漢佰 (HBI) 2012 Q1 法說會逐字稿

Good afternoon. My name is Mike and I will be your conference operator today. At this time, I would like to welcome everyone to the Hanesbrands first quarter 2012 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be question-and-answer session. (Operator Instructions)

Thank you. Mr. Charlie Stack, Chief Investor Relations Officer, you may begin your conference call.

Good afternoon, everyone, and welcome to the Hanesbrands quarterly investor conference call and webcast. We are pleased to be here today to provide an update on our progress after the first quarter of 2012. 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 on the Investor section of our Hanesbrands.com website.

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

Before we begin, as a result of the reduced size of sheer hosiery and changing trends, Hanesbrands decided in the first quarter of 2012 to change its external segment reporting to include hosiery operations within Innerwear segment. Hosiery had previously been reported as a separate segment. Prior-year segment sales and operating profit results including other minor allocation changes have been revised to conform to the current year presentation.

With me on the call today are Rich Noll, our Chief Executive Officer; Bill Nictakis, one of our two Co-Chief Operating Officers, and Rick Moss, our Chief Financial Officer. For today's call, Rich will highlight a few big picture themes, Bill will provide a sense of what is happening in a few of our businesses and Rick will emphasize some of the financial aspects of our results. I'll now turn the call over to Rich.

Thank you, Charlie.

Well, obviously we are not pleased with the loss in Q1. We are tracking well, relative to our expectations with sales, profits, and cash flow running at or above our plans. When you couple that with the visibility of our pricing and cost for the rest of the year, we feel very good about our momentum and our ability to achieve our full-year guidance.

Let me give you a few specifics. First, our core categories which sustained price increases of more than 20% such as underwear and panties continue to perform well with both retail sell-through and our shipments being at or above our plans. Champion was also very strong with sales increases in the mid-teens. Second, we've made good progress repositioning our US Imagewearr to focus more on branded sectors and de-emphasize the low-end commodity segments and in fact we're a little ahead of that schedule. Third, we executed the majority of our previously announced supply chain actions to adjust capacities and these actions cost us a little less than planned.

So we've got very good visibility for the remainder of the year for both price and costs, as I said. Cotton costs are locked through December and we've confirmed pricing with our retailers for over 95% of our expected US volume. And finally, we're making good progress on de-risking our balance sheet. Our inventories have peaked for the year and as they decline, they will begin to generate substantial cash. We remain firmly committed to using that cash to pay down debt for the rest of 2012 and 2013.

So to sum up, the largest margin impacts of cotton inflation, the supply chain realignment, and the operating losses associated with Imagewear are now behind us. Therefore, as planned, our operating margin for the rest of the year should return to a more normal average of low double digits. I'll now turn the call over to Bill to give you a little more detail. Bill?

Thanks, Rich.

We saw solid performance in our core domestic retail categories in both Innerwear and Outerwear segments during the first quarter. Our consumers and retail partners continue to prefer our leading brands as evidenced by retail sell-through in the first quarter that was at or better than planned and the continued increases in shelf space that we've achieved across our businesses.

Let me touch on a few highlights for the quarter, starting with Innerwear. And first, let me discuss price. The short answer is that the pricing strategies and tactics that we've implemented are meeting or exceeding both our expectations and those of our customers. Price gaps now appear to be moving within our historical ranges and our customers acknowledge and are pleased with the positive impact that category prices have had on their business. We have now finalized the vast majority of pricing and package size changes for the balance of the year with retail pricing confirmed for over 95% of our expected US volume.

Now looking at the specific category performances for the quarter, Innerwear sales were led by men's underwear, women's panties, and hosiery which saw increases of at least mid-single digits. These categories benefited from a combination of factors. In addition to price, we launched several new products that are performing well and we gained shelf space which, while having a positive impact in Q1, will have a more positive impact in the second and third quarters. So overall, our Innerwear business delivered to expectations. We took price to offset cotton, innovation is working, space gains are on track, and we're successfully managing the price environment to our customers' benefit.

Now turning to Outerwear, the core retail portion of this business, excluding Imagewear, performed well with sales up 4% in the quarter. Our Champion brand continues to deliver strong results. It grew solid double digits in the first quarter led by our C9 by Champion line that sold at Target. Our retail casualwear category also showed positive momentum. Several new Hanes programs have performed very well and significantly beat retailers' expectations. These program successes have enabled us to offset most of the loss of Just My Size fashion products, with those losses now behind us. Also, Gear For Sports remains on track to deliver $40 million of operating profit in 2012.

