UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

Commission file number: 001-32891

 

Hanesbrands Inc.

(Exact name of registrant as specified in its charter)

 

 

(336) 519-4400

(Registrant’s telephone number including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o     Accelerated filer o     Non-accelerated filer þ

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

As of November 1, 2006, there were 96,306,232 shares of the registrant’s common stock outstanding.

 

 

TABLE OF CONTENTS

 

 

Trademarks, Trade Names and Service Marks

 

We own or have rights to use the trademarks, service marks and trade names that we use in conjunction with the operation of our business. Some of the more important trademarks that we own or have rights to use that appear in this Quarterly Report on Form 10-Q include the Hanes, Champion, C9 by Champion, Playtex, Bali, L’eggs, Just My Size, barely there and Wonderbra marks, which may be registered in the United States and other jurisdictions. Each trademark, trade name or service mark of any other company appearing in this Quarterly Report on Form 10-Q is, to our knowledge, owned by such other company.

 

This Quarterly Report on Form 10-Q and other materials we have filed or will file with the Securities and Exchange Commission, or the “SEC,” contain, or will contain, certain forward-looking statements regarding business strategies, market potential, future financial performance and other matters. Forward-looking statements include all statements that do not relate solely to historical or current facts, and can generally be identified by the use of words such as “may,” “believe,” “will,” “expect,” “project,” “estimate,” “intend,” “anticipate,” “plan,” “continue” or similar expressions. In particular, information included under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains forward-looking statements. Forward-looking statements inherently involve many risks and uncertainties that could cause actual results to differ materially from those projected in these statements.

 

Where, in any forward-looking statement, we express an expectation or belief as to future results or events, such expectation or belief is based on the current plans and expectations of our management and expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. More information on factors that could affect the Company’s financial results is included from time to time in our reports filed with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the fiscal year ended July 1, 2006.

 

These forward-looking statements and such risks, uncertainties and other factors speak only as of the date of this Quarterly Report on Form 10-Q. We expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein to reflect any change in our expectations with regard thereto or any other change in events, conditions or circumstances on which any such statement is based, other than as required by law.

 

We file annual, quarterly and special reports, proxy statements and other information with the SEC. You can inspect, read and copy these reports, proxy statements and other information at the public reference facilities the SEC maintains at 100 F Street, N.E., Washington, D.C. 20549.

 

We make available free of charge at www.hanesbrands.com (in the “Investors” section) copies of materials we file with, or furnish to, the SEC. You can also obtain copies of these materials at prescribed rates by writing to the Public Reference Section of the SEC at 100 F Street, N.E., Washington, D.C. 20549. You can obtain information on the operation of the public reference facilities by calling the SEC at 1-800-SEC-0330. The SEC also maintains a Web site at www.sec.gov that makes available reports, proxy statements and other information regarding issuers that file electronically with it. By referring to our website, www.hanesbrands.com, we do not incorporate our website or its contents into this Quarterly Report on Form 10-Q.

 

HANESBRANDS

 

 

The accompanying notes are an integral part of the Condensed Combined and Consolidated Financial Statements.

HANESBRANDS

(unaudited)

(in thousands, except share and per share amounts)

 

 

 

 

The accompanying notes are an integral part of the Condensed Combined and Consolidated Financial Statements.

HANESBRANDS

(unaudited)

(in thousands)

 

 

The accompanying notes are an integral part of the Condensed Combined and Consolidated Financial Statements.

HANESBRANDS

(unaudited)

(in thousands)

 

 

The accompanying notes are an integral part of the Condensed Combined and Consolidated Financial Statements.

HANESBRANDS

 

Notes to Condensed Combined and Consolidated Financial Statements

(unaudited)

(dollars and shares in thousands, except per share data)

 

(1)  Background and Basis of Presentation

 

These statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) and, in accordance with those rules and regulations, do not include all information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Management believes that the disclosures made are adequate for a fair statement of the Company’s results of operations, financial position and cash flows. In the opinion of management, the condensed combined and consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments necessary to present fairly the results of operations, financial position and cash flows for the interim periods presented herein. The preparation of condensed combined and consolidated financial statements in conformity with GAAP requires management to make use of estimates and assumptions that affect the reported amounts and disclosures. Actual results may vary from these estimates.

 

These condensed combined and consolidated interim financial statements should be read in conjunction with the combined and consolidated financial statements and notes thereto included in the Company’s most recent Annual Report on Form 10-K. The results of operations for any interim period are not necessarily indicative of the results of operations to be expected for the full year.

 

On February 10, 2005, Sara Lee Corporation (“Sara Lee”), announced an overall transformation plan to drive long-term growth and performance, which included spinning off Sara Lee’s apparel business in the Americas and Asia (the “Branded Apparel Americas and Asia Business”). In connection with the spin off, Sara Lee incorporated Hanesbrands Inc., a Maryland corporation (“Hanesbrands” and, together with its consolidated subsidiaries, the “Company”), to which it would transfer the assets and liabilities related to the Branded Apparel Americas and Asia Business. On August 31, 2006, Sara Lee transferred to the Company substantially all the assets and liabilities, at historical cost, comprising the Branded Apparel Americas and Asia Business.

