漢佰 (HBI) 2010 Q3 法說會逐字稿

Good afternoon. My name is Felicia and I will be your conference operator today. At this time, I'd like to welcome everyone to the Hanesbrands third quarter 2010 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. (Operator Instructions) Thank you. I would now like to turn the conference over to Mr. Brian Lantz, Vice President of Investor Relations. Mr. Lantz, please begin.

Good afternoon everyone, and welcome to the Hanesbrands Inc. quarterly investor conference call and webcast. We are pleased to be here today to provide an update on our progress after the third quarter of 2010. Hopefully, everyone has had a chance to review the news release we issued earlier today. The news release and the audio replay of the webcast of this call can be found in the investors 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, such as our most recent forms 10K and 10Q, as well 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. With me on the call today are Rich Noll, our Chairman and Chief Executive Officer and Lee Wyatt, our Chief Financial Officer.. Following our prepared remarks, we have allowed ample time to address any questions that you may have. Rich?

Thanks, Brian. We had a very good quarter. Sales increased 11% with the growth rate accelerating for the third consecutive quarter. Men's underwear and the outerwear segment deserve special mention, both growing close to 20%.

Our brands are performing well with consumers, and delivering results for our retailers, all leading to strong gains in share. And we are well positioned to capitalize on this momentum next year. With both the third quarter and the rest of the year unfolding as expected, I will focus my comments on the Gear for Sports acquisition and our early thoughts on 2011. We are very excited to have Gear for Sports join the Hanesbrands family. As we have begun working more closely with the Gear management team, we have confirmed our thoughts around previously announced synergies and collectively believe there is even more long-term potential than we originally thought. Together, we have tremendous opportunities to drive growth and take additional market share. We expect the transaction to close on November 1st, and with that timing, Gear should add approximately $30 million of sales in the fourth quarter and incrementally add another $200 million next year.

Turning to next year, 2011 has the potential to be another year of strong sales and EPS growth. While we're not providing guidance today, I will make a few comments on 2011 revenue growth, pricing and input costs. In terms of revenue trends, at this point we see the potential to have another year of high single-digit to double- digit sales growth.

Let me highlight a few of the pieces. First, we see the macro consumer environment as having a neutral impact on our top line. Consumers are still appointment shopping, meaning they're spending at key selling periods like back-to-school, but are pulling back in the in-between periods. We expect more of the same next year. Second, our new programs are working for both our retail partners and for us. This strength continues to lead to additional space gains.

We will see sales increases from both a wraparound of the new programs placed in late 2010, as well as incremental space gains from new 2011 programs. While we do have to overlap 2010 fixture filled shipments, the net gains could still add a couple of points of volume growth. Third, from a pricing perspective, we have instituted price increases effective no later than February 1st to offset input cost inflation that we ire seeing. Our retail partners are seeing that these input costs are increasing elsewhere in their apparel businesses and understand that the need is real. So while conversations involving price increases are never easy, there is acceptance. With these increases, we should see $150 million of revenue growth and do not anticipate any substantial negative buying impact. So when you add up all of these revenue trends, combined with the Gear acquisition, we could see another year of high single-digit to double-digit sales growth.

Turning to cost, we are seeing cost increasing at an accelerated rate across a broad set of inputs including cotton, wages and most other commodities and raw materials. The magnitude of these increases for the entire apparel industry is substantial. To successfully navigate such a volatile cost environment, we need to have the visibility to see what's coming at us, to keep our brand strong and to match the timing of price increases to cost increases.

In terms of visibility, our global vertically integrated supply chain gives us an advantage in seeing the substantial input cost inflation working its way through the industry supply chains. This visibility allows us to see trends very early and to prepare well in advance. It has allowed us to lock in many of our costs earlier than this time last year. With all of our costs being solidified for the first half and with cotton, even a little further out.

This first traunch of input cost increases, covered by our announced price increases, annualizes at approximately $150 million. However, input costs have continued to escalate with cotton going from the low 80s to over $1.30 per pound with basis, more than a 50% increase just since this summer. Polyester is projected to rise 20% or more. And worldwide wage pressures are also mounting. So we could see even more input costs inflation into late 2011 and early 2012. Therefore, we have formally notified retailers that if input costs stay anywhere near their current levels, we will implement another pricing action, which could take effect midyear.

Our goal is clear, to utilize price to offset input cost increases and not dilute operating margins. With our unique visibility and our strong brands and share positions, we believe we can navigate this environment successfully and achieve this goal.

From a profit perspective, we are still developing our 2011 plans. So it's too early to provide specific details. However, even in this challenging cost environment, our intent remains to achieve our long-term EPS growth goal at the upper end of our 10% to 20% range.

So to close, this year is continuing to unfold as expected and I feel great about our performance. We are gaining market share, our sales momentum is accelerating in the second half and 2011 has the potential to be another year of strong growth. Lee?