Now, let me provide an update on our US Imagewear business. As communicated on the last earnings call, we intend to focus our resources against those sectors of the channel whose end users value leading brands, great quality, ultimate comfort, and proper fit. This means we'll focus our efforts against unique products such as Champion Activewear, Hanes Beefy-T's, Tagless T's, and EcoSmart, while de-emphasizing the cheap commodity products where brand, comfort, quality, and fit are irrelevant. We've communicated this position to our wholesalers and they now understand how and why we're migrating our business model to be a more value-added branded partner.

As part of the Imagewear plan, we've made significant progress in unwinding our position in the commodity sector. In fact, we're a little ahead of schedule and should have our commodity product inventory appropriately sized by the end of the second quarter, thereby significantly reducing our exposure to further price deterioration in that category. Longer term, we believe that going forward this should be a smaller but more profitable and less volatile category that represents about 4% of our annual sales.

In our International segment, the overall performance mirrored the domestic businesses as it was impacted by the same issues of its Imagewear business in Europe and the cotton inflation that's working its way through the supply chain. In fact, International's operating profit decline was very similar to the overall decline in the total Company. We expect to see its operating margin improve similar to the US beginning next quarter, all of which was built into our guidance. More specifically, regarding our Imagewear category in Europe which is about 12% of our total International business, we're undertaking the same thought process and analysis as we have with the US category. As we fully formulate our plan, we'll apprise both our customers and the investment community on our intentions, no later than our next quarterly conference call.

Shifting to our global supply chain, we're very pleased with our performance. Now that we've settled into our manufacturing footprint and have a more stable environment we're seeing the full benefits of our strategy take hold. Services are at record levels. Quality remains strong. Inventory's being reduced at or ahead of plan and we should again deliver substantial savings. Our supply chain will continue to be a pillar for both near-term success and our longer-term momentum.

So to wrap up, our overall strategy is working as planned. We see a lot of good things and lots of places to give us more confidence in the balance of the year. Product innovation's working. We're gaining space. Our supply chain is delivering cost savings, service, and quality. But, as I reflect upon our first quarter performance, I think the biggest positive is how we and the entire retail community have managed pricing. Up until the dramatic cotton inflation of 15 months ago, the majority of the apparel world was stuck in a cycle of deflation. This is difficult for suppliers and difficult for retailers. As the price of cotton doubled and then tripled, we all had to burst through the traditional apparel pricing paradigm and raise prices and our retailers learned that some level of price increases can work to their advantage. I think this change in perception with regards to price has an ongoing benefit to our retailers as well as to companies such as ours, who have strong brands, quality, and innovation.

I'll now turn the call over to Rick Moss to discuss our financial performance.

Thanks, Bill. Our first quarter financial results unfolded at or a little better than we expected and as a result our outlook for the balance of 2012 hasn't changed. The worst of the margin pressure related to high cotton cost is now behind us, as well as most of the impact of Imagewear. So we continue to expect our margins to improve throughout the year. First, I'd like to review the financial results from the first quarter and then reiterate our guidance for 2012. Finally, I'll talk about our continued focus on de-risking the business.

Sales in the first quarter were $1.008 billion in line with our previous guidance and down 3% versus last year. Our EPS loss of $0.27 was $0.08 better than our previous guidance. Our gross profit margin in the first quarter was expected to be in the mid-20% range and came in at 25.2%, down $100 million or 900 basis points from last year's first quarter. As expected, about half of the gross profit decline came in Outerwear, impacted by the loss in our US Imagewear category and the sales declines in Just My Size. In addition, we recognized $13 million of expenses relating to supply chain adjustments as we discussed on our last call. The balance of the gross profit decline resulted from higher input costs, primarily cotton, net of price increases and cost savings. Our first quarter SG&A dollars decreased $4 million from the prior year, driven primarily by lower distribution costs and lower media spending. Due to the lower sales, the SG&A rate increase slightly year-over-year from 24.4% to 24.6%. Interest expense for the quarter declined $4 million due to lower debt and the tax rate was 15%.