 

On September 5, 2006, as a condition to the distribution to Sara Lee’s stockholders of all of the outstanding shares of the common stock of Hanesbrands, the Company distributed to Sara Lee a cash dividend payment of $1,950,000 and repaid a loan from Sara Lee in the amount of $450,000, and Sara Lee distributed to its stockholders all of the outstanding shares of Hanesbrands’ common stock, with each stockholder receiving one share of Hanesbrands’ common stock for each eight shares of Sara Lee’s common stock that they held as of the August 18, 2006 record date. As a result of such distribution, Sara Lee ceased to own any equity interest in the Company and the Company became an independent, separately traded, publicly held company.

 

The condensed combined and consolidated financial statements reflect the consolidated operations of Hanesbrands Inc. and its subsidiaries as a separate, stand-alone entity subsequent to September 5, 2006, in addition to the historical operations of the Branded Apparel Americas and Asia Business which were operated as part of Sara Lee prior to the spin off. These condensed combined and consolidated financial statements do not include Sara Lee’s European branded apparel operations or its private label business in the U.K. which have historically been operated and managed separately from the Branded Apparel Americas and Asia Business and have been or will be disposed of separately by Sara Lee. Under Sara Lee’s ownership, certain of the Branded Apparel Americas and Asia Business’s operations were divisions of Sara Lee and not separate legal entities, while the Branded Apparel Americas and Asia Business’s foreign operations were subsidiaries of Sara Lee. Because a direct ownership relationship did not exist among the various units comprising the Branded Apparel Americas and Asia Business prior to the spin off on September 5, 2006, Sara Lee’s parent companies’ equity investment is shown in lieu of stockholders’ equity in the condensed combined and consolidated financial statements. Subsequent to the spin off on September 5, 2006, the Company began accumulating its retained earnings and recognized the par value and paid-in-capital in connection with the issuance of approximately 96,306 shares of common stock.

 

HANESBRANDS

 

Notes to Condensed Combined and Consolidated Financial Statements — (Continued)

(unaudited)

(dollars and shares in thousands, except per share data)

Management believes the assumptions underlying the condensed combined and consolidated financial statements for these periods are reasonable. However, the condensed combined and consolidated financial statements included herein for the period through September 5, 2006 do not necessarily reflect the Branded Apparel Americas and Asia Business’s results of operations, financial position and cash flows in the future or what its results of operations, financial position and cash flows would have been had the Branded Apparel Americas and Asia Business been a stand-alone company during the periods presented.

 

(2)  Earnings Per Share

 

Basic earnings per share (“EPS”) was computed by dividing net income by the number of weighted average shares of common stock outstanding during the quarter ended September 30, 2006. Diluted EPS was calculated to give effect to all potentially dilutive shares of common stock. Outstanding stock options and restricted stock units represent the only potentially dilutive effects on the Company’s weighted average shares. There were no shares excluded from the calculation as a result of being anti-dilutive.

 

For the quarter ended September 30, 2006, there were 13 dilutive shares for purposes of computing diluted EPS. For the quarter ended October 1, 2005, basic and diluted EPS were computed using the number of shares of Hanesbrands stock outstanding on September 5, 2006, the date on which Hanesbrands common stock was distributed to stockholders of Sara Lee.

 

(3)  Stock-Based Compensation

 

The employees of the Company participated in the stock-based compensation plans of Sara Lee prior to the Company’s spin off on September 5, 2006. As a result of the spin off and consistent with the terms of the awards under Sara Lee’s plans, the outstanding Sara Lee stock options granted will generally expire six months after the spin off date. In connection with the spin off, vesting for all nonvested service-based Sara Lee RSUs was accelerated to the spin off date resulting in the recognition of $5,447 of additional compensation expense for the quarter ended September 30, 2006. Certain performance-based Sara Lee RSUs remain unvested through the spin off date.

 

The Company established the Hanesbrands Inc. Omnibus Incentive Plan of 2006, the (“Hanesbrands OIP”) to award stock options, stock appreciation rights, restricted stock, restricted stock units, deferred stock units, performance shares and cash to its employees, non-employee directors and employees of its subsidiaries to promote the interests of the Company and incent performance and retention of employees.

 

On September 26, 2006, a number of awards were made to employees and non-employee directors under the Hanesbrands OIP. Two categories of these awards are intended to replace award values that employees would have received under Sara Lee incentive plans before the spin off. Three other categories of these awards were for awards to attract and retain certain employees, including the Company’s 2006 annual awards.

 

Stock Options

 

The exercise price of each stock option equals the market price of Hanesbrands’ stock on the date of grant. Options can generally be exercised over a term of between five and seven years. Options vest ratably over two to three years with the exception of one category of award which vested immediately upon grant. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model using the following weighted average assumptions: weighted average expected volatility of 30%; weighted average expected term of 3.7 years; expected dividend yield of 0%; and risk-free interest rate ranging from 4.52% to 4.59%, with a weighted average of 4.55%.