Thanks, Rich. All the great momentum for 2011 that Rich spoke about is built on the strong results we are reporting today. We had a very good quarter, with now three consecutive quarters of strong top and bottom line growth. Importantly, the year is unfolding as expected and we are building momentum for 2011. To highlight the third quarter results, EPS was $0.63, $0.20 above last year, driven by sales and operating margin improvement.

Sales, which drove about half of the EPS growth were $1.17 billion, up $115 million, or 11% compared to last year. Approximately seven points of the increase was due to space gains, with the remainder due to increase retail sale through and inventory build and a small benefit from foreign exchange rates.

Turning to segment sales, our three largest segments were up double digits compared to last year. Inner wear sales increased 10%, driven by improvements in most product categories. For example, male underwear and women's panties grew solid double digits and bras grew mid single digits.

From a retail perspective, we should note that men's underwear market share grew more than six points in the rolling three months through August.

Outerwear sales grew 19% in the third quarter, with all the categories delivering strong double-digit gains. Our international business segment increased sales 13%, 10% on a constant currency basis. Overall, we're delivering strong results due to our new programs at retail and continued share gains. And as Rich mentioned, our top line performance is accelerating in the second half of 2010.

Total company operating margin for the third quarter was 9.7%, despite significantly higher cotton and service costs.

Cotton costs for the third quarter were $0.72 per pound, a $14 million negative impact. Cotton costs for the full year of 2010 should average $0.69, compared to $0.55 in 2009, up $33 million. The fourth quarter should reflect $0.79 per pound, a $26 million negative impact.

Turning briefly to 2011 input costs, the bulk of our costs are now fixed for the first six months and we're gaining visibility for the full year. More specifically, for cotton, the first and second quarter should reflect costs of $0.83 per pound. Because of our visibility to higher cotton trends we've also locked in the third quarter, which is one quarter further out than we would typically be at this time of the year. So cotton costs for the third quarter should average $0.88, with the month of September at $1 per pound. We'll lock in 2011 fourth quarter cotton costs this winter.

Turning to the balance sheet, as I mentioned last quarter, one result of the increased sales growth is our need for additional working capital. We should end the year with slightly over $1.2 billionin inventory, which includes higher units related to our sales growth in both 2010 and 2011, the impact of higher input cost and Gear for Sports.

With the higher inventory and receivables due to our strong growth, free cash flow looks like it could come in around $150 million for the year.

The October 2nd balance sheet reflects $2 billion in long-term debt and with the current favorable debt markets, we may take steps to lock in an even more favorable structure with a higher mix of fixed rate debt.

As we fold in Gear for Sports acquisition, our leverage ratio on a pro-forma basis should decline to around 3.7 times at year end. And our leverage ratio should continue to decline as we grow EBITDA.

Turning to 2010 guidance, we're projecting full year sales to be approximately $4.3 billion, an increase of 10%. This is the result of strong first half sales and accelerating sales in the second half.

We are also updating our EPS guidance to $2.27 to $2.32, representing growth approaching 40% versus prior year when including prior year's restructuring charges. In summary, the third quarter was another strong quarter for sales and EPS and our sales growth is accelerating in the second half. We continue to leverage the growth platform of strong brands and low cost global supply chain and we're now focused on carrying this momentum through 2011. I'll now turn the call back to Brian.

Thanks, Lee. That concludes the recap of our performance for the third quarter. Now we will begin taking your questions and we'll continue as time allows. Since there may be a number of you that would like to ask a question, I'll ask that you limit your initial questions to a couple and then re-enter the queue to ask additional questions. I would now turn the call back over to the operator to begin the question and answer session. Operator?

(Operator Instructions). Your first question comes from the line of Eric Tracy with FBR Capital Markets.

Good afternoon, guys.

Hey, Eric, how are you doing?

All right. First, nice quarter. Rich, if I could, just kind of focus on next year. Clearly you guys relative to most, as you mentioned being vertically integrated, seem to have really good visibility to these inflationary pressures and that has an instant buying out into 3Q. But maybe just speak to, again, the overall environment, sort of your discussions with retailers, seemingly with, it looks like, a 4% price increase. They are accepting, but just how you think about that when it goes through to the end consumer. Is there going to be some price resistance and how you think that plays out in FY11?

Okay, so first of all, let me just talk about my opinion on sort of where we are with price and cost in terms of 2011. And then I'll hit on the broad underpinnings of supply and demand, and then price discussions at retail.

So first of all for 2011, I'm very confident with our situation because the bulk of what we need to do is already done. As you've mentioned, we've got our costs locked in for the first half. We've got cotton locked in a little bit longer than that, and we've instituted the price increase that we need. So while we still have a little of exposure in that third and fourth quarter, we've also notified retailers that we may need to take additional price increases so they shouldn't be surprised at it. So I'm very confident in our ability to manage the 2011 environment.

