from Jim Duffy - Thomas Weisel Partners.

Jim Duffy - Thomas Weisel Partners

Congratulations on the space wins into 2010. I want to make sure I understand that 5% number, is that a gross number or is that net of programs that you lost with retailers as well?

Richard A. Noll

That is a net number of confirmed space gains and losses and pretty much we know what's going to happen, definitely through the first part of the year. Most retailers make one, or most two, resets with the February/March reset being the most important one. So that's confirmed net gains. So gains minus losses. So roughly $200.0 million.

Jim Duffy - Thomas Weisel Partners

With regards to how that will flow through the model, how will you prioritize spending in support of programs and setting the table for new programs in future years versus just letting the revenue strength lever over some of the cost improvements that you've made in past years?

Richard A. Noll

Are you asking how we might see that impact the overall bottom-line?

Jim Duffy - Thomas Weisel Partners

Yes, in general terms. What will SG&A spending look like in the +5% revenue growth environment. Could we expect—I?

Richard A. Noll

Let me just start with a couple of things here. Overall, we still have a goal for 2010 to continue, even with these gains, to improve our operating margins 50 basis points to 100 basis points. The only real thing that we know we want to add back from an SG&A perspective, that I've talked about actually for the entire year, is we cut media earlier in the year, about $25.0 million in the first half. And I think that was the absolute right decision to make, if people weren't in stores buying a lot of stuff there was no reason to be spending a lot on media.

That cut will need to get restored. I think we need to get back up to that $100.0 million level and then eventually it will with sales.

Lee, do you want to comment about anything more specifically?

E. Lee Wyatt, Jr.

Just a little color on SG&A this year. In the third quarter we reduced absolute dollars down by $12.0 million, and year-to-date we have reduced SG&A by about $78.0 million, so we think we are getting to a kind of nice run rate on SG&A, with the exception of the need to improve or restore some of that media. So we think we are at a point with a base run rate that we can now leverage that in the future, in 2010. It should be very favorable to the bottom line.

Jim Duffy - Thomas Weisel Partners

And is it fair to say you believe you have the infrastructure in such a place that the best use of capital now may be now more focused on growth initiatives. You mentioned acquisitions, what are the characteristics of the type of acquisitions that might make sense? Anything you can speak to on that front would be helpful.

Richard A. Noll

I have always talked about our life in two phases. The first three or four years coming out of the spin was where we needed to spend time investing in rebuilding our infrastructure and rebuilding our brands. And we have now pretty well completed that with the exception of our Nanjing facility, which needs to ramp up this year.

And then the second three to five years is what we would call the optimize and leverage it phase. It's where we've got the opportunity now that we've got the supply chain in place, to optimize it for both cost and working capital efficiency.

So both of those things can help our operating margins expand, as well as help us generate pretty robust cash flow. But then you also want to leverage that infrastructure, both with consistent share gains, which we are demonstrating we can achieve in 2010, but also to begin contemplating bolt-on acquisitions. These would be the types of acquisitions that would be in our core apparel essentials category, would allow us, therefore, to leverage synergies through our supply chain and maybe some overhead, but also provide a platform for growth.

So it could be in areas that would either help us expand in consumer segments that we're not, or in distribution channels that we're not as strong. Or even expand in certain geographies. For example, international. So that's where we think we could go.

The size of the magnitude of these, for example, they are not going to be huge or major things that are going to radically transform the size of our company. They could be acquisitions that could be in the $100.0 million or $200.0 million range that would be relatively small in scope, safe, conservative, but provide tremendous synergies or value. It's now time for us to begin thinking about those and start taking a look more seriously.

We are not in any negotiations now, but it is time for us to begin thinking about it.

Operator

Your next question comes from Scott Krasik - C.L. King & Associates.

Scott Krasik - C.L. King & Associates

To go back to the 2010 sales guidance, you mentioned that the increase would be weighted to the first half. I know you have visibility there in terms of the commitments, but it's not like sales picked up meaningfully for fall this year. Why shouldn't you get similar growth in the back half of the year as well?

Richard A. Noll

Right now our plans show that we would grow with these base gains in both halves. No question about it. What I was trying to communicate is you would probably see slightly higher than the 5% growth in the first half and maybe not so much in the second half, but we would clearly have the opportunity for strong growth.

And additionally, while we're feeling pretty good about the back half, given the commitments and the space that we have, I also think there is some opportunity for consumer spending rebound, or other things to happen that could be positive in the back half of the year.

Scott Krasik - C.L. King & Associates

So really there's a few different avenues where you could be conservative in terms of the outlook?

Richard A. Noll

Yes, and I also want to say that generally our Q1 tends to be the lowest quarter of our four quarters, just seasonally, but a lot of these programs are going to begin shipping in Q1, so Q1 could be pretty strong.