 

HANESBRANDS

 

Notes to Condensed Combined and Consolidated Financial Statements — (Continued)

(unaudited)

(dollars and shares in thousands, except per share data)

The Company uses the volatility of peer companies for a period of time that is comparable to the expected life of the option to determine volatility assumptions. The Company utilized the simplified method outlined in SEC Staff Accounting Bulletin No. 107 to estimate expected lives for options granted during the period.

 

A summary of the changes in stock options outstanding to the Company’s employees under the Hanesbrands OIP during the quarter ended September 30, 2006 is presented below:

 

 

There were 1,123 options that vested during the quarter ended September 30, 2006. As of September 30, 2006, the Company had unrecognized compensation expense related to stock option awards of $13,320. The weighted average fair value of individual options granted during the quarter ended September 30, 2006 was $6.55.

 

Stock Unit Awards

 

Restricted stock units (RSUs) of Hanesbrands’ stock are granted to certain Company employees and non-employee directors to incent performance and retention over periods ranging from one to three years. Upon the achievement of defined goals, the RSUs are converted into shares of the Company’s common stock on a one-for-one basis and issued to the grantees. All RSUs vest solely upon continued future service to the Company. The cost of these awards is determined using the fair value of the shares on the date of grant, and compensation expense is recognized over the period during which the grantees provide the requisite service to the Company. A summary of the changes in the restricted stock unit awards outstanding under the Hanesbrands OIP during the quarter ended September 30, 2006 is presented below:

 

 

As of September 30, 2006, the Company had unrecognized compensation expense related to stock unit awards of $34,284.

 

HANESBRANDS

 

Notes to Condensed Combined and Consolidated Financial Statements — (Continued)

(unaudited)

(dollars and shares in thousands, except per share data)

For all share-based payments under the Hanesbrands OIP, during the quarter ended September 30, 2006 the Company recognized total compensation expense of $314 and recognized a tax benefit of $122. The Company satisfies the requirement for common shares for share-based payments to employees by issuing newly authorized shares.

 

(4)  Restructuring

 

The reported results for the quarters ended September 30, 2006 and October 1, 2005 reflect amounts that have been recognized for restructuring actions. Reported amounts also include the impact of certain activities that were completed for amounts more favorable than previously estimated. The following is a summary of the expense (income) associated with these actions.

 

 

The following table illustrates where the costs (income) associated with these actions are recognized in the Condensed Combined and Consolidated Statements of Income.

 

 

The following provides a detailed description of the 2007 restructuring actions impacting the reported results for the quarter ended September 30, 2006.

 

2007 Restructuring Actions

 

During the quarter ended September 30, 2006, the Company in connection with its plan to migrate portions of its manufacturing operations to lower-cost locations approved an action to close three of its facilities, consisting of two domestic plants and one international plant. This action is expected to be completed within a 12-month period after being approved. The net impact of these actions was to reduce profit before taxes by $13,706.

 

 

HANESBRANDS

 

Notes to Condensed Combined and Consolidated Financial Statements — (Continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

 

The following table summarizes the charges taken for the restructuring activities approved during the quarter ended September 30, 2006 and the related status as of September 30, 2006. Any accrued amounts remaining as of the end of September 30, 2006 represent those cash expenditures necessary to satisfy remaining obligations, which will be primarily paid in the next year.

 

 

The following table summarizes activity in accrued restructuring for each of the prior periods restructuring actions from July 1, 2006 to September 30, 2006. Any accrued amounts remaining at the end of September 30, 2006 represent those cash expenditures necessary to satisfy remaining obligations, which will be primarily paid in the next two years.

 

 

(5)  Income Taxes

 

For the quarter ended September 30, 2006, income taxes have been computed consistent with the Company’s interim period tax expense according to Accounting Principles Board Opinion No. 28, “Interim Financial Reporting” (APB 28) and Financial Accounting Standards Board Interpretation No. 18, “Accounting for Income Taxes in Interim Periods an Interpretation of APB Opinion No. 28” (FIN 18). For the period July 2, 2006 through the spin off on September 5, 2006, the Company’s operations were included in the consolidated income tax returns of Sara Lee. However, income taxes were calculated and provided for by the Company on a separate return basis for the entire quarter. Since Sara Lee will retain liabilities related to income taxes prior to the spin off on September 5, 2006, such amounts have been reflected in the “Parent companies’ equity investment” line of the Condensed Combined and Consolidated Balance Sheets.

 

As of the spin off on September 5, 2006, the Company recorded certain deferred income taxes on temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and their tax basis. These deferred income taxes were transferred to the Company from Sara Lee through the “Parent companies’ equity investment” line of the Condensed Combined and Consolidated Balance Sheets and were primarily related to pension and other employee benefit liabilities assumed as of September 5, 2006 and the contribution by Sara Lee of an intellectual property subsidiary that holds certain of the Company’s trademarks.