So what's driving all of this? And I think cotton is just one of the things that's going on. We're really seeing a -- these impacts broadly across other commodities. Actually, factory supply and demand's pretty tight right now, and also wage pressure. But let me hit on cotton since it's such a hot topic.

First of all, cotton supply and demand has been in a tough situation for five years. Worldwide and in the U.S. supply has been below demand, leading to 15-year lows of cotton inventories. So fundamentally that's what's happening here. This is not a speculative bubble.

We're also seeing the commodity prices of corn and soybeans and other commodities be relatively high. And, in fact, cotton needs to stay above $1 just so it doesn't lose acreage to some of those other commodities. So I believe that these higher prices for cotton are here to stay for a few years. In fact, historically, it usually takes three or four years for these kind of cycles to begin to reverse themselves.

We're seeing that on other commodities. Synthetics are starting to go up. I think I mentioned polyester has gone up about 20%. So I think we're in for a near term a few years of a sustained inflation in apparel. In fact, the President of ________ Fung has been quoted recently as saying that he sees at least a decade of moderate inflation coming down the pike in the apparel industry. And they're like we are, they've got global supply chains and have visibility around the world.

So what it's going to take to be able to successfully navigate this environment is strong brands, which we have, and that visibility that I believe we have an advantage with our global supply chain. Our retailers now are understanding it. They're seeing these types of increases come from all their suppliers. They, like us, realize that this first round at that 3% to 4% level isn't a huge deal and shouldn't have a big volume impact. But as we start to talk about second price increases later in '11 and '12 it remains to be seen what the magnitude or the impact may be. We'll have better line of sight on that on the fourth quarter call and we'll try and quantify that and give you our thoughts then.

And just a to follow up on that, but it does seem like you're already in those discussions with those retailers about, hey, if these costs stay or continue to rise, you do intend to seek those price increases. Have the responses or the feedback been accepting of those or understanding of those?

Yeah. So, clearly the price increases that we've announced are in. They're locked in. They're done. There's -- it's really just a matter of execution. And, in fact, with some retailers and in some channels, the prices have already begun to change.

What we have done is, when we announced a price increase, we then formally put out a letter to all of our retailers. And in there we talked about how we see the supply demand balances of all these commodities probably being at a sustained level. And then if they do state those levels we'll institute second price increase. So we formally notified them of that. We have not talked about any level of price increase because it's way too early to talk about that. That will take us into probably early January or February before we start having those conversations.

So, those that we have talked to about this type of thing realize that it is a distinct possibility, and they're not just expecting it in our categories. I think they're broadly hearing about that from all of the categories that they source. Remember, lot of major retailers source 70% or 80% of their private label goods around the world, and so they've got pretty good visibility of what's going on out there.

Yes. And then lastly, if I could, just in terms of, obviously, one of your bigger retail partners out there, pretty publicly talking about moving back, changing their apparel strategy back to basics, focusing on working with their key national brand and suppliers. Talk to, I guess, what is sort of embedded with your top line outlook next year, in terms of potential shelf gain and new space gains, perhaps relative to that sort of commentary from that retailer.

Well, normally I wouldn't talk specifically about a retailer, but I think you're referring to Wal-Mart and some of the comments that they made at their most recent analyst day. And I'll just repeat some of those and you're spot on, which is in apparel they've talked about their strategy is to drive national brands and basic apparel categories. And those basic apparel categories are underwear, socks, t-shirts fleece and jeans.

And we sell them four of those five categories. And so we feel good about that overall position. We think it's the right strategy for them and it all works well for us.

In terms of overall space gains, I didn't talk anything specifically by channel or by retailer. I think early on in the beginning of the year, as they start to implement that strategy, I think it's going to be driven more by focusing on driving some -- driving what they've already got versus remixing the space a lot. I think that's going to come a little bit later in 2011. So we don't have really a lot of clear visibility of that yet. But as we do, we'll help people understand how it may impact our top line. Clearly, all of those things should be working in our favor.

Okay. Thanks, guys. Best of luck.

Thanks.

Your next question comes from the line of Omar Saad with Credit Suisse.

Hey, Omar.

Thanks. Good afternoon. I appreciate all of the insight into how to think about next year, but I want to spend some time focusing on the quarter. I was a little surprised by the gross margin number. I think it was down 200, 300 basis points year-over-year, especially given that you're not really selling products at the higher cost cotton prices yet. And then it looks like you made up for it with some tight SG&A controls. I know there's issues in terms of bringing in product from overseas, on air freight. Can you walk through the different dynamics, both on the gross margin line and the SG&A line in the quarter and we should think about them -- those dynamics next quarter and beyond?