Looking at the balance sheet, we've now passed the peak levels of our inventory and expect to consistently free up working capital over the next 3 quarters as inventory dollars and units continue to decline. Inventory at the end of the quarter totaled $1.6 billion and is tracking favorably to our plan.

Basically, the first quarter unfolded as we expected and therefore there have been no material changes in terms of our financial outlook and today we're reconfirming guidance for the full year. We continue to expect sales growth of 2% to 4% compared to fiscal 2011 and EPS for the year of $2.50 to $2.60. Excluding the impact of Imagewear, we continue to expect sales trends through May to be fairly consistent with the last 3 quarters. But as a result of our new shelf space gains and more normalized price gaps, we expect to see sales growth resume thereafter.

Turning to US Imagewear's impact on the P&L, the first-quarter loss was approximately $0.18 per share and we continue to expect that the loss for the year will be roughly $0.30 with the balance coming in the second quarter. We're making great progress repositioning our overall Imagewear category, however, as we continue to evaluate it, we may incur some non-cash charges not included in our guidance. When we have more information around these items, we will share them at that time.

For the total business, we continue to expect our gross profit margin percentage to improve over the balance of the year. Second quarter gross profit margin should improve to the high 20s, leading to operating profit margins in the mid to high single digits. The back half of the year is still on track to potentially see gross margins return to low 30s with operating margins in the low double digits. For the full year, we continue to expect to see SG&A flat to slightly down. For the year, interest expense should be approximately $15 million lower than 2011, and our tax rate should be in the low double digits for 2012.

We're also reconfirming free cash flow guidance of $400 million to $500 million for the full year reflecting the unwinding of the inflation in working capital, as well as reduced units in inventory. This free cash flow guidance includes pension contributions between $30 million and $35 million and roughly $45 million of capital expenditures. As we continue to focus on de-risking the business, we're on track to pay down the remaining $300 million of floating rate note at the end of 2012 with a goal of prepaying our 8% notes when they become callable in late 2013. In 20 months, this will bring our total outstanding bonds to $1 billion and should substantially reduce interest expense versus historical levels.

Still inherent in our 2012 guidance is an average operating profit margin of approximately 11% for the second through the fourth quarters. For 2013 modeling purposes, a 10% to 11% operating profit run rate is still a good assumption resulting in 2013 EPS potentially in the low $3 range. As Rich mentioned, with the worst behind us, we now good visibility and are focused on reducing debt, de-risking the business, and showing Hanesbrands true earnings power. I'll now turn the call back to Charlie.

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

(Operator Instructions) We'll pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Bob Drbul from Barclay's. Your line is open.

Hi, good afternoon. I have two questions. The first one is, around some of the pricing actions, what you've done so far and you say you're locked for the year, can you just elaborate a little bit in terms of the pricing that you have locked for the rest of the year, in terms of pack sizes or holding price versus price adjustments? Maybe a little color on category. And then the second question is, I think you mentioned some shelf space increases. If you might be able to quantify that a little bit or detail that a little bit more, that would be very helpful. Thanks.

Great. This is Rich. I'll start with some of the high level and I'll turn it over to Bill to give a little bit more specifics. We've always talked about as we've gone through this to make sure that we're adjusting our prices appropriate for the cost environment that we have. We're doing that. We've done it. We've talked about it last call, the call before. As cotton comes down, we're adjusting our prices and all that's inherent in our guidance and as it's happening our margins are expected, as we projected, to increase to the low double-digit levels in the back half of the year. We're doing it through a number of different techniques. Some of the cases were increasing the pack sizes and other cases we're adjusting prices. In other cases, we're sticking exactly where they've been. And Bill, you want to give a little bit more specifics and then talk a little bit about some of the shelf space gains?

Sure. I think it's been interesting. As we go and talk to our customers about price, their biggest concern, frankly, is that we don't muck up their entire category. Their business is doing well. I think we've helped them managed the price to their advantage for the category. And they're concerned that we cause them a comp store issue, a deval issue, a margin issue down the road. So most of the conversations are how do we go and protect the gains that they have had, because they have inflation and wages and benefits that they need to adjust, too. And I think they've seen the benefit of some modest price increases on their overall business. So we're arm-in-arm and that's why we've had the conversations and we're pretty much set for the balance of the year, in terms of where prices and pack sizes and things like that are going to be.