 

HANESBRANDS

 

Notes to Condensed Combined and Consolidated Financial Statements — (Continued)

(unaudited)

(dollars and shares in thousands, except per share data)

The difference in the effective tax rate of 34.0% for the quarter ended September 30, 2006 and the U.S. statutory rate of 35.0% is primarily attributable to foreign earnings taxed at less than the U.S. statutory rate offset by state taxes and nondeductible items.

 

The difference in the effective tax rate of 17.2% for the quarter ended October 1, 2005 and the U.S. statutory rate of 35.0% is primarily attributable to unremitted earnings from foreign subsidiaries taxed at less than U.S. statutory rate and tax incentives for manufacturing in Puerto Rico.

 

(6)  Comprehensive Income

 

SFAS No. 130, Reporting Comprehensive Income, requires that all components of comprehensive income, including net income, be reported in the financial statements in the period in which they are recognized. Comprehensive income is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources. Net income and other comprehensive income, including foreign currency translation adjustments, minimum pension liabilities and unrealized gains and losses on qualifying cash flow hedges, shall be reported, net of their related tax effect, to arrive at comprehensive income. The Company’s comprehensive income is as follows:

 

 

In connection with the spin off on September 5, 2006, the Company assumed obligations relating to the Company’s current and former employees included within Sara Lee sponsored pension and retirement plans, including $53,813 of additional minimum pension liability that has not been reflected in comprehensive income for the quarter ended September 30, 2006.

 

(7)  Inventories

 

Inventories consisted of the following:

 

 

(8)  Defined Benefit Pension Plans

 

Prior to the spin off from Sara Lee on September 5, 2006, employees who met certain eligibility requirements participated in defined benefit pension plans sponsored by Sara Lee. These defined benefit pension plans included employees from a number of domestic Sara Lee business units. All obligations pursuant to these plans have historically been obligations of Sara Lee and as such, were not included on the Company’s historical Condensed Combined and Consolidated Balance Sheets, prior to September 5, 2006. The

 

HANESBRANDS

 

Notes to Condensed Combined and Consolidated Financial Statements — (Continued)

(unaudited)

(dollars and shares in thousands, except per share data)

annual cost of the Sara Lee defined benefit plans was allocated to all of the participating businesses based upon a specific actuarial computation which was followed consistently. In addition to participation in the Sara Lee sponsored plans, the Company sponsors two noncontributory defined benefit plans, the Playtex Apparel, Inc. Pension Plan (the “Playtex Plan”) and the National Textiles LLC Pension Plan (the “National Textiles Plan”), for certain qualifying individuals.

 

In connection with the spin off on September 5, 2006, the Company assumed Sara Lee’s obligations under the Sara Lee Corporation Consolidated Pension and Retirement Plan, the Sara Lee Supplemental Executive Retirement Plan, the Sara Lee Canada Pension Plans and certain other plans that related to the Company’s current and former employees. The obligations and costs related to all of these plans, in addition to those obligations and costs related to the Playtex Plan and the National Textiles Plan, are included in the Company’s Condensed Combined and Consolidated Financial Statements as of September 30, 2006.

 

The pension expense incurred by the Company for these defined benefit plans is as follows:

 

 

 

 

At September 30, 2006, the Company reported a liability of $223,453 in the “Other noncurrent liabilities” line of the Combined and Consolidated Balance Sheet which included the additional minimum liability of $53,813, net of taxes of $34,261. The amount of assets and liabilities assumed from Sara Lee are based on allocations that are subject to final adjustment.

 

Measurement Date and Assumptions

 

Historically, a March 31 measurement date was used to value plan assets and obligations for the Company’s defined benefit pension plans. In connection with the spin off on September 5, 2006, a measurement date of September 5, 2006 was used to value plan assets and obligations reported for the Hanesbrands Inc. Pension and Retirement Plan, the Hanesbrands Inc. Supplemental Employee Retirement Plan and two Canadian defined benefit pension plans. The weighted average actuarial assumptions used in measuring the net periodic benefit cost and plan obligations for these plans at the measurement date were as follows: discount rate for net periodic benefit cost of 5.89%; a long-term rate of return on plan assets of 7.59%; a rate of compensation increase of 3.90%; and a discount rate for plan obligations of 5.89%.

 

(9)  Postretirement Healthcare and Life Insurance Plans

 

Prior to the spin off from Sara Lee on September 5, 2006, employees who met certain eligibility requirements participated in post-retirement healthcare and life insurance sponsored by Sara Lee. These plans included employees from a number of domestic Sara Lee business units. All obligations pursuant to these plans have historically been obligations of Sara Lee and as such, were not included on the Company’s historical Condensed Combined and Consolidated Balance Sheets, prior to September 5, 2006. The annual cost

 

HANESBRANDS

 

Notes to Condensed Combined and Consolidated Financial Statements — (Continued)

(unaudited)

(dollars and shares in thousands, except per share data)

of the Sara Lee defined benefit plans was allocated to all of the participating businesses based upon a specific actuarial computation which was followed consistently.

 

In connection with the spin off on September 5, 2006, the Company assumed Sara Lee’s obligations under the Sara Lee postretirement plans. The obligations and costs related to all of these plans are included in the Company’s Condensed Combined and Consolidated Financial Statements as of September 30, 2006.