Yes. As we look at the operating margin for the quarter, it came in very much as expected. It's what we thought would develop, and it's reflected in our continued guidance, EPS guidance that we've given. But, specifically the gross margin, there are two things that negatively impacted gross margin in the quarter. The first was higher cotton costs because the P&L this year reflects $.72 a pound. Last year it reflected $0.49 a pound. That's about $14 million of negative impact.

There's another $14 million to $15 million negative impact from these higher service costs because of the short lead times, half of which was air freight and there's distribution costs.

We talked on the last call that for the year, that could be $25 million to $30 million on the P&L. And it looks like it's in that $30 million, maybe even higher, maybe $35 million for the year. So we saw $14 to $15 million of that hit in the third quarter, and we'll see an equal amount or so hit in the fourth. So those are the two elements that really drove down the margin.

Now, think about SG&A, we've done just what we said we were going to do. We were going to leverage SG&A as we grew our top line. And that's exactly what happened. Absolute dollars for the quarter were relatively flat with last year, but given the sales growth, it leveraged them nicely. And I think that's part of our strategy over time for this year and the future, and that is to leverage SG&A.

Okay. So that didn't reflect any sort of pullback on marketing spend, or anything like that?

No.

No, absolutely not. We're -- our marketing spend should be in that low 90s type of range that we've talked about before. We were not clearly cutting expenses in SG&A to offset gross margin as declines. As Lee said, things are pretty much unfolding as we expected in terms of our overall plan. So there was no real surprises at all.

Okay. That's helpful. A couple quick questions. Have you guys laid out the percentage price increase that you're talking about for next year, at least in the first half?

Yeah. I talked about it in terms of dollars, which is about $150 million, which offsets the -- right now what we're seeing from an annualized perspective of input costs increases that we've locked in. The percentage varies tremendously. So we've got from lows of 0% increases, for example, hosiery is not being impacted by these things very much, to low single digits. Some categories are mid single digits. And, actually, at the department store level, we've even got some that are high single digits. So the percentage increase varies a lot more than when we raised price in 2008, because that's how the input costs are actually coming in. But overall, it's about $150 million.

Got it. That's helpful. And then lastly, have you guys looked into noncotton fabrics and other fabrics out there, or new technologies, or new fabrics as a replacement given your long term structural view that cotton will stay high?

Yeah. And so the replacements that are out there are really synthetic fibers. And when you look at the -- what's happening to synthetic fibers, you're seeing very similar types of increases. Not quite at the magnitude of cotton. But nylon, which is a synthetic fiber, polyester, acrylic, all of those go into performance fabrics. They're all up already this year mid teens and I think polyester's projected to go up another 20% or 25%. So, for example, polyester costs now are almost about $0.90 a pound. And it would be a pound-for-pound replacement with cotton. And while at today's market, it would make a little bit of sense, it's not like there's this huge shift that you could make that would save you lots and lots of money. And polyester suppliers see what's happening and they're just going to continue to drive price up. So there's no silver bullet out there. You're seeing a broad set of commodity cost increases that are going to work their way through all of the supply chains.

Okay. And your view on the volume impact, I mean did you see a volume impact from price increases in 2009 when you guys raised prices?

You know, at this small level of impact, we didn't see any material volume increase. So if you're raising prices maybe $0.50 a package, we haven't materially seen an industry wide volume fall off by any stretch of the imagination. Now, if we take prices up in 2012 again, we'll have to better try and get our arms around that, and get a good feel for it. But at these levels we don't really expect any material volume impact.

All right. Thanks so much. Good luck.

Thanks.

Your next question comes from the line of Matt McClintock with Barclays Capital.

Hi, good afternoon everyone.

Hey, Matt.

So a couple of questions. First one is Gear for Sports had something like I believe you $225 million through the end of its fiscal year and I believe your projection for next year is $200 million. Can you maybe discuss that a little bit? What's the reason for the shortfall?

Yeah, Matt. Just the way I talked about it. It's an incremental $200 million on top of the $30 million we'll see this year. So it would be $230 million or around. I said approximately next year. So you'll see $30 million show up in this fourth quarter and then incrementally another $200 million or so next year.

Okay, that's very helpful.

So about $230 million.

Okay, that's very helpful and good clarity. The second question is, your expectation for leverage at the end of this year ticked up slightly to 3.7 times from I believe your previous guidance of 3.5 times. Can you maybe talk a little bit about what the drivers are for that? Is that maybe related to the working capital for Gear for Sports, or is there some other reason why that's ticked up?

Yeah. It's not Gear for Sports. That's coming in exactly as we thought. It's a little bit on the increased working capital, to be honest with you. That's probably going to cost us 20 basis points. But we're still down from 4.6 times last year to the 3.7. It's still very positive, and we're right on track to continually reducing it.