Second part of your question with regards to shelf space, we're gaining space across multiple categories and multiple classes of trade and I think part of the reason is we've had really good productivity on our new products. Our product innovations have worked extremely well for our customers. I'll give you a couple of examples. On men's underwear, one of our best-performing categories over the last couple of years, we're launching a new innovation ComfortBlend. It's a synthetic, cotton-blended product. It's actually a higher ring per garment so it's more profitable at a higher penny profit for our customers, as well as on our side. And we're supporting that with some real impactful marketing that'll show up in late Q2, Q3. We're getting space gains from accounts and we've already gotten it from a couple of them, in Target right now and Kohl's, and it'll be going market-wide here, late Q2. Our bra business, Bali bras, we have a simple sure sizing innovation that's having extreme success in the marketplace. And we've gained space for that, too. So a lot of successes driving our space gains.

Great. Thank you very much. Good luck.

Thank you.

Your next question comes from the line of Eric Tracy from Janney Capital Markets. Your line is open.

Hi, guys, good afternoon. Congrats on a nice quarter.

Thank you, Eric.

If I could ask, Rich or Bill, to follow up on the pricing discussion again, in terms of retailer strategies in the back half in particular. Clearly, it sounds like conversation today has been really, really positive and wanting to hold onto. How do we think about the potential risk if one of the bigger retailers decides to go a little bit more aggressive on pricing as their costs roll off, or is there enough structural cost to them that are going to be sustained, that they're going to want to hold on to the pricing?

Yes, there's two things. One is, again remember, we are adjusting prices down to reflect the lower cotton working through our P&L. That's already in place and that's in our guidance and that's in the conversations in the pack sizes and things like that, that we're bringing out summer and fall. I think the thing that we all have to remember is while we're all talking about cotton, you looked at what is going on with polyester's up 74%, wages over the last couple of years, anywhere from 20% to 90%, based on part of the world. Fuel's up 160%, so there's a lot of other things in play here, for us and for the entire industry.

I think it's important to put into perspective what the level of adjustment we're talking about, relative to the overall increase. Remember, some of our prices are up 25%, 30%. We initially priced for the high watermark of cotton which would've been in that 30% range. Clearly, even for today's low price of cotton, you're still talking about price increases versus 12 or 18 months ago that are 25% higher and that's the appropriate price. So these adjustments have been relatively minor in the scheme of things. We don't want to leave anybody with the impression that prices are coming down a lot. Also, as importantly, it was as all expected. If we kept prices where they were and cotton came down, our operating margins would probably be in the mid- to high-20s. Nobody ever expected that to be sustainable. But with the price adjustments that we've locked in, with the certainty that we have with the retailers that have indicated where they intend to price things, we're very comfortable with the visibility we have about getting our operating margins back to more normal historic levels, or even up into the low double digits that we're talking about for the back half of the year.

And then to follow on that, more sustainably on the out margin line, all the supply chain moves, offshoring the production to low cost, has certainly been masked by the first recession and then on the severe cotton spike. Sounds like some of the supply chain issue is actually starting to show through again. Maybe just remind us, walk us through how we should start to think about that again longer-term, now that you've ramped Nanjing and starting to be an underlying margin expansion driver.

I think the best way to think of this is that we've had a lot of issues with cotton inflation working its way through and Imagewear working its way through and it's all showing up in this first quarter where we've got a loss. As Rick said, our operating margin for the next three quarters inherent in our guidance is around that 11% level and we've talked about that's a reasonable operating margin level, that 10% to 11% to think about into 2013. That's supported by the pricing that we've got. That's supported by the supply chain actions that we've got and a whole host of things. So we believe that our run rate as you're going into the next portion of the year is much more indicative of our true earnings power, as we're now getting this inflationary bubble behind us. Longer-term, we've always talked about the supply chain continuing to deliver advantages, continue to go after our branded business, and remix our business up and then operating margins in that 12% to 14% over time are definitely still achievable. So in '13, we're talking about that rebound as we're not going to have the bad first quarter that we're having this year. Remember, '14, you've got huge interest expense savings that can drive earnings power. But you're going to continue to see operating margins expand over time.

Great. Thanks, guys. Best of luck.

Thanks.

Your next question comes from the line of Susan Anderson from Citi. Your line is open.