 

The postretirement plan expense incurred by the Company for these postretirement plans is as follows:

 

 

 

 

At September 30, 2006 the Company reported a liability of $74,111 in the “Other noncurrent liabilities” line of the Condensed Combined and Consolidated Balance Sheet.

 

Measurement Date and Assumptions

 

Historically, a March 31 measurement date was used to value plan assets and obligations for the Company’s defined benefit pension plans. In connection with the spin off on September 5, 2006, a measurement date of September 5, 2006 was used to value plan assets and obligations reported for the postretirement healthcare and life insurance plans. The weighted average actuarial assumptions used in measuring the net periodic benefit cost and plan obligations for these plans at the measurement date were as follows: discount rate of 5.82% for plan obligations and net periodic benefit cost; and long term rate of return on plan assets of 3.70%.

 

(10)  Long-Term Debt

 

In connection with the spin off on September 5, 2006, the Company entered into a $2,150,000 senior secured credit facility (the “Senior Secured Credit Facility”), a $450,000 senior secured second lien credit facility (the “Second Lien Credit Facility”) and a $500,000 bridge loan facility (the “Bridge Loan Facility”). The outstanding balances at September 30, 2006 are reported in the “Current portion of long-term debt” and “Long-term debt” lines of the Condensed Combined and Consolidated Balance Sheet. The following paragraphs describe these facilities.

 

Senior Secured Credit Facility

 

The Senior Secured Credit Facility provides for aggregate borrowings of $2,150,000, consisting of: (i) a $250,000 Term A loan facility (the “Term A Loan Facility”); (ii) a $1,400,000 Term B loan facility (the “Term B Loan Facility”); and (iii) a $500,000 revolving loan facility (the “Revolving Loan Facility”). The Senior Secured Credit Facility is guaranteed by substantially all of Hanesbrands’ U.S. subsidiaries and is secured by equity interests in substantially all of Hanesbrands’ direct and indirect U.S subsidiaries and 65% of the voting securities of certain foreign subsidiaries and substantially all present and future assets of

 

HANESBRANDS

 

Notes to Condensed Combined and Consolidated Financial Statements — (Continued)

(unaudited)

(dollars and shares in thousands, except per share data)

Hanesbrands and the guarantors. At the Company’s option, borrowings under the Senior Secured Credit Facility may be maintained from time to time as (a) Base Rate loans, which shall bear interest at the higher of (i) 1/2 of 1% in excess of the federal funds rate and (ii) the rate published in the Wall Street Journal as the “prime rate” (or equivalent), in each case in effect from time to time, plus the applicable margin in effect from time to time (which is currently 0.75% for the Term A Loan Facility and the Revolving Loan Facility and 1.25% for the Term B Loan Facility), or (b) LIBOR based loans, which shall bear interest at the LIBO Rate (as defined in the Senior Secured Credit Facility and adjusted for maximum reserves), as determined by the administrative agent for the respective interest period plus the applicable margin in effect from time to time (which is currently 1.75% for the Term A Loan Facility and the Revolving Loan Facility and 2.25% for the Term B Loan Facility). The final maturity of the Term A Loan Facility is September 5, 2012. The Term A Loan Facility amortizes in an amount per annum equal to the following: year 1 — 5.00%; year 2 — 10.00%; year 3 — 15.00%; year 4 — 20.00%; year 5 — 25.00%; year 6 — 25.00%. The final maturity of the Term B Loan Facility is September 5, 2013. The Term B Loan Facility is payable in equal quarterly installments in an amount equal to 1% per annum, with the balance due on the maturity date. The final maturity of the Revolving Loan Facility is September 5, 2011. As of September 30, 2006, the Company had $0 outstanding under the Revolving Loan Facility and approximately $460,000 of borrowing availability. At September 30, 2006, the interest rates on the Term A Loan Facility and the Term B Loan Facility were 7.13% and 7.63% respectively.

 

The Senior Secured Credit Facility requires the Company to comply with customary affirmative and negative covenants and, commencing with the first fiscal quarter ending after December 15, 2006, financial covenants, and includes customary events of default.

 

Second Lien Credit Facility

 

The Second Lien Credit Facility provides for aggregate borrowings of $450,000 by Hanesbrands’ wholly-owned subsidiary, HBI Branded Apparel Limited, Inc. The Second Lien Credit Facility is unconditionally guaranteed by Hanesbrands and each entity guaranteeing the Senior Secured Credit Facility. The Second Lien Credit Facility and the guarantees in respect thereof are secured on a second-priority basis (subordinate only to the Senior Secured Credit Facility and any permitted additions thereto or refinancings thereof) by substantially all of the assets that secure the Senior Secured Credit Facility. Loans under the Second Lien Credit Facility bear interest in the same manner as those under the Senior Secured Credit Facility, subject to a margin of 2.75% for Base Rate loans and 3.75% for LIBOR based loans. The Second Lien Credit Facility matures on March 5, 2014 and includes a penalty for prepayment of the loan prior to September 5, 2009. The Second Lien Credit Facility will not amortize and will be repaid in full on its maturity date. At September 30, 2006 the interest rate on the Second Lien Credit Facility was 9.13%. The Second Lien Credit Facility requires the Company to comply with customary affirmative and negative covenants and, commencing with the first fiscal quarter ending after December 15, 2006, financial covenants, and includes customary events of default.