Okay. And then the last question, Rich, you provided your initial view for next year, and it seems like this year is tracking pretty much in line with your expectations. Can you maybe frame where you stand right now in your longer term plans, your three-year plan that you outlined at your analyst day? Are you tracking right along with that plan, or are you feeling like that maybe you're surpassing expectations or maybe you're falling a little bit behind?

You know, I feel overall we're tracking overall right on the plan, but in a very different way. That plan did not anticipate $1.30 cotton, that's for sure. It didn't -- actually, I believe firmly that we'd start to see moderate apparel inflation after 15 years of deflation. Boy, have I been surprised. We're going into a very different environment over the next four, five years.

And that's where -- let me just mention what -- I want to frame my comments about EPS goals for next year. And I want to stress that we're not giving guidance. I don't want anybody to walk away and say okay, they've just given guidance for next year of15% to 20% EPS growth.

What I want to assure everybody is that in this very volatile environment, we feel very comfortable about our ability to manage in 2011. We've got a lot of what we need to do locked in to manage at least the first good portion of the year with these volatile prices. And that should not be a stopper for us to hitting our long-term growth goals. Clearly there could be upside from there, there can be downside. We'll try and frame all that on our fourth quarter call and help everybody understand it. But I wanted to assure everybody that we're not going to use this volatile cost environment as an excuse to say, oh, we're not going to be -- our goals are off the table for this year. Now we don't have our plans together yet. I don't know exactly where they're going to come out, but we are firmly focused on achieving those goals year in and year out.

Great. Thank you very much.

Your next question comes from the line of Jim Duffy with Stifel Nicolaus.

Thanks. Hello, everyone.

Hello, Jim.

So Rich, I remember you talking to me about apparel inflation like two years ago. You should be on the investment side of the business. On the cost side, clearly you guys have very good visibility into your own cost increases. Do you have a sense for how this compares to cost increases for competitors or, retailers who are sourcing private label?

Yes. The -- obviously, we're all faced with the input cost increases that are coming down the road. Nobody really has an advantage on cotton in the marketplace. Obviously some people -- we decided to go a little bit longer than normal as we seated these trends. Others may decide to wait. And who knows which bet will, in effect, be better. But we do think we have a big advantage because of our cell phone supply chain.

It's clear that manufacturing capacity on a worldwide basis for apparel is tight. A lot of capacity came out in the 2009 recession and we haven't seen a lot added back in, especially with the capital markets being pretty -- a lot tighter, actually, with debt going to manufacturers. So capacity is clearly tight and suppliers I believe are, or will, begin to take advantage of that. It will be a great time to be a manufacturer of apparel selling to people that do a lot of sourcing on a worldwide basis, because I think you're going to see margins expand.

That's a piece that's going to work its way through the apparel industry for people that predominately source, that won't affect people, such as ourselves , that have our cell phone manufacturing supply chains that are pretty much vertically integrated all the way even through yarn manufacturing. So , I believe, that strategy is going to, actually, pay big dividends for us over the next

Okay, great. Can I -- let's revisit your yarn spinning agreement. So I remember you sold the -- your company owned yarn spinning facilities last year, but you've locked into long-term contracts for capacity. How long is this capacity contractually obligated to you, and what percentage of your supply needs does that take care of?

From a yarn perspective, you're spot on. We entered into a long-term contract where we just pay a conversion cost. So there's no margin that increases that we'll see. So our yarn costs are just like when we were manufacturing our own yarn. That's a six-year agreement. It lasts until 2016. So we're well protected from these fluctuations.

Where as, competitors who buy yarn on the open market, I can tell you tho -- yarn costs have gone up at a faster rate than even cotton costs. So we're in a very good situation from that perspective. That covers the bulk of our yarn needs. We do, actually, purchase some yarn outside of those contracts , but even those we had long-term contracts on a conversion cost basis. All of which we locked into when there was excess capacity in the market in 2009 and early

Do you think this position for branded players to perhaps take market share from private label, is there any sort of precedent in the market that might support that thesis?

Well, the first place I think you're going to see companies struggle in this kind of environment is those that have very weak brands. So national brands are strong, the retailers are going to want them, the consumers are going to want them. And, actually, in a period of rising prices, they want stronger brands rather than weaker brands. Weak brands, the consumer doesn't want them as much. The retailer doesn't have as much reason for them to be. And so those are likely to get their margins squeezed, because while they may be able to get priced, they may not get enough to cover all their input costs.

Private label, it's not clear how it's going to fare in this kind of market. On one hand, I think in some areas where supply is tight, they'll do fine because they'll be able to increase prices. In other areas where there's actually still ample supply by category, they're going to be hard pressed to also pass on the full amount of their cost increases. So that's a little less clear to me how it's going to play out. But I, actually, do think the very weak brands, those second and third tier brands are really going to struggle in this kind of environment, and that's good for us.