Hi, guys. Congrats on getting through a tough quarter.

Thank you, Susan.

If you look at some of the categories where it looks like sales are trending pretty good, I think you mentioned men's underwear, in the mid-single digits, women's panties double digits, how do you think about what's driving the sales there. Do you think there's restocking going on? Or are these trends that we can expect to continue throughout the year?

Yes. We suffered a lot of destocking in the fourth quarter. That has stopped but we have not seen retailers go back and try to bring back and restock that inventory. I think the retailers, by and large, are ordering to replenish what's going out the front door. We haven't seen, nor do we anticipate, a big restocking going on. What's driving our business has been space gains that we just started to set, that'll really showing up in Q2 and Q3 and some of our product innovations are working pretty well.

Okay, great. And then if I could just nail down a little bit on the women's side. If you could maybe give a little bit more color on intimates. It sounds like panties were obviously pretty strong. Is that mainly at mass, or also at the department stores? And then, the trends that you're seeing on that side of the business because I know it was a little bit weaker last year out of the department stores.

Let me just talk about Intimate Apparel. So we have our bra business, our panty business, and hosiery shapewear. Our panty business and hosiery shapewear business, we've been focused on over the last 12, 18 months. We're seeing good progress on those. Both of those categories grew for us in the first quarter. We're gaining shelf space going forward so we feel good about the direction we're headed on those. Bras is the big opportunity for us now. And frankly, our focus is take the same approach that we did on panties and hosiery and apply it to our bra business. I think there's two things going on with bras. One's macro and one's ourselves. On a macro basis, our core bra business, Bali and Playtex, appeal to the over 35, fuller-figure woman. She's buying bras less often. She's buying fewer bras when she does buy them and that started in a recession and that behavior has maintained through the first quarter. So we're just seeing less purchase frequency on our core business. Important to note though, our share in mid-tier and department stores on bras is fine. We're flat to up, in terms of market share there, so it's really a macro issue. I think where we've got to do a better job executing is on the mass channel. We haven't kept up with what our customers' expectations are. And we're working aggressively with all three of our major mass customers on developing action plans to help them use our brands to re-energize their categories.

Okay. Great, thanks, guys.

Thanks a lot, Susan.

Your next question comes from the line of David Glick from Buckingham Research. Your line is open.

Thank you. Good afternoon and congrats on the progress. A quick question. I was wondering if you could give us a better sense as to how you see the top line and operating margin progress from Q2 for Q4. I know you don't give quarterly guidance, but maybe a little more color on the relative progress you expect to make from quarter to quarter? Obviously, revenue's down Q1 and operating margin, obviously a tough quarter, given all the headwinds that you described. Mid- to high-singles is a fairly broad range in operating margin. I suspect that the revenue trend should improve, you mentioned, through May. So there's still a month where you have some shelf space gains at the end of Q2 maybe could drive a low single-digit increase in revenue. And then you're coming up against some of the Intimate Apparel destocking, for example, in Q3 and some other things that could turn your trend around. If you could walk us through how the year might unfold, help us understand how the earnings and margins are going to flow as the year goes on, that would be helpful.

David, this is Rich. I think you've actually itemized a number of the things on the revenue side. As you talk about that are actually the drivers that allow growth to happen, the space gains starting to overlap some of the destocking, and the price gaps that were widening last year, as we were driving prices up in the marketplace, usually three to four months, a little bit faster than the overall competition. So, we've been relatively, what we believe, conservative in our top-line planning saying that we're only going to see growth and we're starting to overlap the weakness that we saw last year. In terms of margin cadence and everything, Rick, do you want to talk about some of those things?

Sure. I think if anything, we're more confident of the directions that we've given in terms of where margins are going than we were before. We've seen as a result of the successes we've seen in the first quarter. You should see gross margins, as we've said, in the upper 20s in Q2 as we continue to see the impact of higher cotton cost on our margins wane a little bit. And then as we get into the back half of the year, more normalized margins in those low 30s. That's going to drive that growth of operating profit from the mid- to high-single digits to the low double digits in the back half.

So it's fair to say that you could see slightly positive revenue growth in Q2 and then as the year unfolds, progressively better top line and the same for the operating margin, obviously a single digit in Q2, but increasing as the year unfolds. Is that the best way to think about it?