 

Bridge Loan Facility

 

The Bridge Loan Facility provides for a borrowing of $500,000 and is unconditionally guaranteed by each entity guaranteeing the Senior Secured Credit Facility. The Bridge Loan Facility is unsecured and matures on September 5, 2007. Interest under the Bridge Loan Facility shall be paid at a rate of 9.6475%, increasing by .50% per annum on the third, sixth and ninth month anniversaries of September 5, 2006, not to exceed 11.50% per annum. At September 30, 2006, the interest rate on the Bridge Loan Facility was 9.65%. The Bridge Loan Facility requires the Company to comply with customary affirmative and negative covenants, and commencing with the first fiscal quarter ending after December 15, 2006, financial covenants, and includes customary events of default.

 

HANESBRANDS

 

Notes to Condensed Combined and Consolidated Financial Statements — (Continued)

(unaudited)

(dollars and shares in thousands, except per share data)

Other Financing Agreements

 

On January 27, 2006, the Company entered into a RMB 30 million short-term revolving facility arrangement with a Chinese branch of a U.S. bank that was increased in July 2006 to RMB 50 million ($6,350) Borrowings under the facility accrue interest at the prevailing base lending rates published by the People’s Bank of China less 10%. As of September 30, 2006, the Company had $4,751 outstanding under the short-term revolving facility and $1,600 of borrowing availability. At September 30, 2006, the interest rate on this facility was 4.69%. The Company was in compliance with the covenants contained in this facility at September 30, 2006.

 

Future principal payments for all of the facilities described above are as follows: $24,626 due in the next nine months, $35,875 due in 10 to 22 months, $48,375 due in 23 to 35 months, $60,875 due in 36 to 48 months, $73,375 due in 49 to 61 months and $2,361,625 thereafter.

 

(11)  Business Segment Information

 

During the quarter ended September 30, 2006, the Company changed its internal organizational structure such that operations are managed and reported in five operating segments, each of which is a reportable segment: Innerwear, Outerwear, Hosiery, International and Other. These segments are organized principally by product category and geographic location. Management of each segment is responsible for the assets and operations of these businesses.

 

The types of products and services from which each reportable segment derives its revenues are as follows:

 

 

The accounting policies of the segments are consistent with those described in note 3 to the Company’s combined and consolidated financial statements included in the its Annual Report on Form 10-K for the fiscal year ended July 1, 2006. Beginning in the quarter ended September 30, 2006, the Company began evaluating the operating performance of its segments based upon segment operating profit, which is defined as operating profit before general corporate expenses, amortization of trademarks and other identifiable intangibles and restructuring and related accelerated depreciation charges. Previously, the Company evaluated segment operating performance based upon segment operating profit which included restructuring and related charges. Additionally, as of September 30, 2006, the Company no longer allocates goodwill and trademarks and other identifiable intangible assets to its operating segments for the purposes of evaluating operating performance.

 

HANESBRANDS

 

Notes to Condensed Combined and Consolidated Financial Statements — (Continued)

(unaudited)

(dollars and shares in thousands, except per share data)

Prior year segment results have been restated to conform to the new measurements of segment financial performance.

 

 

 

HANESBRANDS

 

Notes to Condensed Combined and Consolidated Financial Statements — (Continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

 

 

 

 

HANESBRANDS

 

Notes to Condensed Combined and Consolidated Financial Statements — (Continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

 

(12)  Relationship with Sara Lee and Related Entities

 

Effective upon the completion of the spin off, Sara Lee ceased to be a related party to the Company. The Company paid a dividend to Sara Lee of $1,950,000 and repaid a loan in the amount of $450,000 which is reflected in the Condensed Combined and Consolidated Statement of Stockholders’ or Parent Companies’ Equity. An additional payment of approximately $26,306 will be paid to Sara Lee in order to satisfy all outstanding payables from the Company to Sara Lee and Sara Lee subsidiaries. The $26,306 is outstanding as of September 30, 2006 and is reported in the “Due to Sara Lee Corporation” line of the Condensed Combined and Consolidated Balance Sheet.

 

Historically, the Company participated in a number of Sara Lee administered programs such as cash funding systems, insurance programs, employee benefit programs and workers’ compensation programs. In connection with the spin off from Sara Lee, the Company assumed $299,000 in unfunded employee benefit liabilities for pension, postretirement and other retirement benefit qualified and nonqualified plans, and $37,554 of liabilities in connection with property insurance, workers’ compensation, and other programs. These amounts are reflected in the “Accrued liabilities and other” and “Other noncurrent liabilities” lines of the Condensed Combined and Consolidated Balance Sheet.