And then final question and I'll let someone else jump in. Talk to us about the logistics of a price increase. Is there any expenses associated with this? How do you do the inventory management, the transition from one price to another across your categories?

It varies by channel. And so there's a huge amount of work that goes into this, because the retailers need to change all of the prices in their system for every SKU that they handle. We need to change those prices. It all needs to be coordinated on the exact day that the prices actually change.

So you can imagine the amount of data and information that has to flow. That's why retailers need 60 to 90 days to actually physically implement a price increase.

In mid tier department stores, we actually still sticker a lot of the goods. So physically we have to go through and restricker things. So that generates some cost. Lee, what's the total per price change?

It looks like for this spring change we could spend a couple million dollars, actually, just doing all those kind of things.

Some of which, actually, we'll incur in the fourth quarter.

Exactly.

Okay. That's helpful. Thank you.

Your next question comes from the line of Ken Stumphauzer with Sterne Agee.

Good afternoon, guys. Just a couple quick questions for you. Firstly, just to clarify, you now said that you expect kind of those -- the rushing costs, if you will, to be in excess of $30 million. And how much -- did you quantify how much was going to hit in the fourth quarter?

Yes, it will be a similar amount. What we said is it could be $30 million to $35 million for the year. We had about $5 million in the second quarter. We had about $15 million in the third. So about another, say, $14 million or $15 million in the fourth quarter.

And you still at this point don't anticipate with your revenue outlook for 2011 that you could see replication of these costs?

When we -- as we go through and really understand and put our plans together for '11, we'll come back with details for you. But a good portion of these shouldn't repeat. A portion may, but a good portion should not.

Yes, and just to remind everybody exactly what was driving those costs. Remember, when we came into the year, so at the end of January, we were projecting sales growth in the back half of the year of 4%.

By the time we got into the spring, that forecast was going to 10% and -- 10% to 11% in a very short lead time. And that's what was driving a lot of this because we needed to use air freight. Actually, I think that's over half of the cost. Distribution over time, rework and repacking, which is I think the next quarter of it that was driving a lot of this.

So as we start to normalize and don't have that kind of huge unanticipated upside, you won't see that kind of levels of air freight, and rework and things like that going forward. We still do have some of it, though, spilling into, as we said, early next year.

And it spills next -- into next year because as it gets -- air freight gets capitalized. It takes about five months to come in and hit the P&L. So anything that we spend toward the this year would go into next year.

Okay, and then just a little bit more on gross margin. If you were -- so if you were to take those costs out and you guys didn't necessarily indicate how much oil impacted gross profit dollars in the quarter. But would gross margins have -- would they have been up year -over- year, actually, the commodity and the rushing costs and the quarter, as well as for the fourth quarter?

Yeah. I think all you need to do is we quantified the two pieces. We quantified the cotton at $14 million and then these service related short lead time costs of $15 million. So I think that's 300 basis points, ball park on $1.7 billion of sales. I think it's that simple.

Okay. And then just lastly, as far as coming back to the leverage company, I think it steps down again in the middle of next year to maybe 3.5. Do you guys have any concern that just giving all the moving parts with next year, and, potentially, with integrating Gear for Sports that that might be something you immediate to revisit?

We feel good about where we're going to be. It does step down at the end of the second quarter to level at 3.75, but we feel pretty good about that. And one of the things we're looking at right now is going out into the market, and taking advantage of this frothy, high yield bond market out there. So we might have an opportunity to even fix that farther. We feel good even if it's not changed.

Well, let me just follow up on that very quickly then. When you say that, do you mean through derivative contracts or perhaps going and restructuring the debt again?

Actually, it would be with the high yield bond market. When you look at it right now, the high yield bond market is very strong. Our 8% fixed is trading at 107, 108. So trading very well. So it -- what we're evaluating right now is the opportunity of could we go out, could we get long-term money at a very favorable rate and give us a lot more flexibility and favorability in this structure? So we're evaluating that now. And we'll let you know how that evaluation comes out.

Thanks. Best of luck, guys.

Thanks.

Your next question comes from the line of Eric Beder with Brean Murray.

Good afternoon. Congratulations.

Thanks, Eric.

Two questions. One is, could you talk about the competitive response of the player, especially the men's underwear division, the price increases? Are they pretty much matching your price increases? And secondly, you talked in the beginning about Gear that you're seeing some of the stronger long-term opportunities that as you get more involved in the company. Can you talk about what those you're seeing?

Sure. So, first in the terms of overall prices. Now, we don't have a line of sight to exactly what any of our competitors are doing. However, everybody in the apparel industry is facing these same types of input cost increases.

We have been told by our retailers that a number of our competitors are also increasing price across all of our categories. To exactly what degree, we don't really know. I want to reiterate that when we raised price in 2008, in some cases we had people match exactly, increase but only go half way. And others didn't take price increases at all. And it was all irrelevant in terms of how well we were able to continue to gain share, regardless of what our competitors did from a pricing standpoint.