Yes, I think one thing to remember when you look at our top line, even for in the first quarter, when you take out the effect of Imagewear which was $38 million down, and JMS, which we told you was going to be -- last quarter we told you it was going to be between $25 million and $30 million. That was down about $28 million, $29 million. You take those two out and the rest of the business is actually up 4%, or pretty darn close to it. Again, very encouraging in terms of giving us really good confidence going into the rest of this year.

Okay, great. Thank you very much and good luck.

Thanks, David.

Your next question comes from the line of Eric Alexander from Stifel Nicolaus.

Thank you. Hi, guys. Sitting in for Jim today. Good job on delivering the plan, or ahead of plan. Definitely good progress. Looking at, as far as international goes, you guys had noted the sluggish European Imagewear sales and it was going to be under review similar to the US review. Do you guys foresee a future charge to this that maybe isn't captured in guidance today or is that captured? If you could just help me with that, that'd be appreciated.

Yes, I'll just talk about the strategy and, Rick, I'll let you address the other part of the question. Overall the European Imagewear business comprises about 12% of the International segment. It's feeling the same kind of pressures as we're feeling in the US, same types of competitors. Fruit of the Loom, Gildan are both in Europe. A lot of the same types of cotton inflation working its way through International. It's almost like a mirror image of what is going on here. Obviously, we wanted to focus on the big piece of our business, the US Imagewear business, first. We're now undertaking a review exactly how to reposition that European business and as soon as we finalize those plans, we'll make sure that we share them with both the customer groups over there as well as the investment community. So we'll have more about that -- to say about that no later than the next quarter. Rick, on the other?

As we undergo those reviews that Rich has talked about, European Imagewear and other parts of the Imagewear business, there may be some charges that will be non-cash associated with some balance sheet items that have been on the balance sheet for a while. But again, I would emphasize it would be non-cash charges.

Okay, that's helpful. And then a couple questions on inventory. With inventory levels where they are, do you guys expect to see any distribution savings that you saw in the first quarter? Or were lapping more difficult comps, or easier comps, I guess, in the first quarter than we shouldn't expect to see the savings in air freight? And then also, do you still expect to be through your higher cost inventory by the end of second quarter?

Yes. Let me take a crack at that. We were very pleased with the progress in our distribution cost reductions in first quarter. That group is a very important part of the supply chain, that as Bill mentioned, is doing very, very well as this all gels and the footprint solidifies. We expect to continue to see that group perform very well. The second part of your question was --

With overall distribution, how it's going to anniversary to the rest of the year. And I think you just go back to the SG&A guidance, essentially flat or down.

Your next question comes from the line of Omar Saad from ISI Group. Your line is open.

Thanks. Good afternoon, guys.

Hi, Omar.

I wanted to ask a question about department stores. I know it's not as big of a channel for you guys as some of the mass channels. But there's some dislocation going on. JCPenney's going through a reorganization or restructuring. There's some moving pieces across that channel. How do you guys see that channel playing out for your business? How do you feel that you're positioned? Are basics really -- the basic categories that you guys specialize in, are they steady as she goes? Are any of those changes having impact on you?

I think we're real well positioned for the mid-tier department store because they seem to be more focused than ever on moderate priced brands and really the power of big brands. You mention JCPenney. Their strategy's got three components, right? Fewer, bigger national brands, fewer SKUs, edited assortment, and then this whole simplified pricing. The whole thing about fewer brands, bigger, more impactful brands that can drive traffic to their stores, that plays to our wheelhouse. That's what Hanes is. That's what Bali and Playtex is. I think that strategy works well for us and I think as others are looking and say, hey, there's dislocation and how could they possibly seize on it? They come back to brands are the key thing that they can leverage to drive traffic to their stores and let customers know they sell the best brands at a great value. I think it plays well for us.

Great. A quick follow-up on the international piece too. Some of the similar businesses in the imagewear side of it internationally, obviously under pressure there, and you're taking a look at that. What about the commercial businesses internationally? How have they been trending this quarter, in the last quarter, compared to what looks to be pretty robust growth for the last year or two? Which markets remain strong? Are you seeing any softness out there, ex the inventory piece. I'm talking up commercial business.