Scott Krasik - C.L. King & Associates

Lee, on the quarter, other than the lower commodity costs year-over-year, are there other benefits in the fourth quarter to gross margin? I don't think you spoke to that specifically, because to get to the—I know you don't give guidance—but at least to get to the consensus estimates that are out there, it would take something additional to be a meaningful increase, at least sequentially, on the gross margin.

E. Lee Wyatt, Jr.

In terms of the fourth quarter, the things we know are out there are we will continue to have lower cotton costs, we talked about $18.0 million, lower oil and related costs of maybe $5.0 million to $7.0 million, and we will still have some price increases and our initiative savings. We have year-to-date had about $62.0 million in initiative savings. That's about $20.0 million a quarter. So that should continue. So we know of those things.

Richard A. Noll

Just as a reminder, one of the things we talked about weighing on those are some additional costs that we'll incur in the quarter for additional trade spend and some supply chain costs like air freight, to help support the strong shipments that we'll see in Q1.

Scott Krasik - C.L. King & Associates

And the outlook right now, relative to getting some of those opportunistic, were those replenishment sales, the $20.0 million to $30.0 million that you mentioned?

E. Lee Wyatt, Jr.

Yes, we don't know enough right now to know that. That's purely on, for example, timing of shipments between the fourth quarter and the first quarter, so it's hard to tell right now.

Richard A. Noll

If you remember, last December, all the retailers were reacting and pulling inventories way down, but then they've never pulled inventories down in September or December, they always do it in January or February. So last year we felt that pull down happen in December. If that doesn't happen again this year, there is obviously some upside. But it would really be a timing shift from Q4 to Q1, it wouldn't be a fundamental change in what our sales results would be over those two quarters.

Scott Krasik - C.L. King & Associates

Lee, in terms of the refinance, you do have some language in here that it come as early as the fourth quarter. Have you begun the process?

And then to get the flexibility, do you have to accept higher rates and just with the paydown you expect to offset that in terms of accretion and dilution, maybe talk about that.

E. Lee Wyatt, Jr.

We have not announced or initiated a refinancing at this time. But the credit markets are strong enough right now that it would make sense if we could get it done to go ahead and get moving. But we're planning that right now. We're working through what the structure might be and what the timing might be right now.

In terms of rates, when we amended the first lien in the first quarter, we basically marked most of the debt to market, so from a rate perspective a refinancing shouldn't fundamentally change our effect rate. However, from an interest expense perspective next year, this $300.0 million of paydown this year and then the $300.0 million next year will obviously take the overall interest expense down.

Operator

Your next question comes from Rishi Parekh -Stern Agee.

Rishi Parekh -Stern Agee

Under your existing covenants, how much can you spend on acquisitions? Basically what is your restrictive payments basket today?

Richard A. Noll

Well there is an acquisition basket today that limits us to $100.0 million.

Rishi Parekh -Stern Agee

And that $100.0 million debt paydown for next year, does that in any way reflect the parcel increase in your cost of capital, if you do, say, a global refi?

Richard A. Noll

The $300.0 million paydown next year?

Rishi Parekh -Stern Agee

Yes.

Richard A. Noll

Would not be impacted by whether we are refinancing or don't do a refinancing.

Operator

Your next question comes from Eric Tracy - FBR Capital Markets.

Eric Tracy - FBR Capital Markets

Maybe if I could tackle the next year sort of top line in a different manner, and that is from a capacity standpoint. Talked about not only the incremental from Nanjing but adding contract manufacturing. Is that based on that 5% incremental or what is the assumption around other growth that would be embedded in that?

Richard A. Noll

If you remember, we actually pulled production capacity down in 2009 below our projected sales rate in 2009 to help bring down inventories. So we always had to ramp production up for 2010 even if we weren't going to see this kind of sales growth. Now that we're seeing it, and a lot of it is actually weighted earlier in the year, I'll tell you, we're ramping up as fast as we can.

Now, we're going to be able to service all of the business but the entire organization is rocking and rolling and bringing capacity online as quickly as possible. And I will tell you, after the last 18 months, it feels real good chasing upside instead of chasing downside.

Eric Tracy - FBR Capital Markets

That was going to be my next question. Obviously Nanjing just earlier this month coming on line, nothing you're seeing from a transitional standpoint and then obviously layering in contract manufacturing always brings in some complexities, but you feel like the infrastructure is there, particularly to support an early next year?

Richard A. Noll

Absolutely, we feel it's in place and we see—in fact, what a lot of retailers were doing with these new program expansions is they kept calling up trying to move the dates forward and now they're going really, really early, so I think that's a signal of how much they really want our brand.

Nanjing isn't actually early in the year going to play a big part in providing and supporting some of those capacity. It's actually ramp ups in some of our other sewing facilities and some of the other textiles facilities that we're doing to make sure that we can cover it, as well as working with outside contractors.