So we feel really good about our situation and that the competitors are going to do what they're going to do. But, clearly, they've got to deal with these costs.

In terms of Gear, it's, actually, quite simple. They are a great management team. They've got a -- they really understand their channels well. They've got a lot of more share to gain in the college bookstore, as well as the resort and golf channels.

And one of the things that's simply been constraining them is a lack of capacity. So as they plug into our global supply chain, it's going to free up capacity for them to, actually, drive growth at a faster -- even a faster rate than they have been historically. So that's all real good news. And we're feeling really good about that acquisition.

Okay. And actually one other question here. We've talked about China cost increases and you have your largest plant in China, which is where you plan to do most, I gather, of your expansion capacity. Have you rethought maybe expanding some of the other areas out in terms of the cost of other pieces there?

Well, actually, in -- we actually have an Asia cluster which, you're right, it's our largest facility is the textile facility in Nanjing, China . But all of the sewing is located in southeast Asia, Vietnam, Thailand, and so on, which don't feel, at least to the same degree, of China the wage pressure. I do want to stress, however, there's wage pressure worldwide, not just in Asia, but in Central America, and Honduras, and in Dominican Republic and places like that. So this isn't just a China phenomenon.

However, when it comes to China specifically, at most, 1500 to 2,000 of our employees out of 50,000 will be located in the Nanjing plant. So as a percentage of our overall wage cost and employee mix, China is a relatively small part of the overall

Great. Thank you.

Your next question comes from the line of David Blake for the Buckingham Research.

Yes, good afternoon. I just wanted to follow up on some gross margin questions. It looks like you're going to end the year relatively flattish in gross margins in 2010. And then if you think about what you guys have said before about $50 million in supply chain cost savings a year for the next couple years, some of which are gross margins, some SG&A. And you've quantified in the second half of this year about $70 million or so of, to some degree, nonrecurring negative impact to gross margin. It suggests that given the pricing actions you're -- you've taken, and potentially contemplating, that you could see a pretty decent rebound in the gross margin next year, which is probably embedded in some of your preliminary thoughts on 2011. I just wanted to make sure we're thinking about that right and that there is an opportunity, despite the inflationary pressure, that you could see a decent rebound in gross margin next year.

You know, it's still too early to be talking about that right now. Let us finish our plans. Let us gather some more data and understand more pricing and cost over the next quarter and we'll be able to talk about that much more intelligently in the next call. So it's a little early to talk about it.

But the supply chain savings, I assume, are still part of the game plan, this $50 million a year?

Yes. Actually, when you look at this year, embedded in our results, year-to-date we're probably around $30, $35 million of savings. And it's a third in SG&A and two thirds in cost goods. So we're right on track.

Okay great. Thank very much and good luck.

Your next question comes from the line of Scott Krasik with BB&T Capital Markets.

Hey, Scott.

Hi, it's, actually, Kelly calling in for Scott. You guys talked about your goal for about 15% EPS growth next year. I just was wondering what your assumption is in terms of marketing spent for fiscal '11, and also any benefits that you receive from pricing increases on top of what your cost inflation is? Are you compelled to give it back to the retailer in the form of additional brand sport?

I would say the questions you're asking are much more specific than we're prepared to answer on 2011. We don't have our full plans developed at this point. So we don't want to get into the nits and nats. I will say in terms of overall media spend, I have been very clear about this over the years. I believe that our overall advertising to sales ratio that we've been spending is about right. It needs to be a tad higher from where it is. We committed to having good, innovative products in the marketplace and using media to talk to our consumers about them. It's been working. It's driving our top line, helping us grow share. So there's no strategic change in that overall direction. In terms of the specifics that you're talking about, you just need to wait until we get our plans together.

Okay. And just a second question. You have seen Fruit of the Loom come out with their first national TV ad campaign in a long time. Just wondering how you felt about your competitor's position in 2011, specifically with shelf space gain.

So in terms of advertising, you know, Fruit of the Loom does that. It's not their first time in a long time. They do advertise , especially around back-to-school, on fairly periodic basis. But when you look across the entire innerwear categories, our share of voice or our share of advertising spend, swamps our competition. And that's one of the reasons our brands are so strong. So we feel real good about our situation. In terms of the overall shelf space gains that we saw in 2010, we said our programs have been working all year. The retailers like them and that's leading to further shelf -- net space gain. So we feel really good about, not only having that secured, but, actually, continuing to grow from where we are going forward. So we're feeling really good about our situation, our ability to continue to drive the top

Okay, great. Thanks, guys.

Your next question comes from the line of Carla Casella with JP Morgan.