Let me first hit it. On the profit side, obviously, they're all facing the same kind of inflation and pricing issues that we're feeling in the US. That trend is exactly the same everywhere in the world, to be honest. From a top line perspective, which is, I think, where you're more focused, in the quarter we actually saw a little bit of softness across the board around throughout the Americas and Asia. But to tell you the truth, it looks more like it is temporary than something that is actually structural. For example, Brazil is actually relatively soft in the quarter but it's already snapping back and looks like it'll trend to be relatively strong in Q2. So I don't want to over-read into that and say that we're starting to see softness in all of those countries. It may be more just coincidental tactically in the quarter than it is something that's systemic and a trend.

Got you, Rich. Thank you. Appreciate it. Good luck, guys.

All right. Thanks.

Your next question comes from the line of Steve Marotta from CL King and Associates. Your line is open.

Good evening, everyone. You mentioned that inventory is expected to decline each quarter for the balance of the year. Can you give a little bit of guidance on where you expect inventories to end the year, either in a dollar range, roughly, or percentage decline on a year-over-year basis?

Yes, let me answer it this way, Steve. We've said that our guidance for the year on free cash flow was $400 million to $500 million, with about half of that coming from working capital improvements primarily in inventory. So you're going to see significant inventory improvement beginning in Q2 and continuing on through Q4.

Got you. My only follow-up question is, did the marginal strength in the first quarter that you guys experienced affect your promotional cadence at all in the coming quarter? In other words, have you pulled back at all on perhaps planned promotions because things have been so good and your inventory levels are a little bit less than expected?

No, we've locked those promotions in with our retail partners four to six months in advance. So we've been set for the key back-to-school timeframe for awhile.

Okay. All right, thank you very much.

Thanks.

Your next question comes from the line of Scott Krasik from BB&T Capital. Your line is open.

Hi, guys.

Hi, Scott. How are you doing?

Good, Rich, thanks. Just a couple clarifications. Did you say, Rick, that excluding both JMS and Imagewear sales were 4% or was it just ex imagewear?

I said that Imagewear and JMS, the combination of the two together were down a little over $60 million from prior year.

Okay. And just to get a sense of what the gross margins in your Outerwear business may have looked like, excluding the Imagewear hit particularly?

Well, Scott, we don't really talk about gross margins at the segment level. Operating profit margins are what we look at.

Okay. And just to confirm, as you restate numbers here, can we add together the Hosiery and the Innerwear numbers for historical quarters or will you be putting out some sort of a filing on that?

No, Scott. It's as simple as that. You hit the nail on the head. It's Innerwear and Hosiery, put them together, and you've got the new Innerwear.

All right. Thanks, guys. Good luck.

Thanks.

Your next question comes from the line of Andrew Burns from DA Davidson. Your line is open.

Good afternoon. I just wanted to confirm what I think I heard there. In terms of your view on retail inventory levels, it appears that they've normalized and going forward sell-in should closely follow sell-through across most categories and channels? Is that correct?

Yes, I think that's right. I think that's what we're anticipating.

Okay. And then a question, a nice start for Champion Outerwear for the year. You mentioned the C9 program. Is the strength that you're seeing there, is that just improving sell-through or has that program gained some floor space? Any color there would be helpful. Thanks.

Yes, I think if you look at the growth in C9 for the first part of the year, it's a lot of sell-through and a little bit of space and distribution. That business is doing exceptionally well, working hand-in-hand with the Target folks.

Great, thanks. One last one for you. Haven't heard about the graphic tee growth initiatives in a while. I was hoping you could update us on that, how that's tracking and what that opportunity looks like these days? Thank you.

Yes, graphics is a big part of our business. Now remember, we bought Gear For Sports so we've really built our capabilities on graphics over the last 15 to 18 months. And that synergy of combining the Gear For Sports organization and their capabilities along with our core capabilities here, in terms on the retail side, we're really starting to see some nice progress and some very good synergies across both businesses. We're pleased with the performance. We're probably more pleased with what we think we can do over the next 18 months or so on that business.

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

Good afternoon.

Hi, Eric.

You've talked before about inflation, and let's just look beyond the ups and downs of this year and last year. Going forward, what do you think -- how do you think inflation's going to play going beyond 2012?