But they are really in two groups. One would be people that we have strategic relationships with, where we contract a huge portion of their production year-in and year-out. We're ramping up with them. And that's actually to much lower cost and doesn't add as much complexity. But we're also adding just outside contractors as well.

At this point, pretty well, we are sold out for at least through the first quarter and mainly most of the second quarter, so we're feeling pretty good about our situation.

Eric Tracy - FBR Capital Markets

Turning to top line next year and talk a little bit about G&A to support that, but from the gross margin perspective, I know you're not giving exact guidance on it, but is it fair to assume a similar run rate from the supply chain initiatives of that $20.0 million per quarter, or is there a potential with Nanjing coming on, and if so, how should we sort of think about the cadence as the year progresses?

E. Lee Wyatt, Jr.

I would think about it from a pro rata basis. The run rate is going to continue kind of next year in the same kind of rates it is this year, from a savings perspective. And from an SG&A perspective, we think we have kind of sized the SG&A base to where it needs to be, with the exception, again, of that media increase. We should be able to leverage the SG&A.

Eric Tracy - FBR Capital Markets

In terms of bringing Nanjing on line, you obviously have got a lot of play just from domestic growth opportunities, but again, could you speak to whether it's next year or longer term, sort of the international play, whether that's organically developed or now potentially through acquisitions, how do you think about that particularly in Asia?

Richard A. Noll

Let me actually start and talk a little bit about what we've been in Mexico, because we have these—you know, it's about $400.0 million in sales spread between Mexico and Canada and Europe and Asia and even Brazil. And they're run sort of like small, independent companies, almost, and they've got anywhere from $60.0 million to $100.0 million of sales. The overall strategy internationally is you can think of them like they're bolt-on acquisitions that we don't have to buy. And there are synergies that we can create by plugging those smaller companies into our larger, global, low-cost supply chain.

We started that process with Mexico a little over two years, able to help really lower their cost, and it is allowing them to be much more competitive against everybody else in those markets and grow sales. In fact, Mexico has been growing consistently, even through the recession.

We think that is a winning strategy. We can then build out each of those international businesses in our core categories over time and have some good international growth and we think that we should be able to consistently get at least mid-single digits or better growth internationally from our existing businesses by following this strategy.

Longer term, acquisition opportunity could make sense, absolutely. Probably not a lot of people know this, but we have the number one men's underwear share in Brazil. There is no fundamental reason that we couldn't have the number one intimate apparel share in Brazil as well. In China, we've also got plans where we're starting to build our business and I think that market is really a market that we will focus on very heavily on over the next couple of years, continue to build organically but also think about acquisition.

International acquisitions would be a little bit longer term. Not something near term. It's sort of like you want to make sure you're doing something where you can get your arms around, if it's your first acquisition. But I think longer term it could be a good play.

Eric Tracy - FBR Capital Markets

And on the tax, how should we think about that? Are we resetting that 22% to 25% lower next year? I know as you start producing out of Asia and shipping back to duty you're going to [inaudible]. Just sort of talk through what that might look like in 2010.

E. Lee Wyatt, Jr.

Let's talk about 2009 first and then 2010. We determine our tax rate on an annual basis for the full year under GAAP tax. And since now we have better visibility to the amount of restructuring charges, about $70.0 million this year, that's actually driving that rate down to the 16% on an annual basis, this year.

This should be the last year, though, that we have the restructuring, so I think that the 20% to 25% range that we have been using historically, should be a fine range next year again. And we'll go through it as we develop our plan. When we get into February, we will talk more about what the exact rate is, but I think that 20% to 25% range is good for next year.

Operator

Your next question is a follow-up from Jim Duffy - Thomas Weisel Partners.

Jim Duffy - Thomas Weisel Partners

As you're in this optimized phase, I'm wondering if you can speak to some of the areas where you see kind of low-hanging fruit opportunity for productivity improvement and what any potential benefits to margins might be, as we look out to 2010?

Richard A. Noll

I'm going to break it into both cost reduction as well as working capital and I'm going to actually start with working capital. So before, when we had textile facilities in the U.S. and we had the sewing facilities offshore, a lot of working capital sort of is floating around either on boats or going between on trucks. Now that these are tight clusters, where sewing is within a couple of hours drive of the textile facilities, or at most a day away, you are going to need a lot less working capital, work in process, between that textile facility and those sew facilities. And that's a great example of how you can optimize these clusters, for example, where we have textiles in El Salvador, and sewing both in El Salvador and Honduras. Nice, tight cluster, you can reduce the amount of working capital.