Hi. Can you just talk about on the sourcing side what percentage of your goods are coming from, or are sourced out of China now and what are the other key markets are for China?

Total sourcing of finished good for us is about 30% of our total volume. And a piece of that comes from China, but it generally comes from all over the globe.

And then the other 70% which you manufacture, and that's mostly --or how much of that is China?

It's a very small amount right now. The Nanjing plant is just coming up for that cluster, and we do have four sewing plants, as Rich mentioned, in Southeast Asia. But a small portion, at this point.

Okay. And then when you look at the price increases, you mentioned it's going to vary a little bit by product. Does it vary dramatically by type of retail -- you mentioned department stores are a little bit heavier. But what about mass merchant?

Yeah, what you're really going to see is the major driver of differences in price increase is really the construction of the product. So think of it right now with cotton. The more cotton a product has, or the heavier the product, or the more you're going to have a percentage increase. So, for example, fleece is going to go up more than t-shirts. Similarly, department store products tend to be made of finer yarns and heavier products. Those tend to go up at a faster rate than more basic, oriented products that you might see in mass. So that's the dynamic there.

Okay, great. And I can verify your comments that the high yield market's very strong. We're seeing new deals, multiple deals per day.

Oh, yes.

So good luck.

Well, thanks a lot. And I will also make a comment that you raised a couple of questions about China, and other people have as well. I want to stress that this is not a China phenomena that we're seeing. The input costs are going up around the world. And wage pressure is out there around the world. All over Asia you're seeing high single digits to low double digit wage increases. In Central America you're seeing high single digit wage pressure, and on a much higher base. So the sense -- so you're going to see inflation work not just in China, but also in -- I think in all countries around the world.

Right. Well, we're seeing it all over. Yes, that's why I was asking what the other key markets were.

Yes.

Your next question comes from the line of Emily Shanks With Barclays Capital.

Hi. Good afternoon. I wanted to ask around your comments a few questions ago around potentially entering the high yield market with a bond deal. Would you consider refinancing the term loan, and, or, the floaters, or how are we supposed to think about that?

Well, we're just evaluating right now. So it's a little early to comment. But with the market being, again, so strong it's worth evaluating, and that's what we're doing, but don't have specific plans at this time.

Okay. And then you had also mentioned that the incremental 20 days of points in your fiscal year '10 and leverage target was related to working capital investments. I just wanted to understand how we should think about that through the end of the year. Is it that you'll be building inventory through 4Q '10 end and it's just simply a working capital use, or can you give us a little specifics about that? Because I think you had said you were looking to reduce net working capital by 25 to 50 million bucks a year. That was earlier this year.

Well, yes in the past before we've had this significant sales growth, which requires working capital investment to support, we were generating positive results from working capital. This year we're, actually, increasing working capital. We talked about inventory being a little more than $1.2 billion at the end of the year. So we're, actually, investing some right now. That said, that's keeping our leverage at maybe 3.7 at the end of yearversus 3.5, 3.6. So still very positive. But we need to invest in that working capital to drive these kind of sales growth.

Okay, great. But the inventory turns you're still targeting improvement there or steady state? That's the right way to think about it?

No question over time. We -- in the third quarter our turns were like 2.3 times. Now, over the long-term could we be 2.5 to 3? Yes. Long-term we will improve our turns. Right now it's more important to just service this large sales growth.

Okay, great. And good luck.

Thanks.

Your next question comes from the line of Bill Reuter with Bank of America.

Hey, guys. Almost all my questions have been asked -- answered. I guess just one quick one. Given that you guys have not completed the acquisition, or haven't closed the acquisition of Gear, if there were acquisition targets that came up for sale at this point would you guys, potentially, be involved in those auctions?Or are you kind of on hold with acquisitions right now?

Yes, let us go close this one before we start trying to execute another one. Now, clearly acquisitions are something we're thinking about. We'll always be talking to people and if we do another deal well, obviously, we'd announce it. But our focus is crystal clear. We've got a growing organic business that we need to focus on and invest in. We've got the Gear acquisition to close and then to make sure that they're off and running, and can take full advantage of our supply chain. So we've got our work cut out for us before we take on another set of risks.

Given, I guess, your expectations for integrating Gear, or at least bringing them within your house, when would you guys potentially look at potential acquisitions going forward? Like how long does that, typically, take for you guys to feel comfortable?

We've always talked about acquisitions needing to come out of cash flow. It gives you the amount of -- we've used the Gear acquisition used up, actually, a little bit more of than this year's cash flow. So that's going to take 2011 to unfold to generate more cash. And we'll always be thinking about it. But, at this point, we're not ready to -- we need to take care of the acquisition we've got at hand.

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

There are no further questions at this time. Mr. Lantz, are there any closing remarks?

No, we'd just like to thank everyone for attending our quarterly call, and look forward to talking to all of you very soon.

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