Let me give you my overall thoughts on how it's likely to play out rather than, obviously, we can't predict it specifically. But clearly there's a lot of wage pressure in the developing world where the apparel supply chains, including ours, that's where they're located. There's not a lot of other low cost countries that have a billion people in them like China was. A lot of the move toward lower cost countries is now over and those cost of wages, fuel, polyester, all of those things are going to continually work their way through on a more consistent basis. You'll always have the fluctuations with cotton up and down but you're going to see those other things go up and they tend to be relatively sticky. I wasn't running these businesses or some of them back in the '90s and that was an environment where it was the same kind of thing. And prices and apparel tended to go up at about three-quarters of the rate of the overall consumer price index in the US. And so, what you might see is a 3% to 5%, maybe not every single year, but maybe every other year, where you'd see a couple of percent per year. And if I had to guess what apparel's going to look like, in terms of inflation over the next decade, it's probably going to be on the order of that. Retailers feel their own pressure with their own costs going up and now the apparel supply chain's going to have those same types of things. And that's more likely the environment we're going to be in that bodes well for companies that have brands because they've got more pricing power is than those that don't.

Great. We haven't talked about it in a while, with the marketing spend you guys have continued to be the lead marketer in terms of the Innerwear segment. I know you've talked before about taking that to 100 million plus market. Where is the marketing spend now and where do you want to see it go, going forward?

In terms of overall spend this year, we talked about it. We have, in fact, pulled back for two reasons. One is there was some spending that we were doing primarily in the bra category that really didn't have the payback that we really demand of marketing spend. So actually we're pulling that money back and deploying it elsewhere. Some of the other spend, we've also felt in this great margin constrained environment we did pull back on which we'll want to make sure that we restore next year. There, we're talking in the tens of millions of dollars. We're not talking about huge numbers, but don't get me wrong, we're still supporting everything we need to and in fact the underwear launch that Bill had talked about earlier is getting all the traditional support that we would have done in good years or in bad years. So we're feeling that we're spending the right amount, maybe a little bit less, given the margin constraints that we have but that will quickly snap back.

Your next question comes from the line of Emily Shanks from Barclays. Your line's open.

Hi, good afternoon. Thanks for taking the question. It really relates to the existing covenants in your bank facility and specifically the total leverage covenant. I just had a housekeeping item. I was curious, is the reported EBITDA in the press release the EBITDA that's used to calculate the maintenance covenant, and secondarily, what is your calculation of total leverage at this point?

We broke up a little bit there, Emily, but I think I got the gist of your question. First of all, we don't generally disclose the exact difference between the EBITDA and adjusted EBITDA for the leverage covenant. But it is substantially different. So it provides us with a pretty significant cushion in the leverage ratio, as defined in the credit agreements. Emily, I'm not at all worried about our covenants this quarter or next, and then certainly not beyond. I feel very comfortable with where we are. We're not going to have a problem.

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

Hi. One question on Imagewear. Your goal to get to 4%, did you say where that is today and how much of your Imagewear is US versus Europe?

Yes, when we talked about the Imagewear and the 4%, that was specifically the US Imagewear. Imagewear ended last year at around 8% of our overall business and we've talked about as we've remix it and pulled back. Over the long term, it'll probably get down to that 4% level. We're probably moving in that direction this year but we'll probably continue to unwind pieces of it through 2013. So it'll be of a more gradual change.

Your next question comes from the line of Todd Harkrider from UBS. Your line is open.

Todd?

Your next question comes from the line of Eric Tracy from Janney Capital Markets. Your line is open.

Hi, guys. Just a quick follow-up, Rick, for you. As we think about the gross margin in the back half, low 30s is what you suggest for each. But certainly fair to assume that cotton in terms of being locked in 3Q versus 4Q definitely should still be up to the tune of 20% to 30% in 3Q, correct? I just want to make sure I've got the cadence of 3Q, 4Q on a cotton cost basis is accurate.

Cotton costs in Q3 will be, if you look through the P&L, will be a little bit higher than they were in Q3 of last year. Is that what you're asking?

Yes. It's obviously been significantly lower in 4Q. I just want to make sure that I was thinking about that still.

Let me just say this, Eric. As we've said before, pretty much all the cotton flows through -- the cotton that we're carrying on the balance sheet at the end of the year flows through in the first half of the year. And after that, it's really not significant.

Okay. Thanks, guys.

There are no further questions at this time. I turn the call back over to the presenters.

We'd like to thank everyone for attending our quarterly call today and look forward to speaking with many of you soon.

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