Second, because we've only got three clusters, one in Central America, on in the DR, and one now in Asia, we can also start to work with our suppliers to do supplier-managed inventory and that was one of the appeals of the yarn deal. So we could actually reduce our working capital requirements for that as well. Cost is the same thing. If you are moving less product and now you've got a nice, tight, focused cluster, you can work on improving productivity through Six Sigma types of programs and lean programs, to continue to improve our overall productivity.

So we see a lot of cost savings to come. We've got our goal of 50 basis points to 100 basis points of operating margin improvement and we see that through this optimization and leverage phase to be there for the next three to five years.

Jim Duffy - Thomas Weisel Partners

And with regards to ramping capacity for the new programs, do you expect any margin hit from that? You mentioned air freight as a potential. Does using third-party contract manufacturing change the cost profile such that it would alter the margin structure, or is that not an issue?

Richard A. Noll

In the short term when you're ramping up capacity, this quickly, obviously it's not going to be the lowest cost capacity in the world. You're going to use things like air freight, outside contractors. There's obviously a penalty versus all internal production. But those are things that while it will add a little bit of pressure onto the gross margin, that little bit of pressure will be swamped by the additional volumes that you have, and the nice is you have the opportunity to internalize that volume and make it lower-cost later. So these are all good problems to have, we love to have them.

And like I said, the organization is actually very excited about ramping up production to service all of this growth and these market share gains that will come in 2010.

Operator

Your next question comes from David Schmookler- Kingsland Financial Services.

David Schmookler- Kingsland Financial Services

If I remember correctly, you pushed through a 4% price increase back in February in the innerwear segment. Are you looking to take any more price in 2010 or was there any discussion around pricing as you negotiated this extra space at the retailers?

Richard A. Noll

No, we have no planned price increases for 2010. Apparel has actually been in a deflationary environment for quite a while, so our ability to get price last year was a testament to our strong brands. So pricing is something that happens in this industry every year.

I do think if you start to see the economy rebound and some more commodity pressure, pricing will once again become part of the apparel equation. But it won't be an every-year thing, it will be an every-few-year type of thing. We're feeling real good about our price increases. It allowed us some extra margin to play with to use to invest in trade spend and I think it was a contributing factor to us getting these share gains this year.

David Schmookler- Kingsland Financial Services

And as you mentioned on the commodities, specifically cotton, you gave the numbers for the first quarter but given the further move up in cotton currently, how should we be thinking about your cotton costs through the middle to the end of 2010 next year?

E. Lee Wyatt, Jr.

Cotton right now has been trading in that $0.60 to $0.65 range and that's the range we've planned for next year. We know the first quarter, but if it's in that range, cotton will not have a significantly negative impact on the P&L next year. A little bit negative but not materially.

David Schmookler- Kingsland Financial Services

On a year-over-year basis you mean?

E. Lee Wyatt, Jr.

Yes, on a year-over-year basis.

David Schmookler- Kingsland Financial Services

To clarify, you mentioned acquisitions, you are looking in the $100.0 million to $200.0 million range. Is that what you're willing to spend or is that the size of the target on a revenue basis you're looking at?

Richard A. Noll

I was talking more in terms of the amount of cash flow you would have available to do an acquisition.

Operator

Your next question is a follow-up from Scott Krasik - C.L. King & Associates.

Scott Krasik - C.L. King & Associates

Lee, just to follow up on that cotton question, there was some speculation that with production planned up next year, you could see the price being driven back down into the $0.50 range. Is that what you're seeing, expecting or—?

E. Lee Wyatt, Jr.

That the cotton would go back down next year?

Scott Krasik - C.L. King & Associates

Right. As you get to the back half of the year, that production will actually be up and the demand will not be considerably up and you could see it back into that mid-$0.50 range.

E. Lee Wyatt, Jr.

We would love that. For us, projecting commodity markets is not something that we try and do. Our philosophy is to dollar cost average and it will be what it will be.

I do think, though, we used to think of the long-term average price for cotton at around $0.55 a pound, but as we've seen the cost of producing cotton in the world has actually gone up over time and so we now think of it more in terms of that low-to-mid-$0.60 range. And it will fluctuate above and below that, but where it ends up for 2010 remains to be seen.

Scott Krasik - C.L. King & Associates

Any material change that the market doesn't move a whole lot from here, do you have any thoughts on pension expense, the delta next year? Will it be favorable?

E. Lee Wyatt, Jr.

The expense is around $20.0 million this year. It should go down a little bit we would think next year, but there will still be an expense. But don't know yet, will not know until the end of the year. But it could go down $5.0 million or something.

Operator

At this time we have reached our allotted time for questions. I will now turn the conference back over to Brian Lantz.

Brian Lantz

We would like to thank everyone for attending our quarterly call today and we look forward to speaking with all of you again soon.

Operator

This concludes today’s conference call.

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Source: Hanesbrands Inc. F3Q09 (Qtr End 10/03/09) Earnings Call Transcript
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