 

Included in the historical information are costs of certain services such as business insurance, medical insurance, and employee benefit plans and allocations for certain centralized administration costs for treasury, real estate, accounting, auditing, tax, risk management, human resources and benefits administration. Centralized administration costs were allocated to the Company based upon a proportional cost allocation method. These allocated costs are included in the “Selling, general and administrative expenses” line of the Combined and Consolidated Statement of Income and the “Parent companies’ equity investment” line of the Condensed Combined and Consolidated Balance Sheet. For the quarters ended September 30, 2006 and October 1, 2005, the total amount allocated for centralized administration costs by Sara Lee was $0 and $8,100. For the quarter ended September 30, 2006, there were no costs allocated as the Company’s infrastructure was in place and did not significantly benefit from these services from Sara Lee.

 

In connection with the spin off, the Company entered into the following agreements with Sara Lee:

 

 

HANESBRANDS

 

Notes to Condensed Combined and Consolidated Financial Statements — (Continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

 

(13)  Issued But Not Yet Effective Accounting Standards

 

Accounting for Uncertainty in Income Taxes

 

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes: An Interpretation of FASB Statement No. 109 (“FIN No. 48”). This interpretation clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109. FIN No. 48 prescribes a recognition threshold and measurement principles for the financial statement recognition and measurement of tax positions taken or expected to be taken on a tax return. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company is currently assessing the impact the adoption of FIN No. 48 will have on its results of operations and financial position.

 

Fair Value Measurements

 

The FASB has issued FAS 157, Fair Value Measurements (“SFAS 157”), which provides guidance for using fair value to measure assets and liabilities. The standard also responds to investors’ requests for more

 

HANESBRANDS

 

Notes to Condensed Combined and Consolidated Financial Statements — (Continued)

(unaudited)

(dollars and shares in thousands, except per share data)

information about (1) the extent to which companies measure assets and liabilities at fair value, (2) the information used to measure fair value, and (3) the effect that fair-value measurements have on earnings. SFAS 157 will apply whenever another standard requires (or permits) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value to any new circumstances. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the impact, if any, of SFAS 157 on its results of operations and financial position.

 

Pension and Other Postretirement Benefits

 

In September 2006, the FASB issued SFAS No. 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans (an amendment of FASB Statements No. 87, 88, 106, and 132R) (“SFAS 158”). SFAS 158 requires an employer to recognize in its statement of financial position an asset for a plan’s over funded status or a liability for a plan’s under funded status, measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year (with limited exceptions), and recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. Those changes will be reported in comprehensive income and as a separate component of stockholders’ equity. The requirement to recognize the funded status of a benefit plan and the disclosure requirements are effective as of the end of the fiscal year ending after December 15, 2006. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end is effective for fiscal years ending after December 15, 2008. The Company is evaluating the impact of SFAS 158 on its results of operations and financial condition.

 

(14)  Subsequent Events

 

On October 26, 2006, the Company’s Board of Directors voted unanimously to change the fiscal year end of the Company from the Saturday closest to June 30 to the Saturday closest to December 31. The transition period that will result from this change will be from July 2, 2006 until December 30, 2006.

 

This management’s discussion and analysis of financial condition and results of operations, or MD&A, contains forward-looking statements that involve risks and uncertainties. Please see “Forward-Looking Statements” for a discussion of the uncertainties, risks and assumptions associated with these statements. This discussion should be read in conjunction with our historical financial statements and related notes thereto and the other disclosures contained elsewhere in this Quarterly Report on Form 10-Q. The unaudited condensed combined and consolidated financial statements and notes included herein should be read in conjunction with our audited combined and consolidated financial statements and notes for the fiscal year ended July 1, 2006, which were included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission. The results of operations for the periods reflected herein are not necessarily indicative of results that may be expected for future periods, and our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those included elsewhere in this Quarterly Report on Form 10-Q and those included in our Annual Report on Form 10-K.

 

Overview

 

We are a consumer goods company with a portfolio of leading apparel brands, including Hanes, Champion, Playtex, Bali, Just My Size, barely there and Wonderbra. We design, manufacture, source and sell a broad range of apparel essentials such as t-shirts, bras, panties, men’s underwear, kids’ underwear, socks, hosiery, casualwear and activewear. Our brands hold either the number one or number two U.S. market position by sales in most product categories in which we compete.

 

During the quarter ended September 30, 2006, we changed our internal organizational structure such that operations are managed and reported in five operating segments, each of which is a reportable segment: innerwear, outerwear, hosiery, international and other. These segments are organized principally by product category and geographic location. Management of each segment is responsible for the assets and operations of these businesses. Beginning in the quarter ended September 30, 2006, we began evaluating the operating performance of our segments based upon segment operating profit, which is defined as operating profit before general corporate expenses, amortization of trademarks and other identifiable intangibles and restructuring and related accelerated depreciation charges. Previously, we evaluated segment operating performance based upon segment operating profit which included restructuring and related charges.

 

 

 

Spin off from Sara Lee Corporation

 

On September 5, 2006, we were spun off from Sara Lee in a pro rata dividend of all of our outstanding common stock to Sara Lee stockholders. Prior to completing the spin off, Sara Lee received a private letter ruling from the Internal Revenue Service to the effect that the spin off will qualify as a tax-free distribution under Section 355 and a tax-free reorganization under Section 368(a)(1)(D) of the Internal Revenue Code. As a condition to the spin off, on September 5, 2006 we distributed to Sara Lee a cash dividend payment of $1.95 billion and repaid a loan from Sara Lee in the amount of $450 million. As a result of the spin off, Sara Lee ceased to own any equity interest in our company and we became an independent, separately traded, publicly held company. In this Quarterly Report on Form 10-Q, we describe the businesses contributed to us by Sara Lee in the spin off as if the contributed businesses were our business for all historical periods described. References in this Quarterly Report on Form 10-Q to our historical assets, liabilities, products, businesses or activities of our business are generally intended to refer to the historical assets, liabilities, products, businesses or activities of the contributed businesses as the businesses were conducted as part of Sara Lee and its subsidiaries prior to the spin off.

 

Highlights from the Quarter Ended September 30, 2006

 

 

 

 

 

Condensed Combined and Consolidated Results of Operations — Quarter Ended September 30, 2006 Compared with Quarter ended October 1, 2005

 

 

Net Sales

 

 

Net sales declined primarily due to the $13 million impact from the discontinuation of low-margin product lines in the outerwear segment and an $11 million decline in sheer hosiery sales. Additionally, the acquisition of National Textiles LLC in September 2005 caused a $16 million decline as sales to this business were included in net sales in periods prior to the acquisition. Partially offsetting this decline were increased sales of $23 million in activewear. Consistent with the sustained decline in the hosiery industry, we expect the trend of declining hosiery sales to continue as a result of shifts in consumer preferences.

 

Cost of Sales

 

Cost of sales declined year over year as a result of the decline in net sales, manufacturing cost saving initiatives and a favorable impact from shifting certain production to lower cost locations. These changes are partially offset by higher cotton costs, an unfavorable shift in product mix and accelerated depreciation as a result of our announced plans to close two facilities in the United States and one in Mexico.

 

Gross Profit

 

 

As a percent of net sales, gross profit percentage increased from 32.5% for the quarter ended October 1, 2005 to 32.7% for the quarter ended September 30, 2006. The increase in gross profit percentage was due to manufacturing cost saving initiatives of $20 million and a $6 million favorable impact from shifting certain production to lower cost locations. These changes were partially offset by a $10 million impact from an unfavorable shift in product mix, higher cotton costs of $8 million, a $6 million impact from lower manufacturing volume and $4 million in accelerated depreciation as a result of our announced plans to close two facilities in the United States and one in Mexico.

 

Selling, General and Administrative Expenses

 

 

SG&A expenses declined due to a $5 million benefit from prior year restructuring actions, a $4 million reduction in pension and post-retirement expense, a $3 million decrease in ongoing share-based compensation expense, a $4 million decrease in media, advertising and promotion costs and an $8 million decrease in corporate allocations associated with Sara Lee ownership. These decreases were partially offset by $20 million in higher costs primarily associated with charges incurred related to the spin off and related costs and costs associated with being an independent company.

 

Restructuring

 

 

During the quarter ended September 30, 2006, we approved an action to close two domestic facilities and one international facility. This action resulted in a charge of $9 million, representing costs associated with the planned termination of 2,275 employees for employee termination and other benefits in accordance with benefit plans previously communicated to the affected employee group. In connection with the restructuring action, a charge of $4 million for accelerated depreciation of buildings and equipment is reflected in the “Cost of sales” line of the Condensed Combined and Consolidated Statement of Income.

 

Operating Profit

 

 

Operating profit for the quarter ended September 30, 2006 decreased as compared to the quarter ended October 1, 2005 primarily as a result of expenses associated with operating as an independent company, nonrecurring spin off and related costs and restructuring and related charges for facility closures. These

changes were partially offset by manufacturing cost savings initiatives and benefits from prior year restructuring actions.

 

Interest Expense, net

 

 

In connection with the spin off, we incurred $2.6 billion of debt pursuant to a new senior secured credit facility, a new senior secured second lien credit facility and a bridge loan facility, $2.4 billion of the proceeds of which was paid to Sara Lee. As a result, our net interest expense in the quarter ended September 30, 2006 was substantially higher than in the comparable period in fiscal 2005.

 

Income Tax Expense

 

 

Our effective income tax rate increased from 17.2% for the quarter ended October 1, 2005 to 34.0% for the quarter ended September 30, 2006. The increase in our effective tax rate as an independent company is attributable primarily to the expiration of tax incentives for manufacturing in Puerto Rico, which were repealed effective in fiscal 2007, lower unremitted earnings from foreign subsidiaries in the quarter ended September 30, 2006 taxed at rates less than the U.S. statutory rate, state taxes and non-deductible items related to the spin off.

 

Net Income

 

 

Net income for the quarter ended September 30, 2006 was lower than for the quarter ended October 1, 2005 as a result of the items discussed above.

Operating Results by Business Segment — Quarter Ended September 30, 2006 Compared with Quarter ended October 1, 2005